FINANCIAL MARKETS AND THEIR CLASSIFICATION


Author: Awais Ahmad (comsian027@gmail.com)

Financial Markets are places, where Financial Instruments or Financial Assets are exchanged. Financial Markets can be classified on the basis of the nature of instruments exchanged in the economy.

Classification of Financial Markets:

The following are different types of Financial Markets:

1.      Securities Market

Security Markets are the Financial Markets, where securities are exchanged. Securities are financial instruments that have been created to represent a legal obligation to pay a sum in future in return for the current receipt of vlue. Securities, thus represent the cash or cash equivalent received from another person. Security Markets can be further classified into National Market and International Market.

1.1              National Market

National Markets (also called Local Markets) are those within the boundaries of a nation. National Markets cater to the financial requirements of the local players. Players from the foreign countries are permitted to bring their financial instruments into the National Market, subject to their following the rules and regulations imposed by the nation. Each nation has a regulatory authority, under whose scrutiny financial instruments are exchanged in that country. National/Local Market can also be classified into Domestic Segment and Foreign Segment.

1.1.1        Domestic Segment

The Domestic Segment caters exclusively to firms registered in a country. The country’s regulatory authority controls the domestic market. Based on the economic performance of the country, the Domestic Markets are also called Advanced Markets and Emerging Markets. Advanced Markets are usually markets in nations that are economically sound and have also progressed technologically. Emerging Markets are those in developing countries, whose economic progress is forward looking. Domestic Market can also be subdivided into Money Market and Capital Market.

                                                              i.      Money Market

Money Markets are short term Debt markets. Debt is a fixed income security and represents the borrowing of a market player. Money Markets are mostly wholesale markets for financial instruments. Money Market can be classified into the following types:

a)      Call Market

Call Market is a money market, and is one, where Call/Notice Money is borrowed or lent for a very short period. If the money is lent or borrowed for a period of up to 14 days, it is called Notice Money. On the other hand, if the money is borrowed or lent for a period more than 14 days, it is called Call Money. Intervening Holidays and/or Sundays are excluded for computing the holiday duration. No Collateral Security is required to cover these transactions.

b)     T-Bill Market

The Treasury Bill or T-Bill Market is one, where Treasury Bills are exchanged. Treasury/T-Bills are short term (up to one year) borrowing instruments of the government. They are the lowest risk category instruments, maturing in a short duration. A considerable part of the government’s borrowings happen through T-Bills of various maturities.

c)      Inter-Bank Market

The Inter-Bank Market is usually for deposits of maturity beyond 14 days and up to three months. The specified entities are not allowed to lend beyond 14 days.

d)     Certificates of Deposit Market

After T-Bills, the lowest risk category investment option is the Certificate of Deposit (CD) issued by banks and financial institutions. A CD is a negotiable promissory note, secure and short term (up to one year) in nature. They are issued and purchased in CD Markets and for a purpose to augment funds by attracting deposits from corporations, high net worth individuals, trusts and others.

e)      Ready Forward Contracts (Repo) Market

Repo (abbreviated from Repurchase Agreement) Market is one, where the same securities are sold and repurchased by two parties. This type of transaction is called Repo Transaction according to seller’s point of view and Reverse Repo Transaction from the buyer’s point of view of the security. When seller sells the security with the objective of repurchasing it, it is called Repo. On the other hand, when the buyer of the same security purchases it with a view to resell it, it is called Reverse Repo. This phenomenon can be described as in the following:

Repo = Seller sells the same security + Commitment to Repurchase it

Reverse Repo = Buyer buys the same security + Commitment to resell it

The Future Date and Price are mutually decided by buyer and seller of the same security. Whether the transaction is Repo or Reverse Repo depends on which party initiated it. Two terms are necessary to define while discussing Repo Transactions. Repo Period is the period mutually decided by buyer and seller of the security for which the money is borrowed by the seller by selling it. Repo Rate is the Rate of Interest mutually agreed by seller and buyer for the selling and repurchasing of the same security for a time period (Repo Period) in Repo Market. Repos help banks to invest surplus cash. It helps the investors to achieve money market surplus with sovereign risk. It helps the borrower to raise funds at better rates.

f)       Commercial Paper (CP) Market

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. CP enables highly rated corporate entities to obtain sources of short-term borrowings and provides and additional instrument to investors. Such instruments are traded in CP markets.

g)      Inter-corporate Deposit (ICD) Market

Inter-Corporate Deposit (ICD) is an unsecured load, extended by one corporate to another. Existing mainly as a refuge for low-rated corporations, this market allows a fund-surplus corporate to lend to another corporate.

h)     Commercial Bill Market

Bills of Exchange are negotiable instruments drawn by seller (drawer) of goods on the on the buyer (drawee) of the goods for the value of the goods delivered. These bills are called Trade Bills. Trade Bills are called Commercial Bills when they are accepted by commercial banks and are traded in Commercial Bill Market.

                                                            ii.      Capital Markets

Capital Markets exchange both long-term fixed claim securities and residual/equity claim securities. The main economic role of a Capital Market is to match players, who have excess funds to players, who are in need of funds. These markets can be classified into Debt Markets and Equity Markets.

a)      Debt Market

Financial Instruments that have a fixed income claim and have a maturity of more than one year are traded in Debt Market. Debt Market can also be classified into Primary and Secondary Markets.

b)     Equity Market

Equity Instrument bestows ownership on the holder of the security. Equity hence implies ownership rights in the corporate entity that has issued the instruments to the public. Equity Market can also be subdivided into Primary Markets and Secondary Markets.

Primary Markets

The Primary Markets are the doorway for corporate enterprises to enter the Capital Market. The issues of new/fresh/subsequent securities are offered to the public through the primary markets.

Secondary Markets

The Secondary Market refers to the exchange of securities that have been listed through the Primary Market. Such markets offer tradability to the financial instruments. Secondary Markets can be subdivided into Spot Markets and Derivative Markets.

Spot Market

Spot Markets denote the currency trading price of financial instruments. In the context of time, the Spot Markets may range between one day, two days or a week. The transactions in the Spot Markets are settled are settled immediately, that is, on the immediate settlement date.

Derivative Markets

Unlike the Spot Markets, Derivative Markets are Futures Market. Trade takes place here with the intention to settle it at a later date. The trade in Derivative Markets is based on Futures Contract, which is an agreement by one participant to either buy or sell a financial instrument at a predetermined date in the future at a predetermined price.

1.1.2        Foreign Segment

Each nation, besides its exclusive domestic market allows firms registered outside the country to participate in its economic activities. This is termed as Globalization or Opening Up of the Economy. This is known as Foreign Participation in a National Market.

1.2              International Market

International Markets are usually referred to as Offshore Markets. This concept includes opening the National Market to other group countries.

2.      Currency/Forex Market

The Foreign Exchange or Forex Market is on international currency exchange market. It caters the need of International Mobility of funds. The main players in Forex Market are dealers, who are regulated by the specific regulatory authority of the country. Fig. 3 shows the classification of Financial Markets.

References:

Handouts – Investment Analysis and Portfolio Management

Lecutres by Mr. Wasim Anwar regarding Financial Management

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