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Bibliography
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Economica, 1997. – P.127- 135.
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1.1. Concept and structure of the financial market
Any national economy, regardless of its level of development, is characterized by
the existence and operation of specialized markets, where they meet and set, a free or
controlled, supply and demand for financial assets, needed for creating resources for
increasing production of goods and services within firms. In financial economics financial
assets circuit occurs between bidders set of funds (investors) and set their users to achieve
the only goal: satisfying economic needs, which should be completed with profit.
Investors are those who made investments by placing funds for their recovery, and users
are those who mobilize funds to finance their own economic activity. Meanwhile, a
relationship arises feedback from initial users of funds to investors by distributing profits
made from development of financial resources. In a market economy, profit sharing may
however be substituted at any risk distribution if unprofitable use of the funds were
transferred. Transactions between the two categories of participants in the financial flow
are achieved through financial markets.
Financial market is an institution or arrangement to finance the purchase or sale of
goods and services which are called financial assets.
The asset is any form of property that is priced (value), achievable through market
exchange. In the nature of the recovery process assets are of two types: real and financial.
Real assets consist of tangible assets (tangible assets - land, buildings, supplies of
equipment, stocks of materials, products, etc.), intangible property (intangible assets -
patents, trade marks etc.. ) which entered the economic circuit, generate future revenues as
profits, rents, etc..
Financial assets are embodied in the documents (securities or into the account),
which establishes (determine) the holder of the entitlements and rights of its future
revenues from the exploitation of those assets as interest and dividends. Financial assets
according to a particular institution (ex. banks) which facilitates recovery by users are
grouped in banking and non banking assets.
Banking assets resulting from banks and similar institutions operations and it’s
characterized by lack of trade, future income as interest and high level of safety (low risk).
Non-bank financial assets are derived from investment operations and it’s
characterized by marketability, future income as interest, dividends and low safety (high
risk).
Market generally means the place or all means of communication that allows sellers
and buyers to inform each other about the nature of existing assets (real, financial) and
prices required or offered for concluding a transaction. From the definition, the first
element is identifying the nature of asset market.
In economics, a financial market is a mechanism that allows people to easily buy
and sell (trade) financial securities (such as stocks and bonds), commodities (such as
precious metals or agricultural goods), and other fungible items of value at low transaction
costs and at prices that reflect the efficient market hypothesis.
Financial markets have evolved significantly over several hundred years and are
undergoing constant innovation to improve liquidity.
Both general markets (where many commodities are traded) and specialized markets
(where only one commodity is traded) exist. Markets work by placing many interested
buyers and sellers in one "place", thus making it easier for them to find each other. An
economy which relies primarily on interactions between buyers and sellers to allocate
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resources is known as a market economy in contrast either to a command economy or to a
non-market economy such as a gift economy.
In finance, financial markets facilitate--
• The raising of capital (in the capital markets);
• The transfer of risk (in the derivatives markets);
• International trade (in the currency markets)
--and are used to match those who want capital to those who have it.
DEFINITION
The term financial markets can be a cause of much confusion.
Financial markets could mean:
1. organizations that facilitate the trade in financial securities. i.e. Stock exchanges
facilitate the trade in stocks, bonds and warrants.
2. the coming together of buyers and sellers to trade financial securities. i.e. stocks
and shares are traded between buyers and sellers in a number of ways including: the use
of stock exchanges; directly between buyers and sellers etc.
Def . “Financial market includes all relations involving the issuance, circulation,
exchange and storage of money, made directly through its special instruments to support
economic and social activity throughout the capital needed for the operation and
development of production of goods and services or financial market is the mechanism by
which assets are issued and placed in the economic cycle”.
Def . “Financial market is the place or all means of communication which facilitate
the sale and purchase of non-bank financial asset at the prices formed on the basis of
demand-supply and the influence of economic, financial, monetary, psychological and
techniques factors”.
Specialized literature defines financial market as:
The place where capital owners (for various periods of time) meet people who need
such capital to perform different activities, for commercial, private or public
purposes;
Place where capital supply meets capital demand;
The entirety of relations and mechanisms through which the disposable and
dispersed capital of the economy are offered to entities soliciting funds;
An organized market of capital transfers from those who have a surplus of capital to
these who need capital.
In terms of assets is negotiated and the mechanism by which they are placed in the
economic cycle, financial market consists of three major sectors, set up as separate
markets:
1. Banking market.
2. Money Market
3. Capital market
Piaţa financiară
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Piaţa bancară Piaţa de capital Piaţa monetară
The capital market is the market for securities, where companies and governments
can raise long-term funds. The capital market includes the stock market and the bond
market. Financial regulators, such as the U.S. Securities and Exchange Commission,
oversee the capital markets in their designated countries to ensure that investors are
protected against fraud. The capital markets consist of the primary market, where new
issues are distributed to investors, and the secondary market, where existing securities are
traded.
The primary is that part of the capital markets that deals with the issuance of new
securities. Companies, governments or public sector institutions can obtain funding
through the sale of a new stock or bond issue. This is typically done through a syndicate of
securities dealers.
Features of primary markets are:
• This is the market for new long term capital. The primary market is the market
where the securities are sold for the first time. Therefore it is also called New Issue Market
(NIM).
• In a primary issue, the securities are issued by the company directly to investors.
• The company receives the money and issues new security certificates to the
investors.
• Primary issues are used by companies for the purpose of setting up new business or
for expanding or modernizing the existing business.
• The primary market performs the crucial function of facilitating capital formation in
the economy.
• The new issue market does not include certain other sources of new long term
external finance, such as loans from financial institutions. Borrowers in the new issue
market may be raising capital for converting private capital into public capital; this is
known as ‘going public’.
The secondary market is the financial market for trading of securities that have
already been issued in an initial private or public offering. Alternatively, secondary
market can refer to the market for any kind of used goods. The market that exists in a new
security just after the new issue, is often referred to as the aftermarket. Once a newly
issued stock is listed on a stock exchange, investors and speculators can easily trade on the
exchange, as market makers provide bids and offers in the new stock.
In the secondary market, securities are sold by and transferred from one investor or
speculator to another. It is therefore important that the secondary market be highly liquid
(originally, the only way to create this liquidity was for investors and speculators to meet
at a fixed place regularly; this is how stock exchanges originated).
Secondary marketing is vital to an efficient and modern capital market.
Fundamentally, secondary markets mesh the investor's preference for liquidity (i.e., the
investor's desire not to tie up his or her money for a long period of time, in case the
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investor needs it to deal with unforeseen circumstances) with the capital user's preference
to be able to use the capital for an extended period of time. For example, a traditional loan
allows the borrower to pay back the loan, with interest, over a certain period. For the
length of that period of time, the bulk of the lender's investment is inaccessible to the
lender, even in cases of emergencies. Likewise, in an emergency, a partner in a traditional
partnership is only able to access his or her original investment if he or she finds another
investor willing to buy out his or her interest in the partnership. With a securitized loan or
equity interest (such as bonds) or tradable stocks, the investor can sell, relatively easily,
his or her interest in the investment, particularly if the loan or ownership equity has been
broken into relatively small parts. This selling and buying of small parts of a larger loan or
ownership interest in a venture is called secondary market trading.
Under traditional lending and partnership arrangements, investors may be less likely
to put their money into long-term investments, and more likely to charge a higher interest
rate (or demand a greater share of the profits) if they do. With secondary markets,
however, investors know that they can recoup some of their investment quickly, if their
own circumstances change.
The multitude of the types of traded assets on the capital market, the different
organization of these markets and diversity of mechanisms of issuance and
commercialization of specific products, brought to market structuring by several criteria.
According to the transaction object (or to the nature of the traded asset):
a) Stock market - is the market where common and preferred stocks of
joint stock companies are traded.
b) Bond market – also called market of debt instruments, is the place
where debt securities of any type (bonds, treasury bonds, etc) are traded.
c) Futures market – on this market the securities are traded for a future
delivery and payment. The used security is the “future contract”
d) Options market - the market where securities are traded for a future
conditional delivery. The negotiated security is the “option contract”
According to the way of financial asset’s price formation:
a) auction market – transactioning is held by a third party, according to the
accumulation in prices on the received orders to bye or sell a certain security;
b) negotiation’s market – the market where purchasers and sellers negotiate between
them the price and amount of securities, directly or through a broker/dealer.
According to the moment of completion of transaction:
a) spot market (sometimes called cash market or market with cash payments) – here
securities are trade with an immediate payment and delivery. “immediate” is
defined differently on each market and its varies between a day and a week.
b) Fixed-term market – the transaction completion, meaning the delivery of securities
and payment is performed on a future date, fixed in advance.
According to the way of market organization:
a) organized stock exchange – a market with fixed transaction rules. It functions in an
office with a physical central location where the transactions are generally
performed through auctions.
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b) Over-the-counter – a market located in brokers, dealers’ and securities’ issuers’
offices. Due to the fact that transactions are performed in different transactions this
is a market that uses phone, fax, telex or computer.
According to the duration:
a) discontinuous markets – the prices’ formation is generally based on fixing;
b) continuous markets – transactions can take place anywhere and at any time.
c) Mixed markets – are continuous markets which also host discontinuous transactions.
At the issuing entities level, capital demand is generally motivated by two big
categories of determining factors, which divide it in:
Structural demand, resulted from the need of financing large investments,
support of company’s development or creation of new businesses, entering new
markets or in connected domains or new types of activity which imply attracting
reimbursable in medium or long terms funds or reimbursable participating in
future profits;
Cyclical demand, depending on factors linked to credit limits on money market,
budgetary and payment balances deficits etc, generally resulted from transitory
needs which imply attraction of supplementary financial resources from medium
and long term.
Demand carriers from altogether the category “issuers” which implies a very
versatile typology:
Companies borrow money to aid short term or long term cash flows. They also
borrow to fund modernization or future business expansion.
Governments often find their spending requirements exceed their tax revenues. To
make up this difference, they need to borrow. Governments also borrow on behalf of
nationalized industries, municipalities, local authorities and other public sector bodies.
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Governments borrow by issuing bonds. Government debt seems to be permanent.
Indeed the debt seemingly expands rather than being paid off. One strategy used by
governments to reduce the value of the debt is to influence inflation.
Municipalities and local authorities may borrow in their own name as well as
receiving funding from national governments. In the UK, this would cover an authority
like Hampshire County Council.
Public Corporations typically include nationalized industries. These may include
the postal services, railway companies and utility companies.
Many borrowers have difficulty raising money locally. They need to borrow
internationally with the aid of Foreign exchange markets.
Capital supply is provided from the economies of those who have big profits,
after they satisfy their consumer need.
These funds can be kept in a liquid form, which is an alternative that does not bring
any additional profit, besides that of having those economies immediately and without any
additional costs, or they can be placed directly or indirectly in economic activities, the
money being transformed into financial assets.
Many individuals are not aware that they are lenders, but almost everybody does
lend money in many ways. A person lends money when he or she:
• puts money in a savings account at a bank;
• contributes to a pension plan;
• pays premiums to an insurance company;
• invests in government bonds; or
• invests in company shares.
Companies tend to be borrowers of capital. When companies have surplus cash that
is not needed for a short period of time, they may seek to make money from their cash
surplus by lending it via short term markets called money markets.
There are a few companies that have very strong cash flows. These companies tend
to be lenders rather than borrowers. Such companies may decide to return cash to lenders.
Alternatively, they may seek to make more money on their cash by lending it (e.g.
investing in bonds and stocks.)
Capital demand and supply meeting leads to formation of a new rate or quotation,
which is one of the essential forms of distribution of both – obtained profits and risks
related to the stock exchange. A specific peculiarity of the stock exchange implies that
capital demand and supply meet indirectly on this market – through professional
participants.
Combining the above methods for categorization, the main instruments can be
organized into a matrix as follows:
Asset Class Instrument Type
Securities Other cash Exchange- OTC derivatives
traded
derivatives
Debt (Long Bonds Loans Bond futures Interest rate swaps
Term) Options on bond Interest rate caps and
>1 year futures floors
Interest rate options
Exotic instruments
Debt (Short Bills, e.g. T-Bills Deposits Short term Forward rate agreements
Term) Commercial paper Certificates of interest rate
<=1 year deposit futures
Equity Stock N/A Stock options Stock options
Equity futures Exotic instruments
Foreign N/A Spot foreign Currency futures Foreign exchange options
Exchange exchange Outright forwards
Foreign exchange swaps
Currency swaps
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