Published by: Nuru
Published date: 07 Feb 2022
Overview of Financial institutions and markets
Overview of Financial institutions and markets
In this topic Overview of Financial institutions and markets, we have described in brief the financial institutions and markets.
Financial institutions are organizations that issue financial claims against themselves for cash. In other words, they are the specialized firms dealing with financial services and facilitating the transfer of funds from savers to users.
For example; they accept cash on different types of deposit accounts and issue the certificate of deposit(CD). And they may use the cash received on account of CD to purchase T-bill and corporate bonds which facilitate the individuals, businesses, and government to generate the supply funds to deficit units. They also work as the intermediaries between saving units and deficit units of the economy.
1. Direct transfers:
It takes place when a business firm sells its securities directly to the savers. In turn, the savers provide their surplus funds as investments into the securities offered by businesses.
2. Indirect transfers through investment bankers
Investment bankers are specialized institutions whose primary job is selling securities issued by businesses to investing public. As, if the issue of securities has to cover wide distribution, direct transfers are not possible.
Investment bankers generally work in two conditions:
On the basis of Best effort selling: they simply work as a distributor of securities on a commission basis. They don't take responsibility if the entire securities are not sold.
Alternatively, on the basis of an underwriting agreement, they guarantee the sale of entire issues, if issues could not be sold, they will purchase all the securities and sells them to the public at the best possible time at the right price.
3. Indirect transfers through a financial intermediary
Funds are supplied from an entity (individuals, corporations, government) to another entity through financial intermediaries such as banks, insurance companies, and mutual funds.
There occur two ways of financing in this method:
a. Private placement: Way of financing in which issuing corporation directly sells its entire securities to a small group of investors.
b. Public Offerings: Way of financing in which issuing corporation sells its securities publicly to investing public in the primary market.
They are listed below:
1. Depository Institutions: Commercial banks, Credit Unions, Savings and Loan Associations, and Mutual Saving Banks
2. Non-depository institutions: Insurance Companies, Pension funds, Finance Companies, and Mutual Funds
The market that deals with transactions of financial instruments and services are called a financial market. It exists in order to bring buyers and sellers of securities and financial services together. It includes wide areas of stocks, bonds, treasury bills, commercial papers including time deposit, certificate of deposits, bankers' acceptance, and so on.
The development of the financial market adds to the liquidity of financial securities. Investors are generally interested to buy those securities for which a market exists.
Types of financial markets:
a. Primary market and Secondary market:
Primary market:
The market for an original issue of securities where all the proceeds from the issue go to the issuer is called the primary market. They are seasoned and unseasoned markets.
Seasoned market deals with an offering of an additional amount of already existing securities.
Unseasoned market refers to the market for the initial offerings of securities to the public called as IPOs(Initial Public Offerings).
Secondary market:
The market that deals with the trading of outstanding securities among investors to investors are called the secondary market. It has two types: Organized stock exchanges, and Over- the counter market.
Organized Stock Exchange refers to the secondary market in which securities are traded under some established norms. Listing of securities is mandatory in this market. Example: Nepal Stock Exchange(NEPSE) is the only organized stock in Nepal. US has New York Stock Exchange(NYSE), and for the UK, it has London Stock Exchange.
Over- the counter market refers to the informal secondary market where no listing of securities is required. US has NASDAQ (National Association of Securities Dealers Automated Quotation) and India has Over-the-Counter Exchange India (OTCEI) as OTC market.
b. Money market and Capital market:
Money market refers to the market that deals with the trading of short-term securities like treasury bills issued by the government, commercial paper or loan issued by corporations, bankers' acceptance, certificate of deposits, promissory notes, bills of exchange, and any others with less than a year of life.
Capital market refers to the market that deals with the trading of long-term securities like common stock, preferred stock, corporate bonds, etc. traded both in the primary and secondary market.
c. Spot markets and Future markets:
The market that deals with the delivery of assets on spot are called spot markets.
The market in which the participants agree today to buy or sell some specified assets at a specified price in some future date is called a future market.
d. National and International markets:
The market where domestic investors and domestic corporations participate as the buyers and sellers of securities is called the national market.
The market where individual and institutional investors can trade financial securities internationally is called an international market.