FINANCIAL MARKETS:

(a) Financial markets are the markets where economic units with surplus funds such as individual
corporations, the government, or overseas investors lend funds to other economic units who want
to borrow. The economic units with surplus funds (savers) lend money to the economic units
short of funds (spenders). In short, these are structures through which funds flow. Economic
agents with surplus funds supply these funds to economic agents with deficit funds. These
markets can be differentiated by characteristics such as the type of securities traded and/or
maturity of these securities. (See Fig. 1 below):

Fig. 1: Graphic presentation of the financial markets.

DIRECT ROUTE

Surplus Financial Deficit

Agents Funds Markets Funds Agents

As could be seen from the figure above Financial Markets provides the means which funds are
transmitted from the surplus to the deficit economic agents.

Surplus agents, i.e. those consuming less than their disposable income consists of (a) Individuals (b)
Firms, (c) Governments (d) Non-governmental organizations (f) Religious organizations (g) Societies and
(h) Other associations with surplus funds due to their expenditure being less than their income.
The different motives for saving surplus funds are:

(i). to meet unforeseen contingencies;

(ii). to finance future investment;
(iii). to finance future purchases;
(iv). to invest in order to obtain a higher return;
(v). to save for retirement;
(vi). to save for school fees, wedding or to meet a deposit for house purchase and so forth.

Deficit Agents - Individuals, firms and government agencies that have a wide variety of motives
for borrowing funds. Firms raise funds to finance investments. On the other hand individuals
borrow to finance expenditure above current income, particularly major purchases such as a car
or house.

Clearly there is potential for surplus funds to be transferred to deficit agents, and this is done and
through a variety of financial securities.

As we shall see, financial intermediaries play a very important economic role in facilitating the
transfer of funds between deficit and surplus economic, and to large extent because they are able
to reconcile the often conflicting needs of the two types of agents.

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Where Financial Intermediaries are engaged together with Financial Markets, then we have what
we refer to as the FINANCIAL SYSTEM. (See Diagram Below):

Indirect Route FINANACIAL

INTERMEDIARY
Funds Funds Funds

SURPLUS FUNDS FUNDS

AGENTS DEFICIT AGENTS
FINANCIAL MARKETS

Direct Route
Fig: The Financial System

Financial markets can be categorized in a variety of ways including:

(1) Primary Markets

A Primary Market is a Financial Market in which new issues of a security are sold by the issuer to
initial buyers. These are financial markets in which users raise funds through new issues of
financial instruments. Issues are mainly arranged through investment/merchant banks through
underwriting

(2) Secondary Markets

Secondary Markets: -these are financial markets where initially issued securities are bought and
resold. The original issuer is not involved in these transactions. In this type of market securities
that have already been issued can be bought and sold. There are a number of benefits that flow to
both issuers and investors from using security markets.
A Secondary Market is a market in which the trading of shares on the Secondary market takes
place on the Stock Exchange. An exchange is a place where securities are bought and sold e.g.
The London Stock Exchange and Lusaka Stock Exchange.
The Stock Market
- Is a series of exchanges where successful corporations go to raise large amounts of cash to
expand.  Stocks are shares of ownership of a public corporation that are sold to investors through
broker dealers. The investors profit when the companies increase their earnings. This keeps the
U.S. economy growing. It's easy to buy stocks, but it takes a lot of knowledge to buy stocks in the
right company. The Stock Market is a series of exchanges where successful corporations go to
raise large amounts of cash to expand. Stocks are shares of ownership of a public corporation that
are sold to investors through broker dealers. The investors profit when the companies increase
their earnings. This keeps the U.S. economy growing. It's easy to buy stocks, but it takes a lot of
knowledge to buy stocks in the right company.

(3) Over the Counter Markets

Alternatively, secondary markets can operate as Over-The-Counter (OTC) markets, where buyers
and sellers transact with each other not through the Stock Exchange but through individual
negotiation.

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 (4) Money and Capital Markets
Capital markets are markets for long -term borrowing and lending. Money markets are markets
for short term borrowing and lending.

Benefits to issuers:
- Information about the current market value of instruments and thus the value of the corporation.
- Help in evaluation of use of funds raised.
- An indication of issue prices for subsequent issues.
- Secondary markets make it desirable and easier for the issuer to initially sell securities in the
primary market.
-
THE FUNCTIONS OF FINANCIAL MARKETS:
Financial Markets serve six basic functions. These Functions are briefly listed below:
(i) Borrowing and Lending: Financial Markets permit the transfer of funds (Purchasing power)
from one agent to another for either investment or consumption purposes.
(ii) Price Determination: Financial Markets provide vehicles by which prices are set both for
newly issued financial assets and for the existing stock financial assets.
(iii) Information Aggregation and Co-ordination: Financial markets act as collectors and
aggregators of information about financial asset values and the flow of funds from lenders to
borrowers.
In addition, throughout his text Mishkin (Financial Markets and Institutions) consistently
stresses the importance of information. He argues that it is impossible to understand the
special nature of financial markets relative to markets for real goods and services unless one
understands the peculiar types of "asymmetric information problems" intrinsically associated
with financial assets. He argues that these asymmetric information problems have largely
shaped the structure of financial markets in the past, and that the recent surge of innovations
in information technology (IT) -- in particular, Internet-related IT -- is leading to a dramatic
restructuring of financial markets today.
(iv) Risk Sharing: Financial Markets allow a transfer of risk from those who undertake
investments to those who provide funds for those investments.
(v) Liquidity: Financial Markets provide the holders of financial assets with a chance to resell or
liquidate these assets.
(vi) Efficiency: Financial markets reduce transaction costs and information costs.
Benefits to investors:
- Provides ability to turn the investment into cash.
- Liquidity and diversification
- Information about prices and value of investments.
- Investors trade at low transaction costs in organized markets in general.
CONTRIBUTION TO ECONOMIC DEVELOPMENT

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The channeling of funds from savers to spenders is a crucial function for the economy because the people
who save are frequently not the same people who have profitable investment opportunities available to
them i.e. the entrepreneurs. Without financial markets it is hard to transfer funds from a person with
surplus funds and no investment opportunities to one who has investment opportunities but no funds.
They would be unable to transact and both would be worse off as a result financial markets are thus
essential to promoting economic efficiency.

TYPES OF FINANCIAL MARKETS:

1. Money Markets
2. Capital Markets
3. Foreign Exchange markets
4. Stock Markets
5. Bond markets
6. Derivative Markets
Money markets: these are financial markets that trade debt securities or instruments with maturities of
less than one year. Short term excess suppliers of funds supply these to those with short term needs or
shortages of funds. Trading is normally not done in specific locations but mainly over –the- counter (via
telephone lines, wire transfers and computers).
Capital markets: these are financial markets that trade debt instruments with a maturity of more than one
year. Such debt instruments experience wider price fluctuations in secondary markets than money market
instruments because of r longer maturities. The relative size of capital markets depends on two factors:
the number of securities issued and their market prices.
Foreign Exchange markets: these are financial markets where foreign currencies are traded. Cash flows
from sales of securities denominated in foreign currencies expose corporations and investors to risk
regarding the value at which these currencies can be converted into local currency. Currency rates
fluctuate posing risk. There are a number of techniques that can be employed to manage this risk such as
swaps, futures and forward contracts. Governments may intervene directly into foreign exchange markets
or indirectly through interest rates. There are two types of transactions undertaken in foreign exchange
markets:
Spot transactions: involve immediate exchange of currencies at current exchange rates mainly over-the-
counter.
Forward transactions: involve exchange of currencies at a specified date in the future and at a specified
rate.
Stock markets: Is a market where common stock is traded, which represents ownership in a company.
The management of a company acts as an agent for shareholders to protect their interest

Bond markets: Bond markets are markets in which bonds are issued and traded. They are used to transfer
funds from individuals, corporations and government units with excess funds to corporations and
government nits in need of long term debt funding.
Bonds are long term debt obligations issued by corporations and government units to raise funds to
support long term operations and capital expenditure of the issuer. The bond issuers promise to pay a

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specified amount in the future on the maturity of the bond (the face value plus coupon interest). If the
terms of repayment are not met by the issuer bondholders have a claim on the assets of the issuer.
Derivative Markets: are markets in which derivative securities trade. This is the newest of financial
markets and initially developed as a response to the floating rate mechanism of exchange rates in the 1971
and 1973 Smithsonian Agreements and interest rate volatility in the same period.
Derivative security: an agreement between two parties to exchange a standard quantity of an asset at a
predetermined price at a specified date in the future. It is a financial security whose pay-off is linked to
another previously issued security. As the value of the underlying asset changes, the value of the
derivative security changes. For example, a securitized mortgage-backed security’s value is based on the
value of a mortgage.
REGULATION OF FINANCIAL MARKETS
Financial market regulation is aimed at ensuring full and fair disclosure of information on securities
issues to actual and potential investors. Regulatory agencies such as the Securities and Exchange
Commission (SEC) ensure investors have full and accurate information is available about corporate issues
for investment decision-making where securities are sold publicly. Private placements where securities
are sold to a few large investors are not subject to SEC regulation.
Sources of Regulatory influence in Zambia are:
(i) Banking and Financial Services Act (BFSA)
(ii) Building Societies Act (BSA)
(iii) Pension and Insurance Act
(iv) Securities and Exchange Act
(v) Companies Act.
Regulatory Authorities in the Zambian Financial System
 Bank of Zambia – Banks and other financial services providers
 Pension and Insurance Authority – Insurance brokers and Pension Funds etc.
 Securities and Exchange Commission – Stock Exchange, Mutual, Investment Banks
(brokers/dealers)