Financial markets and instruments

Financial markets and instruments

The Financial Markets and Financial Instruments course focuses on the features and use of different types of financial instruments including stocks, bonds and derivatives. They cover financial intermediation, market infrastructure and regulation.

What is Financial market ?
A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets as commodities.

The term “market” is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This may be a physical location (such as the New York Stock Exchange (NYSE), London Stock Exchange (LSE), JSE Limited (JSE), Bombay Stock Exchange (BSE) or an electronic system such as NASDAQ. Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell the stock from the one to the other without using an exchange.

Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, to stock exchanges. There are also global initiatives such as the United Nations Sustainable Development Goal 10 which has a target to improve regulation and monitoring of global financial markets

Types of financial markets
Within the financial sector, the term “financial markets” is often used to refer just to the markets that are used to raise finance. For long term finance, the Capital markets; for short term finance, the Money markets. Another common use of the term is as a catchall for all the markets in the financial sector, as per examples in the breakdown below.

>Capital markets which consist of:
Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.
>>Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.
>>Commodity markets, The commodity market is a market that trades in the primary economic sector rather than manufactured products, Soft commodities is a term generally referred as to commodities that are grown, rather than mined such as crops (corn, wheat, soybean, fruit and vegetable), livestock, cocoa, coffee and sugar and Hard commodities is a term generally referred as to commodities that are mined such as gold, gemstones and other metals and generally drilled such as oil and gas.
>>Money markets, which provide short term debt financing and investment.
>>Derivatives markets, which provide instruments for the management of financial risk.
>>Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.
>>Foreign exchange markets, which facilitate the trading of foreign exchange.
>>Cryptocurrency market which facilitate the trading of digital assets and financial technologies.
>>Spot market
>>Interbank lending market

Analysis of financial markets
Much effort has gone into the study of financial markets and how prices vary with time. Charles Dow, one of the founders of Dow Jones & Company and The Wall Street Journal, enunciated a set of ideas on the subject which are now called Dow theory. This is the basis of the so-called technical analysis method of attempting to predict future changes. One of the tenets of “technical analysis” is that market trends give an indication of the future, at least in the short term. The claims of the technical analysts are disputed by many academics, who claim that the evidence points rather to the random walk hypothesis, which states that the next change is not correlated to the last change. The role of human psychology in price variations also plays a significant factor. Large amounts of volatility often indicate the presence of strong emotional factors playing into the price. Fear can cause excessive drops in price and greed can create bubbles. In recent years the rise of algorithmic and high-frequency program trading has seen the adoption of momentum, ultra-short term moving average and other similar strategies which are based on technical as opposed to fundamental or theoretical concepts of market behaviour.

The scale of changes in price over some unit of time is called the volatility. It was discovered by Benoit Mandelbrot that changes in prices do not follow a normal distribution, but are rather modeled better by Lévy stable distributions. The scale of change, or volatility, depends on the length of the time unit to a power a bit more than 1/2. Large changes up or down are more likely than what one would calculate using a normal distribution with an estimated standard deviation.
Financial market slang

>Poison pill, when a company issues more shares to prevent being bought out by another company, thereby increasing the number of outstanding shares to be bought by the hostile company making the bid to establish majority.
>>Bips, meaning “bps” or basis points. A basis point is a financial unit of measurement used to describe the magnitude of percent change in a variable. One basis point is the equivalent of one hundredth of a percent. For example, if a stock price were to rise 100bit/s, it means it would increase 1%.
>>Quant, a quantitative analyst with advanced training in mathematics and statistical methods.
>>Rocket scientist, a financial consultant at the zenith of mathematical and computer programming skill. They are able to invent derivatives of high complexity and construct sophisticated pricing models. They generally handle the most advanced computing techniques adopted by the financial markets since the early 1980s. Typically, they are physicists and engineers by training.
>> IPO, stands for initial public offering, which is the process a new private company goes through to “go public” or become a publicly traded company on some index.
>>White Knight, a friendly party in a takeover bid. Used to describe a party that buys the shares of one organization to help prevent against a hostile takeover of that organization by another party.
>>Round-tripping
>>Smurfing, a deliberate structuring of payments or transactions to conceal it from regulators or other parties, a type of money laundering that is often illegal.
>>Bid–ask spread, the difference between the highest bid and the lowest offer.
>>Pip, smallest price move that a given exchange rate makes based on market convention.
>> Pegging, when a country wants to obtain price stability, it can use pegging to fix their exchange rate relative to another currency.
>>Bearish, this phrase is used to refer to the fact that the market has a downward trend.
>>Bullish, this term is used to refer to the fact that the market has an upward trend.

Functions of financial markets
Intermediary functions: The intermediary functions of financial markets include the following:
Transfer of resources: Financial markets facilitate the transfer of real economic resources from lenders to ultimate borrowers.
Enhancing income: Financial markets allow lenders to earn interest or dividend on their surplus invisible funds, thus contributing to the enhancement of the individual and the national income.
Productive usage: Financial markets allow for the productive use of the funds borrowed. The enhancing the income and the gross national production.
Capital formation: Financial markets provide a channel through which new savings flow to aid capital formation of a country.
Price determination: Financial markets allow for the determination of price of the traded financial assets through the interaction of buyers and sellers. They provide a sign for the allocation of funds in the economy based on the demand and to the supply through the mechanism called price discovery process.
Sale mechanism: Financial markets provide a mechanism for selling of a financial asset by an investor so as to offer the benefit of marketability and liquidity of such assets.
Information: The activities of the participants in the financial market result in the generation and the consequent dissemination of information to the various segments of the market. So as to reduce the cost of transaction of financial assets.
Financial Functions
Providing the borrower with funds so as to enable them to carry out their investment plans.
Providing the lenders with earning assets so as to enable them to earn wealth by deploying the assets in production debentures.
Providing liquidity in the market so as to facilitate trading of funds.
Providing liquidity to commercial bank
Facilitating credit creation
Promoting savings
Promoting investment
Facilitating balanced economic growth
Improving trading floors

Components of financial market
Based on market levels
Primary market: A primary market is a market for new issues or new financial claims. Therefore, it is also called new issue market. The primary market deals with those securities which are issued to the public for the first time.
Secondary market: A market for secondary sale of securities. In other words, securities which have already passed through the new issue market are traded in this market. Generally, such securities are quoted in the stock exchange and it provides a continuous and regular market for buying and selling of securities.

Simply put, primary market is the market where the newly started company issued shares to the public for the first time through IPO (initial public offering). Secondary market is the market where the second hand securities are sold (security Commodity Markets).
Based on security types
Money market: Money market is a market for dealing with the financial assets and securities which have a maturity period of up to one year. In other words, it’s a market for purely short-term funds.
Capital market: A capital market is a market for financial assets that have a long or indefinite maturity. Generally, it deals with long-term securities that have a maturity period of above one year. The capital market may be further divided into (a) industrial securities market (b) Govt. securities market and (c) long-term loans market.
Equity markets: A market where ownership of securities are issued and subscribed is known as equity market. An example of a secondary equity market for shares is the New York (NYSE) stock exchange.
Debt market: The market where funds are borrowed and lent is known as debt market. Arrangements are made in such a way that the borrowers agree to pay the lender the original amount of the loan plus some specified amount of interest.
Derivative markets: A market where financial instruments are derived and traded based on an underlying asset such as commodities or stocks.
Financial service market: A market that comprises participants such as commercial banks that provide various financial services like ATM. Credit cards. Credit rating, stock broking etc. is known as financial service market. Individuals and firms use financial services markets, to purchase services that enhance the workings of debt and equity markets.
Depository markets: A depository market consists of depository institutions (such as banks) that accept deposits from individuals and firms and uses these funds to participate in the debt market, by giving loans or purchasing other debt instruments such as treasury bills.
Non-depository market: Non-depository market carry out various functions in financial markets ranging from financial intermediary to selling, insurance etc.

What is a financial instrument?
Financial instruments are assets that can be traded, or they can also be considered packages of capital that can be traded. Most types of financial instruments provide efficient flow and transfer of capital to worldwide investors. These assets can be cash, a contractual right to deliver or receive cash or any other type of financial instrument, or evidence of one’s ownership of an entity.

Understanding Financial Instruments
Financial instruments can be real or virtual documents that represent a legal agreement involving any kind of monetary value. Equity-based financial instruments represent ownership of the asset. Debt-based financial instruments are a loan that an investor makes to the owner of an asset.

Foreign exchange instruments include a unique third type of financial instrument. There are different subcategories for each type of instrument, such as preferred stock and common equity.

Types of financial instruments
Financial instruments can be divided into two types: Cash instruments and derivative instruments.
>>Cash instruments
The values ​​of cash instruments are directly influenced and determined by the markets. These securities can be easily transferable.
cash instruments may also be deposits and loans agreed upon by borrowers and lenders.

>>Derivative Financial Instruments
The value and characteristics of derivative instruments are based on the underlying components of the vehicle, such as assets, interest rates or indices.
A stock options contract, for example, is a derivative because it derives its value from the underlying stock. An option gives the right, but not the obligation, to buy or sell a stock at a specified price and by a certain date. As the stock price goes up and down, the value of the option also increases albeit not necessarily by the same percentage.
There can be over-the-counter (OTC) or over-the-counter (OTC) derivatives. OTC is a market or process by which securities – not listed on official stock exchanges – are priced and traded.

Types of Asset Classes for Financial Instruments
Financial instruments can also be divided according to the class of assets, which depends on whether they are debt- or equity-based.
debt-based financial instruments
Financial instruments based on short-term debt last for one year or less. Securities of this type come in the form of commercial bills and bonds. Cash of this type can be deposits and certificates of deposit (CD).

Exchange-traded derivatives under short-term debt-based financial instruments can be short-term interest rate futures contracts. OTC derivatives are forward rate agreements.

Financial instruments based on long-term debt last more than a year. Under the stock, these are the bonds. Cash equivalents are loans. Exchange-traded derivatives are bond futures contracts and options on bond futures contracts. OTC derivatives are interest rate swaps, interest rate limits and ceilings, interest rate options, and foreign derivatives.
Equity-Based Financial Instruments
The securities under equity-based financial instruments are shares. Exchange-traded derivatives in this category include stock options and stock futures. OTC derivatives are stock options and exotic derivatives.
special considerations

There are no securities under foreign exchange. The cash equivalent comes in the form of spot foreign exchange, which is the current prevailing rate. Exchange-traded derivatives under foreign exchange are currency futures contracts. OTC derivatives come in the form of foreign exchange options, futures contracts, and foreign currency swaps.