Importance of Financial Markets

A market is a place where willing buyers and willing sellers meet. There are several markets; capital markets which includes stock markets and bond markets, market for goods and services (commodities), derivatives market consisting of future markets, insurance market and foreign exchange markets. The markets can be international or local with trading taking place at a given location e. g. NYSE, LSE or electronically e. g. NASDAQ. Capital markets can be further split into primary market which is used to trade in newly issued securities and secondary market which is for trading already existing securities (Schenk, R.(2008).

One key feature about markets is that they are interrelated, i. e. they have some kind of connection. The effect of this is that a problem in one of the markets affects the other markets. A good example to illustrate this assertion is the financial market crisis in the USA. The credit crunch effects have been felt the world over (Schenk, R. (2008). A financial market is a place where financial securities are traded. Examples of these financial securities include shares, bonds, debentures, unit trusts etc. The main function of the financial market is to allocate resources to the most production use.

Financial markets also act as a medium through which changes in the economy are transmitted. Intermediaries One of the important aspects of the financial markets is that of intermediation. A lot of investors do not enter the financial markets by themselves but they use financial intermediaries. Examples of these financial market intermediaries are the banks, mutual funds, pension funds, credit unions, savings and loan institutions and even insurance companies. Other investors, though, engage directly in the financial markets and for this, they may earn higher returns due to the higher risk involved (Schenk, R.

(2008). Investors using intermediaries to enter the financial market are able to reduce the level of risk involved in their investments. The financial intermediary can diversify and hence avoid incurring huge losses. Financial intermediaries can also be able to provide liquidity to the investors within a very short period of time. If an investor has invested in real estate e. g. a house, then, converting that house into cash will take time. This is where the financial intermediary comes in. the financial intermediary could experience problems if the investors (depositors) want to withdraw the money at the same time.

Hence an intermediary may be forced to seek financing from the government to meet the demand for the money. As seen earlier, financial markets are interconnected. Financial intermediaries too are interconnected. Financial intermediaries are linked to each other in terms of debts and assets. It is for this reason that if one financial intermediary experiences problems, the other is likely to be affected. The sub prime crisis in the USA clearly illustrates this; Bear Stearns collapses, and what follows is a series of collapses or near collapses that had to be rescued by the government.

Financial intermediaries’ problems can also be felt in the economy. The near recession of the USA economy clearly illustrates this point (Schenk, R. (2008). Role of government in financial markets The government acts as a regulator in the financial markets as well as acting as an intermediary through the central bank. In the USA, the government regulates the market through the SEC and Federal Deposit Insurance Corporation (FDIC). The SEC regulates the stock and bonds as well as shareholders information requirements. FDIC covers deposits at commercial banks and savings and credit societies (Oswego (2008).

Importance of financial markets Apart from providing a place where securities are traded, the financial market also provides an avenue where investors can manage risk. This is done through the use of financial instruments called derivatives. The cause of this risk is the fluctuation of share prices, bond prices, currency rates or even interest rates. Financial markets also serve as a platform for trading in currencies more specifically called the foreign exchange market. Apart from importers and exporters, banks, speculators, government, tourists also form part of the foreign exchange market.

Bond market This is a place where debt instruments/securities are issued and traded. The bond market is also called the debt market, credit market or the fixed income market. The most common debt securities dealt with are government bonds and corporate debt securities. The type of bond markets include asset backed, corporate, funding, municipal, government, mortgage backed, collaterized debt securities etc. Most of these securities are traded over-the-counter (OTC) although some are traded in the exchange.

Trading in bonds is through an electronic system (Faerber, 2001:15). The bond market is also dominated by players also found in the financial markets who are essentially buyers and sellers. Some of the participants in the bond market include the government, traders, institutions and even individuals. The share of the market for individuals is low because of the specific nature and lack of liquidity in smaller bonds. Therefore, a huge proportion of the bond market is dominated by institutional investors e. g. pension funds, banks and mutual funds.

Individuals can be able to access the bond market through investment vehicles like the Exchange Traded Funds (EFTs), bond funds, closed-end-funds or even unit investment trusts. Most of these investment vehicles are able to divide bonds into smaller affordable units that can be easily bought by individuals. The new issues of bonds are normally sold in the primary market through an intermediary e. g. an investment bank. Bonds that have been bought through issue can be disposed off before they mature. This is done in the secondary market (Faerber, 2001:20).

In the USA, the market share of the various bonds varies. The Treasury market forms the largest portion of the bond market. The Treasury bond percentage is over 50. Some of the securities under this category include non interest bearing Treasury bills, Treasury notes, Treasury bonds and Treasury inflation indexed securities. The Corporate bond market represents over 20% of the total bond market. These bonds are basically issued by companies in different sectors of the economy although they are broadly classified as industrial, transportation, utility and financial securities.

Examples of Corporate bonds which can zero coupon or convertible include unsecured bonds (debentures), subordinated debenture bonds, high yield bonds, junk bonds, secured bonds etc. (Faerber, 2001:75). Trends in the bond markets Over the last 8 years, the bond market in the USA has been experiencing some form of volatility. In the year 2000-2003, the bond yields (10 year Treasury note), were falling indicating that the bond prices was rising. The trend, was however, broken in the late 2003 when the prices of the bonds started to decline. This decline indicated that the bond yields were rising.

This trend was observed until early 2007 when the bond prices reversed and started to increase (Douglas, A. (2008). The rise in bond prices (falling bond yields) was short-lived. The first news of sub prime crisis disturbed the bond market. The sub prime crisis caused the credit market crisis. The demand for Treasury bonds started to increase because the investors thought that they will not be affected by the current credit crisis. This was not the case though. The Municipal bonds were the next option but this avenue was also not sufficient.

The other reason why there is instability in the bond market is that the market depends on cash from overseas. The cash flow from foreign countries form a substantial part of the USA bond market and therefore any sign of trouble might result in withdrawals which will cause the bond market to collapse (Jubak, J. (2007). The credit ratings also have not been accurate. Consequently, there have been substantial downgrades of certain bonds which were considered to be good. As the economy continues to falter, the supply remains an issue as the government (USA) aims to jumpstart the economy by issuing an economic stimulus package.

The funds are to be achieved through the sell of bonds, notes as well as printing of money (Hurley M. A. (2008). The prices of bonds are higher which consequently means lower yields because the mortgage rates are down while the mortgage prepayments have risen and thus the investors need to leverage despite more Treasury bonds being sold. Bond issues The bond issues have been on a decline since last year. This is witnessed in all bond types with significant drops being witnessed on the asset backed security bonds as well as investment grade corporate bonds. The ABS bonds fell from a high of about $1.

25 trillion between January and September 2007 to a low of about $ 250 billion in a similar period this year. The investment grade corporate bonds fell from about $ 2. 5 trillion to low of $ 1. 8 trillion in the same period this year. The recent slump in the bond market is a result of the credit crunch which has persisted since last year when the sub prime mortgage crisis started (Thomson Reuters (2008). Most of the investors offloaded the other type of bonds and opted for the government Treasuries. The Treasuries also turned out to be disappointing considering their falling yields

Therefore, over the last one year, the issue of Corporate bonds has been declining largely because of the credit crisis. Share market The stock market also called equity market is a market (private or public) for trading of shares and derivatives. The shares can be listed on the equity market or traded by private placement. The stock exchange is a company or organization that brings buyers and sellers who would trade in the securities. Examples of stock exchanges includes London Stock Exchange, New York Stock Exchange, NASDAQ etc. The stock exchange can be a physical location e.

g. a room or a virtual trading platform (Share market basics (2008). In the stock market, individuals, investment banks and hedge fund traders are involved in the buying and selling of securities. The prices of securities are determined by the forces of demand and supply and the concept of bid-ask. The stock market offers the investors investment vehicles for which they can invest their monies. Companies can also raise capital through the issue of shares. Investors also have access to liquidity as they can dispose off their securities with ease (Share market basics (2008).

The vibrancy of the stock market is also necessary for the overall growth of a country’s economy. Therefore, the stock market that is active is considered to be the engine of the economy. The market ought to be efficient in terms of operations information processing and allocation of securities. This means tat the security prices should be able to reflect the information accordingly. Performance of the stock market The performance of the stock market can be either bearish or bullish depending on the market fundamentals.

A bear market is a decline of over 20% while a bull market is an increase of over 20% (Hays D (2002). Over the last 102 years to 2002, the market in the USA experienced numerous bearish and bullish trends. The Dow Jones Industrials gained an overall rate of 91. 5% in the bull market. In the bear market, the DJI gained 30% over the same period despite the great stock market crash of 1929. The major causes of the changes in the performance of the stock market largely depend on the country. For the USA, for instance, was not affected by wars hence did not experience sustained declines in the stock market.

The European counterparts on the other hand, took time to recover from the effects of war. Advancements in telecommunication and technology are also another factor that changed the performance of the market over time. Globalization is another factor that has enhanced the performance of the stock markets. In the early 1900s, there were many small regional exchanges which were later merged and hence lower operational costs thus realizing superior returns (Hays D (2002). New issue of shares The volume of new issues over the years has been increasing at a high rate.

This is due to the fact that the financial markets have been developing. Equities can be issued in the stock market through an introduction, tender, offer for sale, placement and public issue. Before the financial market crisis, the issue and trading of shares in all the leading stock exchanges was on the rise. Some of the proposed new issues had to be cancelled or suspended until the financial market turmoil calms (BHF-bank (2008) Despite this, the demand for capital has never declined and therefore it will suffice to say that the volume of new share issues in the future will continue to rise.

In the year 2000, the number of issues averaged 700 with the proceeds from these issues averaging $ 125 billion. There was a drop in the number of issues and proceeds in the year 2001- the first quarter of 2003 when the issues rose. In the forth quarter f year 2007, the number of issues and proceeds fell. That drop has continued to the current year. The number of issues in the first quarter of 2008 was about 500, rising to about 900 in the second quarter before dropping to 500 in the third quarter (Thomson Reuters (2008)

It is important to note that a company can raise capital from issues of shares or bonds. The continuing financial market meltdown affected these two critical security markets and this is why the stock indices and bond yields have been affected. The stock market activity in terms of share trading will continue to rise as the world financial markets expands. The need for capital by companies will also ensure that more shares are issued in the stock market. Conclusion I agree with the analyst that the bond and equity markets are on a shaky ground.

The reason for this is that the economy is expected to slow down and thus the investors will find it hard to invest in equities, corporate bonds and other types of bonds given the uncertain economic times. The market fundamentals are also against the bond market currently. Until and when the global credit crisis is over, then the bond and equity markets are going to fully rebound. References BHF-bank (2008). Global equity market slump continues. (Online). Available. Accessed on 26/11/2008 from http://www. fxstreet. com/technical/market-view/fx-briefing/2008-10-27. html Douglas, A. (2008). Bond market collapse is imminent.

(Online). Available. Accessed on 26/11/2008 from http://news. goldseek. com/GoldSeek/1223911533. php Faerber, E. (2001). Fundamentals of the Bond Market. New York. Mc Graw-Hill Professional Hays D,(2002). Morning Market Comments. Stock Market Performance over 102 Years (Online). Available. Accessed on 26/11/2008 from http://www. super-business. net/General-Articles/282. html Hurley M. A. (2008). Today’s market. The outlook today. Take the money and run. (Online). Available. Accessed on 26/11/2008 from http://www. bondsonline. com/Todays_Market/The_Outlook_Today. php Jubak, J. (2007). Steer clear of the rotting bond market.

(Online). Available Accessed on 26/11/2008 from http://articles. moneycentral. msn. com/Investing/JubaksJournal/SteerClearOfTheRottingBondMarket. aspx Thomson Reuters (2008). Deals quarterly reviews. (Online). Available. Accessed on 26/11/2008 from http://www. thomsonreuters. com/content/PDF/financial/league_tables/de/2008/3Q08_equity_capital_mkts. pdf Thomson Reuters (2008). Deals quarterly reviews. (Online). Available. Accessed on 26/11/2008 from http://www. thomsonreuters. com/content/PDF/financial/league_tables/de/2008/3Q08_debt_capital_mkts. pdf Schenk, R. (2008). Overview. Financial Markets.

(Online). Available. Accessed on 26/11/2008 from http://ingrimayne. com/econ/Financial/Overview8ma. html. Seeking alpha (2008). International equity market snapshot. (online). Available. Accessed on 26/11/2008 http://seekingalpha. com/article/85307-international-equity-market-snapshot Share market basics (2008). How stock market works. (Online). Available. Accessed on 26/11/2008 from http://www. sharemarketbasics. com/How-Stock-Market-Works. htm Oswego (2008). Chapter 3. Role of Government in Financial Markets. (Online). Available. Accessed on 26/11/2008 from http://www. oswego. edu/~edunne/342ch3. html

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