Basic Concepts about Basic Concepts about Financial MarketFinancial Market

Market:Market: Market is an institution set up by society to Market is an institution set up by society to allocate resources that are scarce relative to the allocate resources that are scarce relative to the demand for them. Markets are the channels or demand for them. Markets are the channels or mechanism through which buyers and sellers mechanism through which buyers and sellers meet to exchange goods, services and meet to exchange goods, services and productive resources.productive resources.Financial Markets:Financial Markets:We usually describe the financial markets as We usually describe the financial markets as being a system comprised of individuals and being a system comprised of individuals and institutions, instruments, and procedures that institutions, instruments, and procedures that bring together borrowers and severs, no matter bring together borrowers and severs, no matter the location. It is athe location. It is aforum by which suppliers of funds and forum by which suppliers of funds and demanders of fund can transact business demanders of fund can transact business directly.directly.

Functions Performed by Financial Functions Performed by Financial MarketMarket

a) Savings Functiona) Savings Function – – Bonds, stocks and Bonds, stocks and other financial claims sold in the money other financial claims sold in the money and capital markets provide a profitable, and capital markets provide a profitable, relatively low-risk outlet for the public’s relatively low-risk outlet for the public’s savings, which flow through the financial savings, which flow through the financial markets into investment so that more markets into investment so that more goods and services can be produced (i.e., goods and services can be produced (i.e., productivity will rise), increasing the productivity will rise), increasing the world’s standard of living. The financial world’s standard of living. The financial market enabled us to consume amounts market enabled us to consume amounts different than our current incomes. In other different than our current incomes. In other word it allows us to transfer income word it allows us to transfer income through time by either saving or borrowing.through time by either saving or borrowing.

Functions Performed by Financial Functions Performed by Financial MarketMarket

b) Wealth Functionb) Wealth Function –– For those businesses and For those businesses and individuals choosing to save, the financial individuals choosing to save, the financial instruments sold in the money and capital markets instruments sold in the money and capital markets provide an excellent way to store wealth until funds provide an excellent way to store wealth until funds are needed for spending.are needed for spending.

c) Liquidity Functionc) Liquidity Function – – For wealth stored in financial For wealth stored in financial instruments, the global financial marketplace instruments, the global financial marketplace provides a means of converting those instruments provides a means of converting those instruments into cash with little risk of loss. Thus, the world’s into cash with little risk of loss. Thus, the world’s financial markets provide liquidity for savers who financial markets provide liquidity for savers who hold financial instruments but are in need of money.hold financial instruments but are in need of money.

Functions Performed by Financial Functions Performed by Financial MarketMarket

d) Credit Functiond) Credit Function –– Financial markets furnish Financial markets furnish credit to finance consumption and investment credit to finance consumption and investment spending. Credit consists of a loan of funds in spending. Credit consists of a loan of funds in return for a promise of future payment. return for a promise of future payment. Consumers, Businesses, and Governments need Consumers, Businesses, and Governments need credit for several reasons.credit for several reasons.

e) Payments Functione) Payments Function – – Financial markets also Financial markets also provide a mechanism for making payments for provide a mechanism for making payments for goods and services. Certain financial assets, bank goods and services. Certain financial assets, bank checking account, payment order, demand draft, checking account, payment order, demand draft, plastic credit card, ATM card and some other plastic credit card, ATM card and some other instruments serve as a medium of exchange in instruments serve as a medium of exchange in making paymentsmaking payments..

Functions Performed by Financial Functions Performed by Financial MarketMarket

f) Risk Protection Functionf) Risk Protection Function –– The financial markets The financial markets around the world offer businesses, consumers, and around the world offer businesses, consumers, and governments protection against life, health, property governments protection against life, health, property and income risks. This is accomplishing, first of all, by and income risks. This is accomplishing, first of all, by the sale of different types of insurance policies.the sale of different types of insurance policies.

g) Economic Stabilization:g) Economic Stabilization: in recent decades, the in recent decades, the financial markets have been the principal channel financial markets have been the principal channel through which government has carried out its policy of through which government has carried out its policy of attempting to stabilize the economy and avoid attempting to stabilize the economy and avoid inflation. By manipulating interest rates and the inflation. By manipulating interest rates and the availability of credit, government can affect the availability of credit, government can affect the borrowing and spending plans of the public, which in borrowing and spending plans of the public, which in turn, influence the growth of jobs, production and turn, influence the growth of jobs, production and policies.policies.

Classifications of Classifications of Financial MarketsFinancial Markets

Two major Financial Markets are-Two major Financial Markets are-1.1. The Money Market:The Money Market: The money market is created by a The money market is created by a

financial relationship between suppliers financial relationship between suppliers and demanders of short-term funds and demanders of short-term funds (funds with maturities of one year or (funds with maturities of one year or less).less).

22.. The Capital Market:The Capital Market: A market that enables suppliers and A market that enables suppliers and

demanders of long-term funds to make demanders of long-term funds to make transactions. Included are securities transactions. Included are securities issues of business and government.issues of business and government.

The Money Market The Money Market InstrumentsInstruments

Treasury Bill-Treasury Bill- Sold to institutional Sold to institutional investors by the Treasury (in BD it is the investors by the Treasury (in BD it is the Treasury of Bangladesh Bank) to finance Treasury of Bangladesh Bank) to finance the government’s short term requirements the government’s short term requirements for which maturity normally last from 91 for which maturity normally last from 91 days to 1 year.days to 1 year.

Repurchase Agreements-Repurchase Agreements- Used by Used by banks to adjust reserves. Here banks sell banks to adjust reserves. Here banks sell investments with repurchase promise for investments with repurchase promise for very short time. very short time.

The Money Market The Money Market InstrumentsInstruments

Bankers’ Acceptances-Bankers’ Acceptances- Firm’s promise Firm’s promise to pay; guaranteed by a bank. Usually to pay; guaranteed by a bank. Usually low degree of risk involved here if bank low degree of risk involved here if bank is strong and reputed.is strong and reputed.

Negotiable Certificates of Deposits Negotiable Certificates of Deposits (CDs)-(CDs)- Issued by major money-center Issued by major money-center commercial banks to large investors. commercial banks to large investors. This instrument is riskier than Treasury This instrument is riskier than Treasury bills.bills.

Commercial Paper-Commercial Paper- Issued by large, Issued by large, financially secure firms to large financially secure firms to large investors. It has law default risk.investors. It has law default risk.

The Capital Market The Capital Market Instruments:Instruments:

Corporate Bonds-Corporate Bonds- Issued by corporations to Issued by corporations to individuals, institutional investors, and individuals, institutional investors, and corporations. Risk depends on the company and corporations. Risk depends on the company and normally riskier than government bonds, but normally riskier than government bonds, but not as risky as stock. Example, IBBL public not as risky as stock. Example, IBBL public bond.bond.

Preferred Stock-Preferred Stock- A special form of ownership A special form of ownership having a fixed periodic dividend that must be having a fixed periodic dividend that must be paid prior to payment of any common stock paid prior to payment of any common stock dividends. In Bangladesh companies are not dividends. In Bangladesh companies are not allowed to offer preferred stock.allowed to offer preferred stock.

The Capital Market The Capital Market InstrumentsInstruments

Common Stock-Common Stock- Units of ownership, Units of ownership, or equity in a corporation. It is issued or equity in a corporation. It is issued by corporations to individuals and by corporations to individuals and institutional investors. Common institutional investors. Common stock holders earn a return by stock holders earn a return by receiving dividends or by capital gain receiving dividends or by capital gain through realizing increases in share through realizing increases in share price.price.

Classification of Capital Classification of Capital MarketMarket

Primary Market:Primary Market: The primary market is The primary market is for the trading of new securities never for the trading of new securities never issued before. Its principal function is issued before. Its principal function is raising financial capital to support new raising financial capital to support new investment in buildings, equipment, and investment in buildings, equipment, and inventories or even to pay off the inventories or even to pay off the previous debts. Investors engage in a previous debts. Investors engage in a primary-market transaction when they primary-market transaction when they purchase shares of stock just issued by a purchase shares of stock just issued by a company.company.

Classification of Capital MarketClassification of Capital Market

Secondary Market:Secondary Market: The secondary market The secondary market deals in securities issued previously. The deals in securities issued previously. The proceeds from any share sold in the secondary proceeds from any share sold in the secondary market does not go to the corporations directly. market does not go to the corporations directly. But it creates a market for the sellers to trade But it creates a market for the sellers to trade their ownerships. Thus, its chief function is to their ownerships. Thus, its chief function is to provide liquidity to security investors- that is, provide liquidity to security investors- that is, provide an avenue for converting financial provide an avenue for converting financial instruments into ready cash. The volume of instruments into ready cash. The volume of trading in the secondary market is far larger trading in the secondary market is far larger than the primary market. than the primary market.

Secondary Market:Secondary Market: The secondary market The secondary market deals in securities issued previously. The deals in securities issued previously. The proceeds from any share sold in the secondary proceeds from any share sold in the secondary market does not go to the corporations directly. market does not go to the corporations directly. But it creates a market for the sellers to trade But it creates a market for the sellers to trade their ownerships. Thus, its chief function is to their ownerships. Thus, its chief function is to provide liquidity to security investors- that is, provide liquidity to security investors- that is, provide an avenue for converting financial provide an avenue for converting financial instruments into ready cash. The volume of instruments into ready cash. The volume of trading in the secondary market is far larger trading in the secondary market is far larger than the primary market. than the primary market.

Security ExchangeSecurity Exchange

Securities Exchange –Securities Exchange – Organizations that provide the Organizations that provide the

marketplace in which firms can raise funds marketplace in which firms can raise funds through the sale of new securities and through the sale of new securities and purchasers can resell securities. The best-purchasers can resell securities. The best-known organized exchanges in the world known organized exchanges in the world include the New York Stock Exchange include the New York Stock Exchange (NYSE), the American Stock Exchange (NYSE), the American Stock Exchange (AMEX), the London Stock Exchange, the (AMEX), the London Stock Exchange, the Hong Kong Stock Exchange, and the Hong Kong Stock Exchange, and the Singapore Stock Exchange.Singapore Stock Exchange.

Some Other Types of MarketSome Other Types of Market

Debt MarketsDebt Markets are the markets where are the markets where loans are traded. In this case debt loans are traded. In this case debt instruments are necessary for trading instruments are necessary for trading which represent as a contract that which represent as a contract that specifies the amounts, as well as the specifies the amounts, as well as the times, a borrower must repay the funds times, a borrower must repay the funds provided by lender. The borrower can be provided by lender. The borrower can be an individual, a government or a business.an individual, a government or a business.

Mortgage MarketsMortgage Markets deal with loans on deal with loans on residential, commercial and industrial real residential, commercial and industrial real estate, and on farmland.estate, and on farmland.

Some Other Types of MarketSome Other Types of Market

Consumer Credit MarketsConsumer Credit Markets involve involve loans on autos and appliance, as well as loans on autos and appliance, as well as loans for education, vacation, marriage loans for education, vacation, marriage and so forth.and so forth.

A Spot MarketA Spot Market is one in which assets or is one in which assets or financial services are traded for financial services are traded for immediate delivery (usually within one or immediate delivery (usually within one or two business days).two business days).

Some Other Types of MarketSome Other Types of Market

A Futures and Forward MarketA Futures and Forward Market is is designed to trade contracts calling for the designed to trade contracts calling for the future delivery of financial instruments.future delivery of financial instruments.

Over the Counter Market:Over the Counter Market: If a security If a security is not traded in an organized exchange, it is not traded in an organized exchange, it is customary to say it is traded over the is customary to say it is traded over the counter (OTC). The over the counter counter (OTC). The over the counter market is an intangible organization that market is an intangible organization that consists of a network of brokers and consists of a network of brokers and dealers around the country.dealers around the country.

The Role of Securities The Role of Securities Exchanges:Exchanges:

Securities exchanges create continuous Securities exchanges create continuous markets in which firms can obtain needed markets in which firms can obtain needed financing. They also create efficient financing. They also create efficient markets that allocate funds to their most markets that allocate funds to their most productive uses. This is especially true for productive uses. This is especially true for securities that are actively traded on securities that are actively traded on major exchanges, where the competition major exchanges, where the competition among wealth- maximizing investors among wealth- maximizing investors determine and publicize the prices.determine and publicize the prices.

Financial Institutions and Financial Institutions and Fund Transfer systemFund Transfer system

1.1. A A Direct TransferDirect Transfer of money and of money and securities occurs when a business sells its securities occurs when a business sells its stocks or bonds directly to savers stocks or bonds directly to savers (investors), without going through any type (investors), without going through any type of financial institution. In Bangladesh, of financial institution. In Bangladesh, government owned oil and gas companies government owned oil and gas companies went directly to the share market without went directly to the share market without going through any financial institutions as going through any financial institutions as guarantors.guarantors.

Financial Institutions and Financial Institutions and Fund Transfer systemFund Transfer system

2.2. Through an Through an Investment Banking HouseInvestment Banking House funds are also transferred among funds are also transferred among different sectors. In this case they serve different sectors. In this case they serve as an intermediaries or middlemen and as an intermediaries or middlemen and facilitate the issuance of securities. facilitate the issuance of securities.

3.3. Transfer can also be made through Transfer can also be made through

other other Financial IntermediariesFinancial Intermediaries such as a such as a bank or a mutual fund.bank or a mutual fund.

Capital Market EfficiencyCapital Market Efficiency

An efficient capital marketAn efficient capital market is one is one in which the prices of securities in which the prices of securities “fully reflect” all available “fully reflect” all available information. The reflection or information. The reflection or reaction of market prices to new reaction of market prices to new information should be information should be instantaneousinstantaneous and and unbiased.unbiased.

Efficient Capital Market Efficient Capital Market (Cont.)(Cont.)

A market which truly reflects the A market which truly reflects the demand and supply equilibrium price of demand and supply equilibrium price of the stocks.the stocks.

share share SSpriceprice

DD

OO Number of Share TradedNumber of Share Traded

Types of Types of Capital Market EfficiencyCapital Market Efficiency

1.1. Weak form efficiencyWeak form efficiency-- which implies that the which implies that the information contained in the past sequence information contained in the past sequence of prices of a security is fully reflected in the of prices of a security is fully reflected in the current price of that security.current price of that security.

2. 2. Semi-strong form efficiencySemi-strong form efficiency-- which implies which implies that all publicly available information is fully that all publicly available information is fully reflected a security’s market price, including reflected a security’s market price, including information about past prices and volume.information about past prices and volume.

Types of Types of Capital Market EfficiencyCapital Market Efficiency

3. 3. Strong from efficiencyStrong from efficiency-- which which implies that all information, implies that all information, whether public or private, is whether public or private, is fully reflected in a security’s fully reflected in a security’s price.price.