FINANCIAL MARKETS AND PRODUCTS

• Financial markets – markets in which funds are

transferred from people who have an excess of
available funds to people who have a shortage.
Financial markets are (arenas) structures
through which funds flow.
• They are crucial to promoting greater economic
efficiency by channeling funds from people who do
not have a productive use for them to those who
• Indeed, well-functioning financial markets are a key
factor in producing high economic growth, and poorly
performing financial markets are one reason that many
countries in the world remain desperately poor.
• Activities in financial markets also have direct effects on
personal wealth, the behaviour of businesses and
consumers, and the cyclical performance of the
economy.
• Financial markets can be distinguished into: (1) primary versus
secondary markets and (2) money versus capital markets.
Primary markets – markets in which corporations raise funds
through new issues of financial instruments, such as stocks and
bonds.
• The fund users have new projects or expanded production
needs, but do not have sufficient internally generated funds to
support these needs. Thus, the fund users issue securities in the
primary markets to raise additional funds.
• Primary market financial instruments include issues of
equity by firms initially going public (e.g., allowing their
equity (shares) to be publicly traded on stock markets for
the first time). These first-time issues are usually referred
to as initial public offerings (IPOs).
• Primary market securities also include the issue of
additional equity or debt instruments of an already publicly
traded firm.
• Secondary markets – markets that trade financial instruments once
they are issued. Once financial instruments such as stocks are issued in
primary markets, they are then traded (that is, rebought and resold) in
secondary markets.
• Buyers of secondary market securities are economic agents
(consumers, businesses, and governments) with excess funds. Sellers of
secondary market financial instruments are economic agents in need of
funds.
• These markets therefore save economic agents the search and other
costs of seeking buyers or sellers on their own.
 Capital Market Versus Money
Market

• Money markets – markets that trade debt

securities or instruments with maturities of one
year or less.
• In the money markets, economic agents with
short-term excess supplies of funds can lend
funds (i.e., buy money market instruments) to
economic agents who have short-term needs or
shortages of funds (i.e., they sell money market
 Money Market Instruments
• Treasury bills – short-term obligations issued by
the government.
• Federal funds – short-term funds transferred
between financial institutions usually for no more
than one day.
• Repurchase agreements – involving the sale of
securities by one party to another with a promise
by the seller to repurchase the same securities
from the buyer at a specified date and price.
• Commercial paper – short-term unsecured
promissory notes issued by a company to raise
short-term cash.
• Negotiable certificate of deposit – bank-
issued time deposit that specifies an interest rate
and maturity date and is negotiable, (i.e., can be
sold by the holder to another party).
• Banker’s acceptance – time draft payable to a
• Capital markets – markets that trade equity
(stocks) and debt (bonds) instruments with
maturities of more than one year.
• The major suppliers of capital market securities
(or users of funds) are corporations and
governments. Households are the major suppliers
of funds for these securities.
 Capital Market Instruments

• Corporate stock – the fundamental ownership

claim in a public corporation.
• Mortgages – loans to individuals or businesses to
purchase a home, land, or other real property.
• Corporate bonds – long-term bonds issued by
corporations.
• State and local government bonds – long-term
bonds issued by state and local governments.
• Bank and consumer loans – loans to
commercial banks and individuals.
• Derivative Security Markets – the markets in which
derivative securities are traded. A derivative security
– a financial security (such as a futures contract, option
contract, swap contract, or mortgage-backed security)
whose payoff is linked to another, previously issued
security such as a security traded in the capital or
foreign exchange markets.
• Derivative securities – involve an agreement
between two parties to exchange a standard
quantity of an asset or cash flow at a
predetermined price and at a specified date in the
future.
• As the value of the underlying security to be
exchanged changes, the value of the derivative
security changes.
 Financial Services Institutions
and their Functions

The main institutions in financial services are;

• Banking
• Insurance
• Building Societies
• Unit Trusts
• Finance Houses/Companies
• Banking – Generally, banks offer the
services of cash accessibility, asset
security, money transfer, deferred
payments (loans) and financial advice
(on investments, wills, taxation, leasing,
mergers, acquisition and others).
• The sector includes:
• Merchant banks – offer fundraising services, loan
services and underwriting services for large
corporations and individuals with high net worth. They
specifically perform the functions of issuing new shares,
privatization, financing international trade, raising
capital for major investments and selling new stocks
and bonds.
• Retail banks – offer banking services to
individuals and small businesses. They perform all
the functions of banks but majority in money
transfer and deferred payment. Some examples
are Barclays, GCB, etc.
• Thrifts – depository institutions in the form of
savings associations, savings banks, and credit
unions. Thrifts generally perform services similar
to commercial banks, but they tend to concentrate
their loans in one segment, such as real estate
loans or consumer loans.
• Insurance companies – financial institutions that
protect individuals and corporations from adverse
events.
The need for insurance arises due to;
Social system – hazards resulting from social
issues like burglary, riots, arson, strikes or
kidnapping.
Natural system – uncertainties arising as a
Technical system – uncertainties created by deliberate
actions by individuals and institutions within a society such
as contamination, breakdown, collision, fire explosion, etc.
• Types of Insurance
• General Insurance – provides insurance services to
protect or cover individual and organizational properties
and liabilities such as claims involving bodily injuries as a
result of operations or damages to rented properties.
• Life insurance – provides insurance services to
cover causes of death to beneficiaries of the
insurance. Examples are State Insurance
Company (SIC), Enterprise Insurance Company
and Alliance Assurance.
• Building societies – financial institutions owned
entirely by members and have the traditional role of
providing loans for construction trade and the
purchase of dwellings.
• They are referred to as mutual societies as they offer
services like mortgage loans and other financial
services to their members.
• Unit Trust – They collect funds from a number of
investors, pool the subscriptions received and
invest the total in a range of securities, mainly
the stocks and shares of quoted companies.
• Finance Houses – are engaged in the financing
of hire purchase and other instalment credit
transactions.
• Mutual funds – financial institutions that pool
financial resources of individuals and companies and
invest those resources in diversified portfolios of
assets.
• Pension funds – financial institutions that offer
savings plans through which fund participants
accumulate savings during their working years before
withdrawing them during their retirement years.