Financial Markets

What are financial markets?

•A financial market is a market in which people and entities can trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and bonds, and commodities include precious metals or agricultural goods.

en.wikipedia.org/wiki/Financial_market

What are financial markets?

•Broad term describing any marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives.

www.investopedia.com

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Benefits of Financial Markets

•Funds are directed to deficit spending units (DSUs) which can use them most efficiently

•Liquidity is provided to savers

Why Firms Invest and Borrow•There are times when companies are

confronted by capital deficiency. And there are times when opportunities for investment come by but the company cannot provide the needed amount of money to take advantage of these opportunities. Thus, when firms borrow, they enjoy the following:▫Quantity discounts for bulk purchases

granted by suppliers▫Additional revenues from sales

Methods by which financial markets transfer funds•Direct Finance

▫Refers to lending by ultimate borrowers with no intermediary. Under this method, the SSU gives money to the DSU in exchange for financial claims on the DSU. The claims issued by the DSU are called direct claims.

▫SSUs have a venue for savings with expected returns while DSUs are provided with a source of funds for consumption or investment.

Disadvantages of Direct Financing

•There are few DSUs which can transact in the direct market because the denominations of securities sold are very large.

•It is difficult to match the requirements of SSUs and DSUs in terms of denomination, maturity, and other factors.

Methods of Direct Financing

•Private Placement▫Selling of securities by private negotiation

directly to insurance companies, commercial banks, pension funds, large-scale corporate investors, and wealthy individual investors.

Methods of Direct Financing – cont’n

•Broker and Dealers▫A broker is one who acts as an intermediary

between buyers and sellers but does not take title o the securities traded.

▫A dealer is one who is in the security business acting as a principal rather than an agent. The dealer buys for his account and sells to customers from inventory. He makes profits by selling this inventory of securities at a price higher than the acquisition cost.

Examples of Brokers in Baguio City•R. Coyiuto Securities, Inc.•Regina Capital Development Corp.

Methods of Direct Financing – cont’n

•Investment Brokers / Investment Banker▫A person who provides financial advice and

who underwrites and distributes new investment securities.

•Indirect Finance▫Also called financial intermediation▫Refers to lending by an ultimate lender to a

financial intermediary that then relends to ultimate borrowers.

▫Financial intermediaries include commercial banks, mutual savings banks, credit unions, life insurance companies, and pension funds.

Classification of Financial Markets• Primary market• Secondary market• Money market• Capital market• Bond market• Stock market• Mortgage market• Consumer credit

market

• Auction market• Negotiation market• Organized market• Over-the-counter

market• Spot market• Futures market• Options market• Foreign exchange

market

Primary Market• This is where newly issued primary and

secondary securities are traded for the first time.

• Large corporations needing large amount of funds usually tap the primary market through issuance of bonds.

• The primary markets are where investors can get first crack at a new security issuance. The issuing company or group receives cash proceeds from the sale, which is then used to fund operations or expand the business. Exchanges have varying levels of requirements which must be met before a security can be sold.  (investopedia)

•For instance, if Ayala Corporation decides to sell a new stock to raise equity funds, it will be a primary market transaction. Since it is the first time the company has sold stock to the public, it is called an initial public offering (IPO). The proceeds of the sale go to Ayala Corporation, the issuing company. Investors who have subscribed to the IPO have provided the company with the necessary funds to continue its operation and expansion, and become part owners of the company.

•An underwriter or investment banker assists the issuer of a new security in setting the offering price and in marketing the securities to the public. The investment bankers serves as a middleman in the transfer of funds between the company in need of capital and the public, and facilitates the issuance of shares.

Secondary Market

•Financial market through which existing financial securities are traded.

•A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. (investopedia)

•If you decide to buy existing shares of Ayala Corporation, you cannot buy them directly from the issuing company anymore since they have all been sold to the investing public during the initial public offering.

•So, how can you avail of AC shares when the IPO has been completed? Investors can only buy these shares from

existing shareholders who are willing to sell their shares. When they do so, it is a secondary market transaction. The proceeds from this transaction don not go to the issuing corporation; instead they go to the investor who sold his shares.

•Once the initial sale is complete, further trading is said to conduct on the secondary market, which is where the bulk of exchange trading occurs each day. Primary markets can see increased volatility over secondary markets because it is difficult to accurately gauge investor demand for a new security until several days of trading have occurred.

•In the primary market prices are often set beforehand, whereas in the secondary market only basic forces like supply and demand determine the price of the security.

Money Market

•Financial market on which debt securities with an original maturity of one year or less are traded.

•The money market is where short-term funds are raised through the buying and selling of short term debt securities such as commercial papers. (PSE)

Capital Market•Portion of the financial market where trading

is undertaken for securities with maturity of more than one year. In the Philippines, it is subdivided into 3 parts: bond market, stock market, and the mortgage market

•The capital market is where long-term funds are raised through the bond market, which deals with long-term debt securities such as bonds, the stock market which deals with equity securities or stocks. (PSE)

•Capital markets channel savings and investment between suppliers of capital such as retail investors and institutional investors, and users of capital like businesses, government and individuals. Capital markets are vital to the functioning of an economy, since capital is a critical component for generating economic output. Capital markets include primary markets, where new stock and bond issues are sold to investors, and secondary markets, which trade existing securities. (investopedia)

Bond Market

•Market for debt instruments of any kind.•The bond market primarily includes

government-issued securities and corporate debt securities, and facilitates the transfer of capital from savers to the issuers or organizations requiring capital for government projects, business expansions and ongoing operations. (investopedia)

•The Philippine domestic bond market consists of short- and long-term bonds, mainly issued by the national government.

•The Philippine bond market is dominated mainly by Treasury notes and bonds. Although the size of the Philippine corporate bond market is still small relative to government bonds, it has been growing rapidly over the years.

•In the Philippines, corporate bond issuance came from various sectors, mostly banks, real estate and telecommunication companies, toll way operators and a beer-based conglomerate.

•The growth in the region’s bond market was driven partly by huge demand from foreign investors looking for more attractive returns than those available in the United States, Europe and other developed markets.

Stock Market

•Financial market where the common and preferred stocks issued by corporations are traded.

•A place, whether physical or electronic, where stocks, bonds, and/or derivatives in listed companies are bought and sold. (financial dictionary)

Mortgage Market

•Deals with loans on residential, commercial, and industrial real estate, and on farmland.

•A market for loans to people and organizations buying property a market for mortgages that have been bought by financial institutions and are then traded as asset-backed securities. (financial times)

Consumer Credit Market

•Involved in loans on autos, appliances, education, travel, etc.

Auction Market• One where trading is conducted by an independent

third party according to a matching of prices on orders received to buy and sell a particular security. If there is a match, trade is consummated.

• A market in which buyers enter competitive bids and sellers enter competitive offers at the same time. The price a stock is traded represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to sell at. Matching bids and offers are then paired together and the orders are executed. (investopedia)

•4 buyers want to buy a share of XYZ and make the following bids: $10.00, 10.02, 10.03 and $10.06. Conversely, there are 4 sellers that desire to sell XYZ and they submitted offers to sell their shares at the following prices: $10.06, 10.09, 10.12 and $10.13. In this scenario, the individuals that made bids/offers for XYZ at $10.06 will have their orders executed. All remaining orders will not immediately be executed and the current price of XYZ will then be $10.06.

Negotiation Market•When buyers and sellers of securities

negotiate with each other regarding price and volume, either directly or through brokers to dealers, they are engaged in the negotiation market.

•Through the negotiation market, the situation wherein securities are not frequently traded and which are in large volumes may not be readily accommodated in the auction market for lack of time is remedied.

Organized Market

•Financial market with fixed trading rules.•PSE is an example of an organized market

Over-the-Counter Market• Stocks of corporations not listed and therefore

not traded in the stock exchange but registered and licensed by the Securities and Exchange Commission for sale to the public are only available in the so-called over-the-counter (OTC) market. This market is not a specific organization but another way of trading securities. OTC transactions are carried out by direct inquiries and negotiations among the buyers and sellers through the use of mail, telephone, telegraph, Teletype, or other forms of communications.(PSE)

Spot Market

•This is where securities are traded for immediate delivery and payment.

•The spot price is the main feature of the market.

•The Wholesale Electricity Spot Market (also known as WESM) is the Philippine spot market for the trading of electricity as a commodity.

• The trading process maybe summarized in five steps as follows:

1.Trading participants submit online hourly energy offers (price and quantity).

2.The Market Operator matches offers of generators with demand bids of customers, prioritizing the lowest offers (generators) and highest bids (customers).

3.The Market Operator submits the dispatch schedule to the System Operator for central dispatch and informs the trade participants of the price and schedule.

4.Electricity is dispatched to the buyer, for distribution to the end-users.

5.Electricity used is measured and settled using the locational marginal prices and schedule.

Futures Market

•Market where contracts are originated and traded that give the holder the right to buy something in the future at a price specified by the contract.

Options Market

•Market where stock options are traded. A stock option is a contract giving the owner the right to either buy or sell a fixed number of shares of stock at any time before the expiration date at a price specified in the option.

Foreign Exchange Market

•Market where people buy and sell foreign currencies.