Free «Financial Markets» Essay Paper
Financial markets are the basis for the economic development and growth. They provide the market agents with an opportunity to get funding for the investments. Financial market is a direct marketplace, where financial resources are distributed among its participants. The economic agents have the ability to get the financial recourses from financial markets in capitalist economies, while in socialistic economies the financial flows are directed with a help of government (Levinson, 2009). Therefore, every capitalist economy requires a financial market with its complicated structure as a source for financial resource distribution and driver of its economic development.
The main agents operating on financial markets are government, population, financial institutions, infrastructure participants, foreign participants, and non-financial organizations. Financial markets have several classifications. According to one of them, financial markets consist of money market and capital market (Levinson, 2009). Money markets are the markets where short-term operations are committed. Short-term securities include short-term treasury bills, commercial papers, and federal funds. Money markets are necessary for the corporations to support their need in working capital. The main financial organizations are banks that attract money to loan them to the other market participants. Short-term securities have high liquidity and lower prices changes than capital markets. For this reason, investments in money market are less risky than in the capital markets (Levinson, 2009). Money markets have several financial instruments. First, there are short-term unsecured loans, represented by an interest rate charged by banks to the best quality company. Second instrument includes short-term loans to the financial institution charged by Federal Reserves, also known as a discount rate. Third type of instruments is overnight loans which are borrowed from one bank to another, such as federal funds. Fourth financial instrument is represented by short-term unsecured notes issued by treasury department, such as a treasury bill. Finally, there are short-term unsecured notes issued by major corporation, known as commercial papers (Levinson, 2009). Therefore, money markets provide the liquidity of the enterprises, population, financial, and non-financial institutions.
The capital market is the market that supports long-term capital investments. The operations of long-term financial instruments buying and selling are committed in the capital market. The terms or these financial instruments are more than one year. These financial securities have less liquidity; they are riskier and more profitable. There are middle-term and long-term credits and middle-term and long-term securities and shares. Corporations in the capital market form their financial recourses for the expense bond and stock emissions and bank’s loans. Financial institutions form their financial recourses to exploit them during the time of circulation (Levinson, 2009). Therefore, the conditions for the capital markets existence are low inflation and economic and political stability.
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Capital markets have such instruments as bonds and stocks. Bonds could be treasury bonds, which are issued by treasury with a maturity of more than 10 years, municipal bonds issued by municipals, and corporate bonds issued by corporations. The stocks could be either preferred stocks, which provide steady income and limited voting right, or common stocks that provide an income that depends on profits and full voting right (Freixas, Hartmann, & Mayer, 2012). Therefore, the capital market is a market that provides long-term investments.
If a corporation does not want to be dependent on some bank or one loan organization, or the sum or long-term credit is so big that a bank cannot provide such a sum of money, it could issue corporate bonds. Bonds could have coupons and could be with zero coupons. Coupons are the interest that a corporation pays for the money, which can be paid yearly, semi-annual, and quarterly. Zero coupon bonds are the bonds that do not provide coupons; they are sold at a huge discount from face value. In order to pay bonds, corporations have to create reserves each year to pay off principal on the maturity date. For this reason, some corporations issue amortized bonds (Levinson, 2009). This type of bonds is issued when the amount of the issue is huge, which means that at the date of maturity a corporation will have to pay back a huge amount of money. In order to avoid this problem, a corporation issues amortized bonds, which will be repaid earlier to reduce the sum of the nominal at the end of the maturity date.
In case a corporation does not know the future market situation, it can issue a callable bond. This type of bonds if a corporation expects that the market interest will decrease. Some corporation in their attempt to attract a long-term capital can issue convertible bonds. Convertible bonds are the instruments that provide their owner a right to convert the bonds into shares (Levinson, 2009). Nevertheless, some corporations could issue warrants. Warrants are securities that provide the right, but not the obligation, to buy or sell a security earlier than the date of maturity.
In case a corporation intends to receive a long-term capital, it can issue shares. The emission could be on the stock market. Some corporations could decide to commit a stock split in case a stock price is very high (Levinson, 2009). It is made for the purpose to increase the liquidity of the shares. For example, Warren Buffet’s stock price is more than 1000 dollars per share that decreases the liquidity of its stocks. Nevertheless, stock splits create stock dilution and voting power per share dilution. In case the owners of the corporation want to exclude minority owners, they can organize a stock reverse dilution. Therefore, shares and bonds are the instruments of the capital markets that help corporations to get the investments and develop their business.
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All these securities are dependent on the ratings provided by the accredited rating agencies. There are three worldwide famous rating agencies, such as S&P, Moody’s, and Fitch (Levinson, 2009). They have different rating systems and methods. Besides S&P, Moody’s, and Fitch, each country could have its national accredited rating agencies. S&P, Moody’s, and Fitch rate not only securities, but also countries and cities. Therefore, all the participants of financial market have its role and fulfill their functions.
Additionally, financial markets can be divided into the primary market and secondary market, depending on whether it is a new emission or an old one (Levinson, 2009). The primary market is a market for new issues of securities. The market can be divided into private placement, which includes private investors, bondholders, and stockholders, and public offering, which is represented by investment banks or underwriters. The emissions can be of two types: initial public offering (IPO) and seasoned offering, such as an offering of the public company which shares are already traded on the secondary market.
The secondary market is a market for transfer of existing shares, which is also divided into the organized stock exchange, such as NYSE, AMEX, Pacific, Chicago, Boston, Philadelphia, and Cincinnati, and the counter, represented by national association of security dealer automatic quotation (NASDAQ). Organized stock exchanges have the physical trading floor, specialists, and auctions. The counter has no physical trading floor, dealers, and negotiations. The secondary market supports liquidity, determines stock and bond prices, and provides securitization operations (Levinson, 2009).
Securitization is the process when illiquid assets are transformed into liquid securities (Jobst, 2008). In the process of securitization, the standard debts are transformed into a pool of debts. After this, the special purpose vehicle (SPV) issues debt securities (asset-backed) to investors. Rating agencies rate the securities, and bank receive the necessary liquidity to invest the capital in further projects. In this case, banks become not loan institutions but intermediate agents that collect credit agreements and unite them in pools of agreements.
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Moreover, financial market is divided into securities market; foreign exchange market, such as Forex interbank market where banks trade currencies and derivatives based on these currencies; market of financial services, which include auditors, consulting firms, and traders; gold and treasury metals market where gold, platinum, silver, and precious stones are traded; property market; and derivatives market.
Thus, financial market is a basis for the capital economy existence. It should have levels and be well organized and legislatively coordinated. The financial market regulation is one of the key aspects of the success of a financial market. The legal guarantee of investors’ rights gives an opportunity for the market to develop. Therefore, the developed financial markets provide a strong stimulus for the economies to grow.