Question

Discuss the types of financial institutions involved in the financial market and the markets they serve. Be sure to distinguish between the primary and secondary markets and the money and capital markets.

● Discuss what it means when it is said that markets are “efficient” and include an explanation of whether this seems true today.

● Discuss the role of regulators in the financial market. Your discussion should include information about the importance of accounting as a key to the success of those regulators.

300 words

Answer 1

The different types of financial institutions involved in the financial market are as follows :-

1.) Exchanges – Exchanges provide a venue where the traders can meet. Exchanges sometimes act as brokers by providing electronic order matching. Exchanges regulate the members and require firms that are listed on the exchanges to provide timely disclosures.
2.) Investment Banks – Investment Banks sell common stock, preferred stock and debt securities to investors and also provide advice to the firms regarding M&A and fund raising.
3) Brokers – They help client buy and sell securities by finding counter parties to trade in a cost efficient manner.
4) Dealers – Dealers facilitate trade by buying or selling from their own inventory and make profits with the differences in the bid & ask spreads.
5) Insurance Companies – Insurance companies are intermediaries that charge a premium from you in return of the risk reduction that they offer to the insured.
6) Depository Institutions – Depository Institutions include banks, credit unions and savings and loans. The basic business model is to pay interest on customer deposits and provide facilities like checking accounts, debit and credit card facilities etc.
7) Clearinghouse – Clearinghouses also act as intermediaries between buyers and sellers in the financial markets and provide escrow services and guarantees of contract settlement.
8) Custodians - Custodians hold market integrity by holding client securities and preventing their losses due to fraud , theft or other forms of losses.

The difference between different types of markets are as given below :-

1.) Primary Capital Market – The primary market serves the sale of newly issues shares . New issue is either in the form of firms already serving the market and is called secondary issue or issue by firms that are not yet publically trading called IPO.
2) Secondary Markets – Secondary markets refer to the markets where securities get traded after their initial issuance.
3) Money Market – Money market is that part of the financial market which deals in the buying and selling of loan securities for a period of less than 365 days.
4) Capital Markets – Capital markets facilitate the buying and selling of long term equity and debt securities and channel the wealth from the savers to companies and governments.

When it is said that the markets are efficient, it is meant that the current price of the security is one which the security fully, quickly and rationally reflects all available information about the market. So the expected return on the stock is just the equilibrium return of the market forces of demand and supply for the risk that the investors undertake and the security prices are unbiased estimators of their values and you cannot beat the market.

This does not seem today specially in the developing markets because of the huge discrepancies between the prices and prices and are biased estimators of their values because of variables like lacl of education, regulation, technology etc. but in case of the developed markets we are gradually moving towards efficiency because of the development in same variables referred above.

Market regulators help in minimizing the following issues in financial markets :-

1.) Fraud & Theft – Timely disclosures and regulating activities of parties like investment managers help in reducing the problem of theft & fraud faced by investors.
2.) Insider Trading- They help reduce insider trading by imposing huge penalties on the market participants in case found so and thus help in increasing efficiency.
3) Defaults- They help in parties to honor their obligations in the market.
4)Costly Information – They help in obtaining costly information for very less rates from market participants to investors and increasing efficiency.

Accounting is important for the key success for these regulators because financial statements like income statements, balance sheet etc represent the true picture of the entities and different parties can misrepresent their results by different accounting policies or manipulations so to reduce this different accounting bodies like FASB, ICAI etc have been set us which set up and govern these practices to reduce the misinterpretation and also impose heavy fines on the defaulters.

I hope this makes sense :)
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