Financial Markets Basics – 1

“Financial Market role is to facilitate trades between buyers and sellers.”

Financial markets are there from a long time and with time it evolved, so does market participants. Technology and involvement of different market participants really effected the market. To understand the market properly we need to know who are the participants and what are their roles.

Why there is a need of Financial Markets ?

  1. Raising Capital :- To fund operations and other business activity. Stock market is a great example of this where firms generates cash by public IPO and other sort of methods.
  2. Risk Management :- Financial markets gives brilliant opportunity to manage risk. For an example, Gold merchants and jewellers manage their stock risk by hedging their position in the commodity market.

Participants:-

  • Governments: Government needs capital to repay loans, covering short-falls in revenue collection and also to fund their various projects and purchases. Indian govt is very actively divesting their stakes in PSU and launching new IPOs to generate cash which will be used to boost the economy.

** Quantitative Easing is a policy which is adopted by central banks to prevent economy from stalling. It is done by flushing the economy with cash and this is very essential to boost economy. Higher cash in market ensures lower interest rates and that makes it cheap to buy credit which make companies to take more credit which would result in lower unemployment rates which is also inversely correlated to economy growth.

Right now India is facing issue of low economy growth rate and high unemployment rate which can be very disastrous for the country growth. The divestment of Govt. PSUs will generate cash which would be then flushed in the market with the intention to boost the economy.

Usually Govt. buys bonds from banks which makes bank cash rich and subsequently they reduce interest rates because of high supply of free cash.

Q.E is the reason why interest rates are low in India.

  • Investment banks : The main role of investment banks are to facilitate mergers, acquisition and act as an intermediate between issuers and buyers of securities.
  • Insurance companies : These companies invest their client premiums in the market and act as a buyer of securities. They create portfolio of various asset classes including Govt. bonds and fixed incomes too.
  • Clearing houses : Clearing houses are responsible for facilitate trade between two or more parties. The main role is to reduce the risk of member firm falling to honor its trade settlement obligations.
  • Brokers/Dealers : They are responsible in facilitating financial transaction on behalf of their clients which includes retail investor and banks.

Market Types :

  1. Money Markets
  2. Capital Markets
  3. Currency Markets
  4. Commodity Markets
  5. Other Markets

Money Markets : Instruments traded are short-term debt investments. Maturity is less than 1 year. Low risk and low volatility instruments with high volume traded by institutions and retailers. Instruments traded in money markets are :-

  • Treasury Bills : These bills are issued by central government and are also known as one of the safest investment option. They carry zero risk so returns are also low compared to other instruments. T-Bill average return for INDIA is around 7.8% pa.
  • Certificate of Deposits : It is issued by banks against the funds deposited for a specific period. FD is a common example of CD . Returns in INDIA varies from 4 to 7 % pa.
  • Commercial Papers : Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. This is usually issued for paying short term debts by commercial firms. Interest rates in INDIA varies from 6 to 10 % pa.

Capital Markets : Instruments traded for long-term horizon in order to access the capital to fund activity of institutions. Debt and equity markets are two parts of Capital Markets.

Debt Market – In debt market institution take debt to fund their activity by selling bonds which has a face value which is repaid by the bond issuer at the maturity of bond. Govt. bonds, Corporate and Treasury bonds are example of debt instruments.

Equity Market – This market is one of the popular market where institute sell their stakes in order to raise capital. The investors invests in this market in anticipation of dividend gains or price gain in future. Ex Stocks

Currency Markets : Trading of various world currencies comes under currency market. Currency conversion is made possible by these markets. Volatility of currency markets are pretty high and is one of the most traded markets by retailer because of high leverage offered by brokers.

Sport Market : All the immediate transfer of currencies are done in Spot and defines current rate of currency at the time.

Future Market : These market consist of future delivery. This is done by buying and selling contracts which includes an obligation of buying currency with defined quantity and a specific time in the future .

Commodities market : Commodity markets are one of the most volatile markets this is why the institutes don’t engage in spot trading. Derivatives are mainly traded in commodities market.

Note : This post is my personal note which includes data from different sources. The content totally represent my understanding of concepts of finance.