CHAPTER 7 FINANCIAL

MARKETS: AN OVERVIEW
INTRODUCTION
 Financial markets
Financial markets are the meeting place for
people, corporations and institutions that either
need money or have money to lend or invest. In a
broad context, the financial markets exist as a vast
global network of individuals and financial
institutions that may be lenders, borrowers or
owners of public companies worldwide.
 FINANCIAL MARKETS IN ACTION
• Thanks to the global financial markets, money flows around the world between Investors,
businesses, customers, and stock markets. Investors are not restricted to placing their
money with companies in the country where they live, and big businesses now have
international offices, so money needs to move efficiently between countries and
continents. It is also important for the growth of the global economy that people are able
to invest money outside of their domestic markets. Corporations rely on the financial
markets to provide funds for short-term operations and for new plant and equipment. A
firm may go to the markets and raise financial capital by either borrowing money through
a debt offering of corporate bonds or short-term notes, or by selling ownership in the
company through an issue of common stock.
• When a corporation uses the financial markets to raise new funds, the sale of securities is
said to be made in the primary market by way of a new issue.
• After the securities are sold to the public (institutions and individuals), they are traded in
the secondary market between investors.
• It is in the secondary market that prices are continually changing as investors buy and sell
securities based on their expectations of a corporation’s prospects. It is also in the
secondary market that financial managers are given feedback about their firm's
performance. Those companies that perform well and are rewarded by the market with
high priced securities have an easier time raising new funds in the money and capital
markets than their competitors. They are also able to raise funds at a lower cost.
 FUNCTION OF FINANCIAL MARKETS
Financial markets (bond and stock markets) and
financial intermediaries (banks, insurance companies
among others) have take basic function of getting
people together by moving funds from those who have
a surplus of funds to those who have a shortage of
funds. Well functioning financial markets and financial
intermediaries are crucial to our economic health.
Indeed, when the financial system breaks down, as it
has in Europe and in Southeast Asia recently, severe
economic hardship results.
Discussion:
• Those who have savings and are lending funds (the lender - savers), are
at the left and those who must borrow funds to finance their spending
(the borrowers- spenders), are at the right.
• The principal lender-savers are households, but business enterprises and
the government as well as foreigners and their government, sometimes
also find themselves with excess funds and so lend them out.
• The most important borrower-spenders are businesses and the
government (particularly the material government) but households and
foreigners also borrow to finance their purchases of cars, furniture's and
houses.
• The arrows show that funds flow from lendersavers to borrower-
spenders, both directly and indirectly.
• Funds flow from lenders to borrowers indirectly through financial
intermediaries such as banks or directly through financial markets, such
as the Philippine Stock Exchange.
 WHAT FINANCIAL MARKETS DO
1. Raising capital.
2. Commercial transactions.
3. Price setting.
4. Asset valuation.
5. Arbitrage.
6. Investing.
7. Risk management
 WHAT FINANCIAL MARKETS DO
1.Raising capital. Firms often require funds to build new facilities,
replace machinery or expand their business in other ways. Shares,
bonds and other types of financial instruments make this possible.
The financial markets are also an important source of capital for
individuals-who wish to buy homes or cars, or even to make credit-
card purchases.
 WHAT FINANCIAL MARKETS DO
2.Commercial transactions. As well as long-term capital, the financial
markets provide the grease that makes many commercial
transactions possible. This includes such things as arranging payment
for the sale of a product abroad, and providing working capital so
that a firm can pay employees if payments from customers run late.
 WHAT FINANCIAL MARKETS DO
3.Price setting. The value of an ounce of gold or a share of stock is no
more, and no less, than what someone is willing to pay to own it.
Markets provide price discovery, a way to determine the relative
values of different items, based upon the prices at which individuals
are willing to buy and sell them.
 WHAT FINANCIAL MARKETS DO
4. Asset valuation. Market prices offer the best way to determine the
value of a firm or of the firm's assets, or property. This is important
not only to those buying and selling businesses, but also to
regulators. An insurer, for example, may appear strong if it values the
securities it owns at the prices it paid for them years ago, but the
relevant question for judging its solvency is what prices those
securities could be sold for if it needed cash to pay claims today.
 WHAT FINANCIAL MARKETS DO
5. Arbitrage. In countries with poorly developed financial markets,
commodities and currencies may trade .at very different prices in
different locations. As traders in financial markets attempt to profit
from these divergences, prices move towards a uniform level, making
the entire economy more efficient.
 WHAT FINANCIAL MARKETS DO
6. Investing. The stock, bond and money markets provide an
opportunity to earn a return on funds that are not needed
immediately, and to accumulate assets that will provide an income in
future.
 WHAT FINANCIAL MARKETS DO
7. Risk management. Futures, options and other derivatives
contracts can provide protection against many types of risk, such as
the possibility that a foreign currency will lose value against the
domestic currency before an export payment is received. They also
enable the markets to attach a price to risk, allowing firms and
individuals to trade risks so they can reduce their exposure to-some
while retaining exposure to others.
 STRUCTURE OF FINANCIAL MARKETS
Funds in a financial market can be obtained by a firm or an individual
in two ways.

1. debt instrument
2. equity instruments
1. Debt instrument - is a contract to make fixed peso payments at
regular intervals (interest and principal) until a specified date
(maturity date).

- Common method for raising funds: Issue a debt instrument (e.g.,

bond or mortgage).
- Maturity is the number of years until the instrument expires.
- Short-term debt: Maturity less than a year.
- Intermediate-term debt: Maturity between one and ten years.
- Long-term debt: Maturity of ten years or longer.
2. Equity instruments - provide claims to share in a business's net income and
assets.
- Second method of raising funds: Issue equity instruments (common or ordinary
stock).
- Ownership of one share of common stock represents a proportionate ownership
of net income and assets.
- Equities make periodic payments (dividends) but have no maturity date,
considered long-term securities.
- Equity ownership comes with voting rights on important firm issues and the
election of directors.
- Disadvantage of owning equities: Equity holders are residual claimants; debt
holders get paid before equity holders.
- Advantage of equities: Direct benefits from increased profitability or asset value
because of ownership rights. Debt holders receive fixed payments.
The following markets are of most interest to the
financial manager:
The functions of the financial market serves
for debt and equity securities can be
categorized into:
1. Primary Market
2. Secondary Market (Stock Market or
Exchange. )
a. The Organized Stock Exchange
b. The Over-the-Counter (0TC) Exchange.
 1. Primary Market
- Primary Market: Involves the initial/ original sale of
securities by governments and corporations.
- Often conducted privately, not widely known to the
public.
- In a primary market transaction, the seller is the
corporation or government.
- The purpose of these transactions is to raise funds
for the selling corporation or government.
- Corporations engage in two types of primary market
transactions, public offerings and private placements.
 2. Secondary Market (Stock Market or Exchange. )
- The secondary market is often referred to as the
stock market or exchange.
- After the initial sale to the public, securities can be
traded in the secondary market.
- Securities brokers and dealers are essential for the
functioning of the secondary market.
- Brokers act as intermediaries, connecting buyers
with sellers of securities.
- Dealers facilitate transactions by buying and selling
securities at stated prices.
 2. Secondary Market (Stock Market or Exchange. )
a. The Organized Stock Exchange

a. The Organized Stock Exchange

- The stock exchanges will have a physical
location where stocks buying and selling
transactions take place in the stock exchange
floor (e.g., Philippine Stock Exchange, New
York Stock Exchange, Japan Nikkei, Shanghai
Components, NASDAQ, etc.)
 2. Secondary Market (Stock Market or Exchange. )
b. The Over-the-Counter (0TC) Exchange.
b. The Over-the-Counter (0TC) Exchange.
- Over-the-counter (OTC) markets are where shares, bonds, and money
market instruments are traded.
- OTC markets use a computerized system with screens and phones for
trading.
- NASDAQ is an example of an OTC market where dealers use computers
to buy and sell stocks.
- Dealers in OTC markets match buy and sell orders from investors.
- Dealers keep an inventory of stocks they trade to facilitate matching
orders.
- While many common stocks are traded over the counter, the largest
corporations typically have their shares traded on organized stock
exchanges.