OVERVIEW OF FINANCIAL MARKETS

DEFINITION OF FINANCIAL MARKETS

Financial markets are structures through which the fund flows. They are institutions and
systems that facilitate transactions in all types of financial claim. A financial claim entitles a
creditor to receive payment from a debtor in circumstances specified in a contract between
them, oral or written. Depositors have financial claims on banks where they hold their deposits;
bondholders have financial claims on companies issuing bonds they hold. Financial markets are
the meeting place for those with excess funds (investors or lenders referred to as
surplus/savings units) and those who need funds (borrowers or issuers of securities referred to
as deficits units).savings from households and businesses are channeled to those individuals
and businesses which needs the funds. The needs of deficit units and surplus units gave rise to
financial markets. Financial markets are at the heart of financial system determining the volume
of credit available, attracting savings, and setting interest rates and security prices.
PRIMARY MARKETS
Financial claims are initially sold by deficit units in primary markets. Primary markets are
markets in which users of funds, raise funds, through new issues of financial instruments such
as stocks and bonds. They consist of underwriters, issuers, and instruments involved in buying
and selling original or new issues of securities referred to as primary securities. In other words,
primary markets are markets for primary securities (new issues of financial instruments like
stocks and bonds). They raise cash for the issuing company, which acts as borrower by
increasing its current capital stock when it issues stock, or outstanding liabilities when it issues
bond. The government also acts as a borrower when it issues bond or Treasury bills. The
primary market transaction involves either equity security (stock) or debt security (bond). These
new issues are issued to initial suppliers of funds or investors.
The following figures depict primary market transactions. The corporation needing
funds issues new or original issues of either stocks or bonds directly to the investors or to
underwriters/financial intermediaries who in turn sell them to the investors. Financial
intermediary acts as a middleman or bridge that will satisfy the needs of the deficit units and
the surplus units.
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Deficit Units Surplus Units

Borrowers/Users of Initial supplier of

funds; Corporations funds; Households and
issuing new/original businesses
issues of stocks or
bonds

Primary Markets Involving Direct Selling (Without an Intermediary

Deficit Units
Underwriters Surplus Units
Borrowers/Users of
funds; Corporations Investment/ Initial supplier of
issuing new/original Merchant banks funds; Households and
issues of stocks or intermediary businesses
bonds
 Primary Markets Involving an Intermediary
Most primary market transactions are done through investment banks, also called
merchant banks, which help the corporations issuing the stocks or bonds sell these stocks or
bonds to interested investors. Investment or merchant banks purchase shares issued by the
issuing company in an underwriting transaction and then sell these issues to the public. An
underwriter guarantees the sale of the issues, but does not intend to hold the shares or bonds
in his own account. However, if the issue is unsuccessful and public investors refuse to purchase
the issues, the underwriting carries the issues as its own investment, while waiting for morale
favourable market conditions.
Investment banks provide the following services:
1. Provide funds in advance (giving cash to the issuer based on the agreed price of the
security, usually a certain percentage of the total agreed price)
2. Give advice to issuing corporations as to the price and number of securities to issue
3. Attract the initial public purchasers of the securities
4. Act as a market analysis and advisor to the issuing company
5. Absorb the risk and cost of creating a market for the securities

Primary market issues are generally for public offerings or publicly traded securities like
stocks of companies already selling stocks in the market or stock exchanges. If these companies
need additional funds, they create new issues to raise the firm`s capitalization or create new
issues of bonds or debt instruments, thereby increasing its outstanding liabilities to meet the
needs for the funds. First time issues for the public are called initial public offerings (IPO).
SECONDARY MARKETS
Once financial instruments are issued in primary markets, they are then traded in
secondary markets. Secondary markets are like used car markets. Secondary markets are
markets for currently outstanding securities, referred to as secondary securities. These
securities were previously bought and owned and now being resold either by the initial
investors or those who have purchased securities in the secondary market. Secondary markets
provide liquidity for investors as they sell their financial securities when they need cash.
All transactions after the initial issue in the primary market are done in the secondary
markets. For instance, X owns stocks initially issued by METF Company and later on sells these
METF Company stocks to Y; the sale of X to Y or anyone else is done in the secondary market.
Transactions in the stock and bond market exchanges are secondary market transactions.
Shares held by the public are termed outstanding shares or securities. They do not increase the
capital stock of the original issuing company or its outstanding liabilities unlike in primary
market transactions. Secondary markets only transfer ownership, but do not affect the total
outstanding shares or securities in the market. Only when the issuing corporations redeem
bonds or retire stocks will outstanding shares or securities be reduced. Redemption of bonds
decreases total outstanding debt securities in the market and at the same time reduces the
outstanding liabilities of the issuing company. Retirement of stocks reduces the total
outstanding equity securities in the market and the outstanding capital of the issuing
corporation.

Securities
Financial Markets Other Suppliers of Funds
(Owners of outstanding Brokers (Buyers of outstanding
securities: Investors) securities: Investors)
Dealers
 Secondary Market with Secondary Securities Offered for Sale
Secondary markets exist for the purpose of marketability or easy selling/transfer of
ownership and liquidity or easy convertibility to cash of securities. Marketable securities are
classified in the balance sheet as cash equivalents because of these characteristics. The role of
the secondary market is to assure that a holder can sell and convert to cash his security at any
time.
The securities exchange serves the following purposes:
1. Provides marketability by allowing savers to sell their securities immediately
2. Provides liquidity by raising cash any time
3. Provides valuation by serving as a means for determining current values of shares and
ultimately of companies

IMPORTANCE OF FINANCIAL MARKETS

● Financial markets provide a place where participants like investors and debtors,
regardless of their size, will receive fair and proper treatment.
● They provide individuals, companies, and government organizations with access to
capital.
● Financial markets help lower the unemployment rate because of the many job
opportunities it offers

FUNCTIONS OF FINANCIAL MARKETS

Financial Markets perform various functions in any country, allowing companies and
traders to buy and sell the different financial instruments and financial securities. It acts as an
intermediary between savers and the investors by mobilizing the funds between them and
helps determine the prices of securities. It plays a crucial role in allocating the limited resources
available in the economy of any country.
#1 – Price Determination

The financial market performs the function of price discovery of the different financial
instruments traded between the buyers and the sellers on the financial market. The prices at
which the financial instruments trade in the financial market are determined by the market
forces, i.e., demand and supply.
So the financial market provides the vehicle by which the prices are set for
both financial assets which are issued newly and for the existing stock of the financial assets.

#2 – Funds Mobilization

Along with determining the prices at which the financial instruments trade in the
financial market, the required return out of the funds invested by the investor is also
determined by participants in the financial market. The motivation for persons seeking the
funds is dependent on the required rate of return, which the investors demand.

Because of this function of the financial market only, it is signaled that funds available
from the lenders or the investors of the funds will get allocated among the persons who need
the funds or raise funds through the means of issuing financial instruments in the financial
market. So, the financial market helps in the mobilization of the investors’ savings.

#3 – Liquidity

The liquidity function of the financial market provides an opportunity for the investors
to sell their financial instruments at their fair value prevailing in the market at any time during
the working hours of the market.
 In case there is no liquidity function of the financial market. The investor forcefully have
to hold the financial securities or the financial instrument until the conditions arise in the
market to sell those assets or the issuer of the security is obligated contractually to pay for the
same, i.e., at the time of maturity in debt instrument or at the time of the liquidation of the
company in case of the equity instrument is until the company is either voluntarily or
involuntarily liquidated.
Thus, investors can sell their securities readily and convert them into cash in the
financial market, thereby providing liquidity.

#4 – Risk sharing

The financial market performs the function of risk-sharing as the person who is
undertaking the investments is different from the persons who are investing their fund in those
investments.

With the help of the financial market, the risk is transferred from the person who
undertakes the investments to those who provide the funds for making those investments.

#5 – Easy Access

The industries require the investors to raise funds, and the investors require the
industries to invest their money and earn the returns from them. So the financial market
platform provides the potential buyer and seller easily, which helps them save their time and
money in finding the potential buyer and seller.

#6 – Reduction in Transaction Costs and Provision of the Information

The trader requires various types of information while doing the transaction of buying
and selling the securities. For obtaining the same time and money is required.

But the financial market helps provide every type of information to the traders without
the requirement of spending any money by them. In this way, the financial market reduces the
cost of the transactions.

#7 – Capital Formation

Financial markets provide the channel through which the new investors’ savings flow in
the country, which aids in the country’s capital formation.

CLASSIFICATIONS OF FINANCIAL MARKETS

1. By Nature of Claim

● Debt Market: These Markets offer debt instruments and fixed claims like bonds and
debentures, etc. for trading. Traders can buy these Financial holdings at debt
Markets for a fixed return and an agreed-upon maturity period.

● Equity Market: These Markets are designed for residual claims. Investors can deal in
equity financial holdings in such Markets.

0. By maturity of claim
 ● Money Market: Certificates of deposits, treasury bills, etc. are available in these
Markets for trading. These are usually short term financial holdings, and can be traded
online since these Markets usually do not exist physically.

● Capital Market: Among classification of Financial Markets, capital Markets are divided
into primary and secondary Markets. Primary Markets allow newly listed companies to
issue new securities, while also allowing listed companies to issue new shares.

0. By Timing of Delivery

● Cash Market: These Markets offer real time transactions which are immediately settled
between different sellers and buyers.

● Futures Market: Among various types of Financial Markets and their functions, these
Markets offer transactions where settlements and commodities are delivered in future
dates.

0. By organizational Structure

● Exchange-Traded Market: These are centralized trading Markets which record immense
trading on a daily basis. These have standard procedures which regulate their
functioning while trading financial holdings like shares.

● Over-the-Counter Market: These Markets have customized procedures and do not have
any centralized organization. Traders can trade without involving any broker in their
transactions. Typically offering shares from small companies, investors can trade in
these Markets online.
REFERENCES:
https://www.wallstreetmojo.com/functions-of-financial-markets/
https://www.investopedia.com/terms/f/financial-market.asp
https://corporatefinanceinstitute.com/resources/capital-markets/financial-markets/
https://www.vedantu.com/commerce/financial-market