Question

What are and how financial markets are organized?

Answer 1

Financial markets mainly divided into 3 parts.

1. Capital Market
2. Money Market
3. Foreign Exchange Market

1. Capital Market:-  It is a market for long term securities. Here 'securities' mean tradeable financial assets and long term mean it has a maturity period of more than 1 year. This capital market is also divided into 2 parts,

a) Primary Market:- It is the market for the new issue. It is called IPO or Initial Public Offering.

b) Secondary Market:- After issuing, stocks are traded by stock brokers. This market is called the secondary market. The stock exchange is a secondary market.

Instruments of the capital market are followed,

• Fixed income securities:- This types of securities have a fixed return after the maturity period. Like Bonds, Debentures and Preference Shares. Bonds are debt security. It is issued by the government. Government raises capital by issuing bonds in the market. Individuals and organizations buy these bonds. Bonds have a coupon rate(interest rate) written on it. In the USA they are generally having face value $1000 or $100. That means anyone can buy multiple of this amount. They generally pay yearly or half-yearly. Debentures are the same as Bonds, but these are issued by companies. That's why these are having a risk amount attach with it. Preference shares are hybrid securities. These are having both debt and equity characteristics. Preference share carries a fixed rate of dividend.
• Equity Shares:- Equity shares represent ownership in an organization. Equity shareholders are the ultimate risk bearer in an organization. When there are having a net income, first preference shareholders will get their fixed rate; after whatever left, it will go to the shareholders as a dividend. They don't have a fixed amount of return. Many times organizations don't give a dividend, they keep it for future proceeding.
• Mutual Fund Units:- These are investment institutions. They collect money from individuals by issuing mutual fund units and invest those in the market. When they get a return, pays a dividend to the mutual fund unitholder.
• Derivative Securities:- It is a contract between two parties with an underlying asset. Two very popular derivatives are Future contracts and Options Contracts. A future contract is an agreement between two parties to exchange a specified asset at a specified date and price. In an option contract, there is a legal right to buy(Call) or sell(Put) an asset at a specified date and price.

2. Money Market:- It is a market for short term securities. The 'short term' means the maturity of less than 1 year. This market is hugely used by companies to meet their working capital finance. When there is a short term deficit or surplus, organizations used to borrow or invest in this market. Here the risk is very less. Some important instruments of the money market are -   

• Treasury Bills (Issued by governments for short term capital raising)
• Commercial Papers (Issued by top private organizations with higher credit rating)
• Certificate of Deposit (Promissory note issued by the bank)

3. Foreign Exchange Market:-  This is a market where participants buy, sell and exchange currencies of different countries. Participants of this market are Traders, Banks, MNCs, Foreign exchange brokers, central banks etc.