OFPPT

Office de la Formation Professionnelle et de

la Promotion du Travail

BUSINESS ENGLISH
READING COMPREHENSION AND PRECIS

MODULE: ANGLAIS TECHNIQUE

FILLIERE: GEOCF

Prepared by: M. ELARROUJI

HOW TO USE THIS DOCUMENT
The texts are set to be read before class time. Trainees will read the texts, explain
difficult words, and extract the key information. A chart representing the essential ideas
in the text is preferable.
TEXT 1:
Introduction to Financial Markets and Institutions
There are certain types of financial markets and financial institutions that are found in almost every country
in the world. For instance, most countries where economic activities take place have an established stock
exchange and a banking system. Each of these institutions is different and hence perform different
functions. However, together, these financial markets and institutions make up a financial system. Financial
systems all over the world are similar to some extent since all of them tend to have some common features.
However, financial systems also tend to have unique features based on political, economic, and even
cultural factors.

In this article, we will have a basic look at the fundamental features of the financial system.

What is a Financial System?

A financial system is a complex, interrelated arrangement of financial institutions and markets. In order to
understand the system as a whole, we first need to understand its component parts. The financial systems
across the world are generally known to have three components. These components are as follows:

 Private financial institutions (banks, insurance companies, mutual funds, etc.)

 Government regulatory agencies which overlook these institutions
 The Central bank which decides the monetary policy and thereby impacts all institutions in the
financial market

How the Financial System Works?

A wide variety of motives are at play in the financial system of any country. The three types of institutions
mentioned above have very different incentives.

 For instance, private financial institutions are driven purely by financial motives. Private Banks,
insurance companies, and mutual funds collect money from people who have surplus money to
invest. At the same time, they lend this money to industrialists who need money upfront in order to
make investments. The profit motive makes banks and other financial institutions compete with
each other in order to find a mechanism in which savings can be transferred to investors with the
minimum transaction costs.
 The financial system is the best example of Adam Smith’s invisible hand at work. In the pursuit of
their individual profits, these financial institutions lead the entire economy towards growth and
development. This transfer of funds from the idle to the industrious forms the backbone of any
economy. Empirical data clearly indicates that countries with more advanced financial systems
record better economic growth. Therefore, having a well-developed financial system is an indicator
of a developed economy.
 The regulatory agencies have a very different function as compared to private bodies. Their task is
to ensure that private companies compete with each other in a fair and equitable manner. For
instance, the regulatory body monitoring the stock market needs to ensure that it prevents insider
trading. It is the job of the regulatory body to ensure that the information related to the company
must become available to everyone at the same time. This ensures that no party has an information
advantage over the other. If the regulatory agency fails to do so, the stock market will cease to
function. For some time, a handful of people will make money at the expense of everybody else.
Over a period of time, investors will simply lose faith in the market and stop investing.

The job of regulatory agencies is to ensure fair play in the markets. Almost every major financial
institution viz. banks, insurance companies, mutual funds, etc. require their own regulatory agency.
However, it needs to be understood that excessive regulation is not always good. Excessive
 regulation means that a lot of rules have to be followed. As a result, compliance costs increase for
companies. This makes them less competitive in the international market. Also, excessive
regulation limits the flexibility of investors to run their company in the manner they want.
Therefore, the amount of regulation has to be just right. It should only prevent unfair trades from
happening. Once again, the empirical data is quite clear on the fact that any country which has
been able to set up an effective regulatory mechanism has reaped dividends in the form of rapid
economic growth.

 Lastly, a special mention needs to be given to central banks. This is because, on the one hand, they
perform the regulatory function, but on the other hand, they also decide the money supply of any
country. This money supply is one of the factors which leads to economic cycles. Also, economic
cycles like recession, depression, and boom phase affect the entire financial industry and even
other industries. It is for this reason that the central bank is considered to be the most powerful
monetary authority in any country. There is considerable debate about how this institution should
be structured. Some countries prefer to keep this institution in private hands whereas there are
other nations who have nationalized it. We have covered the structural design of the central bank
in a separate article.

Therefore, it can be said that a financial system is formed with many different types of parties. These
different types of parties have different needs. These different needs, as well as the contribution of the
different parties to the overall financial system, have been summarized above.

TEXT 2:
The Functions of a Financial System
Financial resources are scattered across the economy. This is the reason that there is a need for a financial
system that can enable the timely deployment of these resources across different parts of the economy at
the right time. A well-functioning financial system is supposed to perform several functions. Some of these
functions have been mentioned in this article.

Function #1: Facilitating Payments

The transfer of goods and services can take place smoothly only if there is a mechanism in place to ensure
that the payments reach in time. This function is carried out by the payments system. The payment system
can be viewed as a subset of the financial system. It is composed of several institutions, such as banks,
depository institutions, and private companies.

These institutions pool in their services to provide convenience to users. As a result, users can use different
mechanisms like a check, credit cards, and even wire transfers to pay for goods and services. The slow
movement of money had been an impediment to trade and commerce for many years. However, now, with
the advancement in technology, money can be transferred instantaneously to almost any part of the world.

From the consumer’s point of view, these services appear to be seamless. However, the reality is that for
every swipe or check that is issued, a complex settlement process needs to be undertaken. This is why there
are special institutions called clearing houses that undertake this process.

Function #2: Transfer of Resources

The cash flow which individuals and companies have sometimes may not match with the cash flow that
they desire. For instance, a retired person may have a lump sum of money. However, they may be more
interested in a periodic sum of money. On the other hand, a company may want a significant sum of money
upfront so that they can invest it in a project. In return, they may be willing to make a series of payments.
Both of these tasks are accomplished through the financial system. The financial system allows investors to
transform their resources and access it during a point of time that is convenient for them.

Function #3: Risk Management

The derivatives market and the insurance market are an important part of the financial system. These
markets have been created with the sole purpose of rationalizing the risk, which is an inevitable part of the
life of individuals as well as businesses.

Using the financial system, individuals are able to pool in their resources and cover themselves in case any
unforeseen event happens in their lives. In many countries, the government has created a social welfare
system. This can also be seen as a system of insurance, which is a part of the larger financial system.

Function #4: Managing Information

The financial system provides important information, which is important for the well-being of the economy
as a whole. One of the most important information provided by the markets is about prices. The price
information is the basis on which all of the economic theory has been developed. It is the basis on which all
economic decisions are made.

For instance, the law of demand as well as supply, both have a price as an important parameter. Hence,
traders and other individuals use this information in order to decide the amount they will produce or buy.
This means that the economy as a whole also rations its resources based on the price information. This
mechanism is extremely important for the economy since it is this mechanism that enables maximum
utilization of underlying resources and, therefore, maximum economic growth.

Other prices like interest rates, foreign exchange rates, and even stock prices are important indicators.
Individuals can cater to their investment plan based on the information received from the financial system.

Function #5: Efficient Middleman

The financial system plays the role of an efficient middleman. This is because the financial system allows
the savings to be diverted towards productive activities with the least amount of transaction costs. The
financial system consists of various systems that have been created, keeping in mind the needs of the
specific markets. For instance, banks and debt holders based system has been created to fund infrastructure
projects which continue over the long term. At the same time, equity-based securities have been created for
investors who want to participate directly in the business by taking the associated risks.

Function #6: Pooling of Resources

The financial system makes it possible for a group of investors to achieve what they could not have done
individually. For instance, individual investors are limited by their knowledge when they start investing in
stocks. However, when a group of investors gets together, the pool of funds becomes so large that they can
afford to hire a team of specialists. This enables them to compete with the bigger funds on an equal footing.
The ability to pool resources and deploy them safely is the hallmark of any financial system. All major
financial systems and services like banking, insurance, and even mutual funds are the result of the proper
discharge of this function.

Therefore, it would be appropriate to say that financial systems perform a lot of functions that can be
considered fundamental. If these functions are not discharged, the markets, as we know today would not
exist.

TEXT 3:
Financial Systems and Economic Development
Financial institutions and markets are together called the financial system. This financial system is the
backbone of the national economy. This is because the efficiency with which the financial system works
plays a very important role in the economic development of a nation. The role of the financial system may
not be apparent since we assume its existence to be a given. However, when we do start paying attention to
the financial system, it is easy to see why it plays a foundational role in the economic development of a
country.
This article lists down certain examples that explain how financial systems play an important role in the
economic development of a nation.

Interest Rates Stabilization: The financial system ensures that all the organizations and institutions which
it is composed of, behave as one unified system. Generally, healthy competition is promoted between the
members of the system. This means that members have to compete with each other by lowering their costs.
As a result, the benefits of lower interest rates are passed on to the consumers. It is the existence of the
financial system, which ensures that interest rates remain stable across the country. The banking system led
by a central bank makes this possible. In the absence of a financial system, each region would have its own
interest rate based on the availability of capital. However, with the financial system in place, interest rates
remain the same across the entire country. As a result, businessmen and entrepreneurs throughout the
country are on an equal footing.

Aids Trade and Commerce: Credit risk has always been the main factor that inhibits trade and commerce.
If a seller is not sure about whether they will get paid for the goods which they sold, then they will not sell
more goods till the earlier payment has been received. This reduces inventory turnaround and leads to a
decline in trade and commerce. Financial systems ensure quick and timely payment. With the advent of
advanced technology, it is now possible to remit money to any part of the world within a few seconds.
Hence, financial markets and institutions aid in trade and commerce and even improve the gross domestic
product of a country.

Aids International Trade: The risks inherent in trade and commerce get multiplied several times when it
comes to international trade. This is because firstly, the seller and buyer, are in different legal jurisdictions.
Hence, the enforceability of contracts is reduced. Secondly, the quantity of goods involved in import and
export transactions is extremely large. Hence, the outstanding amounts also become large, and this ends up
increasing the overall risk in the transaction.

Financial systems play a very important role in the international trade process. This is because importers
and exporters generally use banks as an intermediary in the process. The importer deposits money with the
bank in the form of a letter of credit. This letter of credit is then paid to the exporter by the bank when
goods are received. As a result, neither party has to rely on each other. Instead, both of them can rely on the
bank, which has a higher credit rating and therefore aids in the reduction of risk. Similarly, countries have
created special boards for export credit and promotion. These boards provide important services like
insurance and payment guarantees in international trade. It would be fair to say that in the absence of
financial markets and systems, international trade would be negatively impacted.

Aids in Attracting Capital: Stable financial markets raise investor confidence. As a result, investors from
domestic as well as international markets start investing in the capital markets. As a result, more capital
becomes available to domestic companies. They can then use this capital to increase economies of scale,
which makes them more competitive in the international market. If these financial institutions and markets
were not present, foreign investors would find it very difficult to locate investment opportunities and follow
through with them.

Aids Infrastructure Development: Financial markets play a vital role in infrastructure development, as
well. This is because the private sector may face great difficulties in raising large amounts of funds for
projects with a high gestation period. It is the financial markets that provide the liquidity required by
investors. Investors can sell their securities and cash out whenever they want. It is not important for the
same investor to hold on to the security for the entire tenure of the loan. Key sectors like power generation,
oil, and gas, transport, telecommunication, and railways receive a lot of funding at concessional rates
thanks to the financial markets.

Financial markets also allow governments to raise large sums of money. This enables them to continue
deficit spending. In the absence of financial markets, governments would not be able to continue deficit
spending, which is important to fund infrastructure projects in the short run.

Help in Employment Creation: The financial system provides capital to entrepreneurs who want to start a
business. When these businesses come into existence, they, directly and indirectly, require the services of a
wide variety of personnel. As a result, a lot of employment is generated in the economy. The financial
services sector provides a lot of employment. Many of these jobs are high paying white-collar positions that
are capable of bringing the employed person into the middle class.

To sum it up, financial systems are like the foundation of a building. This is because the financial system is
fundamental, and the economy cannot stand without it. However, until everything is working fine, no-one
notices the financial system just like the foundation.

TEXT 4:
The Role of Government in Financial Systems
In the previous articles, we have already established that the financial system of any country is the key to
its economic prosperity. It is for this reason that these financial systems need to be appropriately
maintained. The government is the party that is most suited to this maintenance of financial systems.
However, too much government intervention is not desirable since it interferes with the laissez-faire policy,
which is important for financial markets.

Therefore, the government has a challenging role. It is supposed to ensure the proper functioning of the
financial systems. However, it is supposed to do so without direct intervention. In this article, we have
enumerated some of the steps which governments take in order to indirectly influence the financial system
and create a positive environment of growth in the economy.

Interest Rates and Loanable Funds: The central bank, which is a quasi-government body, decides the
level of interest rates in an economy. The interest rate is a very important number for the economy. This is
because the interest rate decides the time preference of people. If the interest rate is high enough, people
will postpone their consumption for a future date. However, if the interest rate is low, people will consume
immediately, and the savings rate will reduce. Hence, interest rates have a direct impact on the amount of
loanable funds in the economy. These loanable funds, on the other hand, have a direct impact on capital
formation and the entire economic process.

Reserve Requirements: Apart from interest rates, the central bank of any country can also alter the supply
of loanable funds by altering the reserve requirements. The modern banking system is based on the concept
of fractional reserve banking. This means that modern banks need to keep a fraction of their reserve with
the central bank before they lend out the rest of the money. Hence, if the proportion of funds which they
need to keep with the central bank increases, the amount of loanable funds decreases correspondingly, the
government can increase or decrease the reserve requirement in order to regulate the money supply.

Minting of Money: The government is the only agency which is authorized to create money supply in a
country. Therefore, it is the responsibility of the government to ensure that excess money is not printed and
flooded in the market. Financial systems tend to fail if there is excessive inflation in the economy.
Countries like Zimbabwe provide good examples to study this fact.

Fiscal Policy: The government can also regulate the functioning of the financial system with its fiscal
policy. Normally, countries where governments spend most of the money, do not have well developed
financial systems. This is because there is already infrastructure in place to sell government-backed
securities. However, if capital does not flow into private hands via the equity market and bank loans, other
channels of financing remain underdeveloped. Also, if the government starts undertaking the bulk of viable
projects, then the financing channels for the private sector do not grow as fast as they should. The
government must ensure that a balance is struck between the public sector and private sector funding.

Transaction Costs and Taxes: Governments can severely impact the functioning of credit markets if they
start levying excessively high transaction costs. A transaction cost creates friction in the financial market.
They deter investors from trading more often. Hence, it is the job of the government not to treat financial
markets as a source of revenue. The taxes and charges imposed on the financial markets should be minimal
as a turnaround in the financial markets means that there is more liquidity in the financial system. Liquidity
is a desirable quality since it promotes investments and increases economic growth as well as prosperity.

Deposit Insurance: The government also has the responsibility to stabilize the banking system. Usually,
this is done by providing deposit insurance. Governments all over the world guarantee the safety of
depositor funds up to a certain amount. This is a very important function since, without this function, the
funds which are deposited with banks would reduce drastically. As a result, the flow of funds from the idle
to the industrious would be impacted.

Regulatory Role: Last but not least, it is the job of the government to ensure that each type of financial
institution has its own regulator. This regulator must prevent malpractices. Malpractices can be practices
that jeopardize the safety of investor funds. Alternatively, they can be practices that suppress competition in
the sector. Fortunately, frameworks that define the role of regulators are already well developed in most
nations. The present task of governments is just to keep pace with the technology, which in itself is quite
challenging.

It would be fair to say that the government is directly in charge of the growth of the financial system. The
above-mentioned steps are just an indication of how much depends upon the actions of the government.
This is also the reason why sometimes a change in government has an immediate and negative effect on the
functioning of the entire financial system.

TEXT 5:
Comparing Different Financial Systems
Economists all over the world are of the opinion that markets are the best system for allocating scarce
resources. However, they do not seem to agree so much on what the nature of those markets should be?
Countries like the United States, Japan, and France, etc. all do follow the market structure. However, there
are glaring differences in the type of markets present in each of these countries.

In this article, we will have a closer look at the different types of financial systems as well as the
comparison between them.

Why Do Different Financial Systems Exist?

Different financial systems exist because of the unique financial needs of different countries.

 For instance, in some countries, stock markets have a high degree of importance. However, in
some other countries, there is more reliance on the market for government debt.
 Similarly, in some countries, the majority of the finance which the corporations use is raised by the
banking sector. Therefore, the regulation of the banking system becomes more important in such
countries
 Lastly, some countries rely on capital, which has been generated internally by savings. On the
other hand, there are countries which rely on capital which has been invested by a foreign country.
If a country relies on the latter, then the regulations relating to foreign investment become quite
important.

Comparison between Different Financial Systems

The difference between financial systems can be best understood with the help of an example.

For instance, the United States and Germany are both developed countries. Ideally, their financial
system should be quite similar, given that the needs of their economy are also quite similar. However, this
is not reality. In fact, the financial systems in these countries are so different that they can be called polar
opposites of one another.

The United States’ financial system is completely dependent upon the financial markets. The United
States has some of the best securities markets in the world. When it comes to trading in stocks, bonds, and
even derivatives, the American markets provide the most depth to investors. This is the reason why most of
the capital raised in America is channelized through the stock markets.

Proponents of the stock market believe that it helps improve the efficiency in the American markets. This is
because once a company is listed on the stock market, it becomes vulnerable to a hostile takeover.
If the current management is not managing the company efficiently, then there are specialized funds that
will buy out the company, replace the management, and make a quick buck in the process. These hostile
takeovers cannot happen if banks are the main source of funding for an organization.

The German stock markets aren’t central to its economy. Even though Germany is one of the most
developed countries in the world, its stock market is not considered to be important from an international
standpoint.

Instead, in the German financial system, most of the money is raised using bank loans! The German
government prefers the banking system to the stock market. The reasons behind this are unknown.
However, there is widespread speculation that banking credit is relatively easier to control, and hence, the
Germans prefer the banking sector. Also, since banking securities are not traded openly on exchanges, the
chances of an asset bubble are also less. As a result, Germans consider the banking system to be more
robust.

However, the problem is that the German banking system is very concentrated. The three top banks viz.
Deutsche Bank, Commerzbank, and Dresdner control more than three-quarters of the capital in the
economy. This leads to multiple problems.

Firstly, this means that if the government can control these three banks, it can basically control the flow of
capital in the entire economy. This is akin to centralized planning seen in communist countries and
different as compared to the market system followed worldwide.

Also, since the capital is concentrated, so is the risk. If these three banks face a credit crisis, then the entire
economy faces a credit crisis. This is what is happening in Germany as of now.

The German government made an unsuccessful attempt to merge Deutsche Bank and Commerzbank since
both banks are facing economic issues.

On the other hand, the United States is known for promoting competition amongst its banks. The
United States has many regional and national banks that have significant control over the market. In the
United States, it is very difficult, if not impossible, for a small group of banks to control the entire market.

The United Kingdom has adopted the middle path when it comes to financial markets. The United
Kingdom also has four major banks that control the entire banking sector viz. Barclays, Lloyds, NatWest,
and Midland.

The United Kingdom also has efficient stock and bond markets. There is an equal allocation of capital
between the banks and the securities markets.

The banking system in France is also more prominent as compared to its capital markets. Also, in
France, the major banks are either owned or directly controlled by the government.

The bottom line is that there are several types of financial systems possible. In general, all institutions are
present in almost every country. However, even though the type of institutions remains the same in each
market, the relative importance of these institutions changes.

TEXT 6:
The Flow of Funds in a Financial System
The economy of any nation can be viewed from the point of view of fund flow. This is a unique way to
view the economy, which until now has only been viewed as a sum of all the sectors in it.

In simple words, this means that the economy as a whole is a combination of several smaller units. These
smaller units are constantly transferring funds to one another. As a result, some units in the economy have a
surplus, whereas others are running a deficit.
The transfer of funds is basically a map that aids in developing a clearer picture of the economic
relationships which prevail in the economy. A better understanding of the economy can be obtained by
using fund flow as a tool for analysis. This can be done by following the steps given below:

1. Firstly, it is important to group together homogenous economic entities and form one sector.

For instance, the economy can be viewed as a combination of the household sector, the business
sector, the financial sector, the government sector, and the financial institution sector.

In some countries, the international sector may be listed down separately. This needs to be done
only if international investments are significant. Otherwise, they can be added to the government,
business, or financial sector depending upon who is conducting the transactions.

It is important not to create too many or too few sectors. The number of sectors created should be
enough to aid analysis, but no so much that it unnecessarily creates complications.

2. Secondly, the profit and loss account and balance sheet for each sector need to be drawn up.
This means that the flow of money through each of these sectors should be mapped using the
sources and application of funds principles which are used in accounting.

This may not be an easy task since the financial details related to private and household sectors are
not easily available. Details pertaining to the government and the financial sector are published,
whereas those related to other sectors are not.

3. The next step is to classify the sector as having a surplus or being deficient. In some cases, the
sectors will be balanced. This means that the amount of money flowing into the sector will be
exactly equal to the amount of money flowing out of the sector.

It needs to be understood that at the end of the exercise, the sum total of all surpluses and deficits
should be zero. This will always be the case unless there is a lot of money flowing into or out of
the entire economy. If that is the case, then, as mentioned above, the international sector should be
considered to be a separate sector within the economy.

The purpose of the exercise is to understand which sectors of the economy are funding, which other sectors
of the economy. Once the cash cows of the economy are identified, it is possible for the government
to create schemes that help that sector grow even further.

Using this fund flow exercise, it is possible to create an entire map of the various transactions happening in
the economy from a macro point of view.

This exercise enables the understanding of how financial systems play an important role in the economy.
This is because all the money which is routed from any surplus sector ends up being in the hands of a
deficient sector after using the financial system.

From the point of view of the government or the regulator, it is important to identify the paths between
surplus and deficient sector so that that the bridge connecting the two can be built as soon as possible.

Using Fund Flows to Understand The International Financial System

The fund flow approach, which can be used to understand the flow of funds within an economy, can also be
used to understand the flow of funds between different economies.

In the international economy, there are deficit countries that are in need of funds from other countries.
Also, there are surplus countries that have additional funds to lend out to other countries.
The international financial system also has to be set up in such a way that it becomes easier for the deficient
countries to receive funds from countries that have a surplus.

The bottom line is that fund flows within an economy provide important clues about how the financial
system operates in that country. It also provides important clues about the gaps that exist in the financial
system and provides a roadmap for the steps which need to be taken to fill that gap.

TEXT 7:
Primary Markets vs. Secondary Markets
The buying and selling of financial securities is a complex process that has evolved over many years. Each
security represents a claim on the financial resources of a firm. The claim could be an equity claim or a
debt-related claim.

When a retail investor looks at the stock market, they see only the market where they transact with other
investors. However, a lot of investors do not know where the securities come from? In this article, we will
explain the concept of primary markets and the issuance of new securities. We will also explain how each
stock and bond market is actually intrinsically made up of two markets viz. the primary market and the
secondary market. The similarities and differences between the markets have been explained in detail in the
article below.

How are Financial Securities Issued?

Retail investors are familiar with the process of trading financial securities. However, they do not know
much about how these securities come into existence. In order to explain how securities come into
existence, we need to explain what a primary market is.

A primary market is a market where transactions happen between the issuing corporations and investors.
Let’s understand this with the help of an example. If corporation A wants to raise money by selling stock,
they create new securities that represent a claim on their assets. These securities are then sold to retail or
institutional investors. The key point to be noted is that the money from the sale of securities goes to the
company issuing the securities. Therefore, markets, where securities are created and sold for the first time,
are called primary markets. Retail investors seldom participate in primary markets. Earlier, most of these
securities would be purchased by investment banks and financial institutions behind closed doors.
However, now these securities are sold to the larger group of people via initial public offers.

Once the investor has security, they need not hold it till maturity. In the case of equity stocks, there is no
maturity at all! Therefore, the market also allows one investor to sell a security to another investor. In this
case, the sale proceeds do not go to the company. Instead, they go to the investor that sold the security.
Most retail investors are familiar with the process of transacting in secondary markets. Investment banks
are not involved in the functioning of the secondary markets. Instead, brokers and dealers intermediate in
this kind of market. The difference between brokers and dealers has been explained in a subsequent article.

Functions of the Security Market

The primary market has only one important function. It helps the firm selling securities to raise cash.
However, it would be impossible to sell securities in the primary market if the secondary market did not
exist. Some of the features of the secondary market have been explained in this article.

 Liquidity: It is important to understand that people buy securities in the primary market since they
are sure that they will be able to sell these securities in the secondary market whenever they want.
The secondary market creates a system in which the original company does not have to refund
money if the investor wants to sell its security. Instead, a different investor can pay the money to
the first investor. This allows the first investor to completely walk out of the transaction, leaving
the new investor and the company as the parties to the investor. This allows the company to keep
the money indefinitely while at the same time, the investor has the liquidity, which allows them to
cash out on the transaction.
  Price Discovery: The secondary markets aid the proper functioning of the primary markets. This
is because they allow the primary markets to price securities. The investors who buy securities in
the primary market only pay the price, which they think they can obtain in the secondary market
when they sell the security. Therefore, in the absence of the secondary market, it would be difficult
to ascertain what the price of the security should be.
 Dynamic Pricing: Secondary markets also allow securities to be priced dynamically. This means
that the prices of securities go up and down depending upon the type of information that the
market has about the firm. The market price of the securities fluctuates on a real-time basis. This
allows investors to book profits and exit the transactions if required. Also, it is this price in the
secondary market, which is an indicator that a company is actually doing well. The management of
the company is usually rewarded based on the price signals which the secondary market provides.
However, this creates a problem, as well. This is because the price variations in the short run may
not necessarily reflect what is best for the firm in the long run.

To sum it up, each securities market is required to have two subsections viz. the primary market and the
secondary market. No market can function if it has only one of these markets. Securities markets require
constant inflow of newer securities via the primary market and the provisions for trading them via the
security market.

TEXT 8:
Money Markets vs. Capital Markets
Financial markets are markets where financial instruments or securities are traded. Financial markets can be
classified based on various parameters. In order to understand the types of financial markets, we need to
first understand the broad categories in which it is subdivided.

The broadest classification divides financial markets into two types’ viz. money markets and capital
markets. In this article, we will understand what money markets and capital markets are and the
difference between the two.

Money Markets vs. Capital Markets

The difference between money markets and capital markets is actually quite simple. Money markets
transact in financial securities that have a maturity of less than one year. Commercial paper, short term
treasury notes, promissory notes, and bills of exchange are commonly traded on the money market.
Therefore, it can be said that money markets are used by firms who are looking to borrow money for a very
short period of time.

On the other hand, securities sold on the capital markets have maturities that are at least longer than a year.
Most financial instruments sold on these markets have extremely long term maturities i.e., a decade or
more. Also, a lot of equity stock is sold in the capital market, and equities do not have any definite
maturity! Preferred stock, common stock, bonds, gilts, and debentures are the financial instruments that are
commonly transacted in the capital market. All stocks and bonds which retail investors commonly buy are
said to be a part of the capital markets. Therefore, it would be fair to say that companies use the capital
market when they want to raise money for the long term.

Differences between Money Market and Capital Markets

 Funds raised from the money market are used to meet the working capital needs of the firm. As a
result, each firm only borrows a small amount of money relative to its total asset base. On the other
hand, funds raised from the capital market form the entire asset base of the company.
 The primary function of the money markets is to provide short term liquidity to the economy. On
the other hand, the primary function of the capital markets is to channelize the savings of the
economy in a meaningful way to aid growth and development.
 Most transactions that happen on the capital market are routed via exchanges. There are dealers
who specialize in making markets in every security which is sold on the exchange. On the other
hand, most securities sold in the money market are sold over the counter. There are no market
makers, but there are brokers who help parties find counterparties.
  Money markets are more liquid as compared to capital markets. This may be counterintuitive given
the fact that money markets don’t have market makers and capital markets do. However, since the
maturity of money markets is smaller, a lot more investors are willing to deploy their funds in
these short term funds.
 Money market instruments have a short term maturity. Hence, the funds raised from these
securities are not deployed in risky projects. As a result, money market instruments are known for
having a lower risk. On the other hand, capital markets deploy money in complex projects because
of the long term nature of these funds. As a result, capital market instruments are believed to be
riskier. Once again, this is counterintuitive given the fact that in capital markets, the exchange acts
as a counterparty to all transactions. Hence, the risk should ideally be low. In most circumstances,
money markets are considered to be absolutely safe. However, in some cases, they end up giving
negative returns as well. Therefore, investors need to be careful while selecting money market
funds, as well.
 The returns obtained from the money market are equivalent to the cost of capital i.e., the interest
rate in the economy. It is unusual for investors to earn significantly more than the interest rate. On
the other hand, the potential returns in capital markets are almost unlimited. This can be attributed
to the higher duration as well as a higher risk, which is undertaken by the investors.
 The most active participants in money markets are banks and other financial institutions. Banks
frequently want to raise short term funds since they have to show that they have the reserves
necessary to make the loans. Also, other financial institutions like mutual funds and pension funds
are required to keep some amount of liquid cash on hand. This is because they need to pay back
investors who want to redeem their investments. However, cash does not provide any return.
Money markets are the next best alternative. They are so liquid and risk-free that they can almost
be considered equivalent to cash. Most investors know that they can easily redeem their money
market funds to cash without any loss of value.

The bottom line is that capital markets and money markets both serve different but complementary needs.
Hence, both thee markets complete the financial system of any country.

TEXT 9:
Dealer Markets vs. Broker Markets
Markets across the world can also be segregated based on the type of intermediary. Prima facie, it may
appear that the type of intermediary is not of much consequence. However, over time, market participants
have realized that the type of intermediaries has a profound effect on the liquidity, efficiency as well as
transaction costs related to trading.

Primarily, all markets can be divided into two types based on the type of intermediaries. Some markets are
known as broker markets, whereas others are known as dealer markets. Each type of market has its own
advantages as well as disadvantages. This is the reason why both types of markets are still found in the
world. For instance, the New York Stock Exchange (NYSE) is a prominent example of a broker market,
whereas the NASDAQ is a prominent example of a dealer market. The difference between the types of
markets has been listed in this article.

Difference between a Broker Market and a Dealer Market?

Brokers, as well as dealers, are both intermediaries. However, there is a huge difference in the way they
operate in the market. For instance, the job of a broker is to ensure that buyers and sellers meet. The broker
charges a commission on the sale price of the goods or securities being sold in the market. This means that
brokers never actually take ownership of the underlying goods or securities being sold. As such, they do not
have to invest their own capital or take any risks. Since brokers have limited liability, companies with
limited capital and a limited network can also become brokers. The barriers to entry are low, and the
competition amongst brokers is intense. This is the reason why brokerage rates are reducing. Nowadays,
there are many discount brokers who charge a fixed fee regardless of the transaction value!

Dealers perform a very different function as compared to the brokers. This is because dealers are actually
the counterparty for both transactions. This means that for the buyer, they are the seller, whereas, for the
seller, they are the buyer. Hence, if a person or an institution wants to sell something, they purchase the
goods or securities from them, keep them in their possession and sell them when they find a suitable buyer.
This means that they have to invest their own capital in order to buy the asset. It also means that they will
have to absorb the loss if the asset drops in price before they can find another buyer. Since dealers take
additional risks, they need more compensation. This is the reason they do earn via commissions. Instead,
they earn via spreads.

A spread is a difference between the price at which the dealer is willing to buy and the one at which it
is willing to sell. Spreads reflect the riskiness of the underlying asset. If the asset is likely to experience a
steep drop in value, the spread is higher to ensure that the dealer has an appropriate margin and does not
suffer a loss. Also, becoming a dealer is quite difficult. This is because it requires a lot of capital. Also, it
requires a huge network, so that the dealer is able to offload securities and minimize their risks as soon as
possible. This is the reason why only banks and huge financial institutions perform the role of a dealer.

Disadvantages of a Dealer Market

Prima-facie, it may appear that the dealer market is actually a better market system as compared to the
broker market. This could be because of the fact that the dealer market provides fast liquidity. If a person
wants to sell their goods or securities, they can do it instantaneously. They do not have to wait for a
counterparty. Finding the counterparty becomes the job of the dealer.

However, it needs to be understood that the dealers charge a hefty premium for this service. The spread
charges are much higher when compared to brokerage. Therefore, the transaction costs in the markets made
by dealers are prohibitively high. This leads to lower transaction volumes.

Also, markets made by dealers do not guarantee higher liquidity. This is because, in times of crisis, when
prices are falling rapidly, dealers quickly stop buying more goods and securities and actually look to
offload what they have. This phenomenon has been seen several times, the most recent example being the
Great Recession of 2008.

Lastly, dealers actually have more information as compared to regular market participants. They can
transact at lower transaction costs as compared to other participants in the market. Also, they have more
information as compared to other participants in the market. In many cases, dealers choose to side-line their
socially important function of providing liquidity. Instead, they choose to become efficient proprietary
traders. Because of their special abilities, they are able to exploit opportunities that other market
participants are not able to exploit.

The bottom line is that dealer led markets do provide certain advantages over broker markets. However,
these advantages do come at a cost. In general, markets in which a lot of people trade are made by brokers
because finding counterparties is not so difficult. On the other hand, markets with fewer participants are
dealer made markets since finding counterparties is a challenge.

TEXT 10:
How do Stock Markets Work?
Prima facie stock markets appear to be very simple. It seems like there are buyers and sellers who meet on
their own and interact during the transaction. However, the reality is that stock markets operate through a
complicated mechanism wherein several different players are involved in the process. This is why a central
intermediary party called the exchange is required in order to conduct all transactions smoothly.

In this article, we will have a closer look at the different stages which happen when a transaction
takes place. We will also identify the different parties which are engaged in the transactions.

Stage #1: Placing Orders

Stage 1 is visible to buyers and sellers. This is why buyers and sellers consider this to be the entire process.
The rest of the steps usually take place behind the scenes and hence are not known to the buyers and sellers.

In this stage, buyers interact with their brokers. They place buy and sell orders depending upon the price,
which is prevailing in the market.
Stage #2: Price Discovery

In the second stage, the brokers place the order in the open market based on the instructions from the client.
The brokers have a connected system wherein they can place, buy, and sell orders. It must be understood
that the price at which buy and sell occurs is not the same as the one at which the order was placed.

In most cases, buy and sell transactions happen so fast that the price which was being quoted is the price at
which the buying and selling actually happens. This creates the illusion that the price is known first, and the
transaction happens later. The reality is that the price is determined during the buy and sell process. Some
brokers have buy orders with given prices. Others have sell orders with given prices. If the prices do match,
transactions happen, whereas if the prices don't match, the orders are revoked after some time.

Hence, when transactions happen on the exchange, price discovery happens simultaneously.

Stage #3: Position Keeping

If the next stage, the exchange has to provide order confirmation to both parties. Both parties do not know
each other. For each of them, the counterparty is the exchange. Also, many exchanges facilitate trading
with keeping the lot size as small as one!

This means that a person can even buy or sell a single share! Hence, if a person wants to buy 1000 shares, it
could be sourced from different people. The priority is obviously given to sellers who are willing to sell at
the lowest price. This is done to ensure that the average price of the purchase goes down.

The exchange not only matches the buy and sell requirement, but it also provides confirmation of orders.
Also, in the case of forwards and futures, exchanges provide other crucial services like record keeping and
maintaining the margin. Basically, all the services from the execution to the settlement of the trade are
provided by the exchange.

Stage #4: Settlement

The next step in the process is called settlement. This step does not take place on the same day as the
original trade. When the trading takes place, only the price is locked, and the actual settlement takes place a
day or two after the actual trade.

The process of settlement is initiated after the exchange sends the trading information to the depository
institution. Buyers and sellers do not directly interact with the depository institution. Instead, the agents of
buyers, as well as sellers, interact with them. It doesn't matter if the brokers have to deal with one
depository or multiple. This is because, for the outside world, the depository institutions function as one
single system.

The actual transfer of shares takes place here. It is the custodian who changes the name of the owner of the
shares in their record after receiving instructions from the exchange.

Stage #5: Clearing

The last step in the process takes place between the custodian and the brokers. This is where the entire
communication loop is closed. For instance, when a buyer makes a payment to buy shares, the brokers have
an open credit and no corresponding debit.

Once the custodian changes the name of the owner of the shares, he sends a communication to the broker.
This communication creates an open debit entry. Now, the clearing process is about reconciling the open
debits with the open credits. The broker is therefore sure that the money which they paid on behalf of the
customer has been used to buy shares which are now in the customer's name.

The confirmation and matching of the buyers' instructions and the custodians' communication are called
clearing. This process is of utmost importance to ensure that there are no unfinished transactions.
To sum it up, the stock exchanges have a complicated process in place. This complicated process may seem
unnecessary. However, the reality is that this complicated process is actually the backbone of the entire
system. This process facilitates the execution of millions of deals without making any errors or causing
expensive delays.