Structure of Financial Markets
We discussed earlier the concept and functions of financial markets. There are different types of financial markets. Financial markets are classified in different ways. They are classified on the basis of the nature of the instruments traded in the markets, issues of traded instruments, organization of the markets, maturity of instruments traded in the markets, and political boundary of the markets.
According to the ways funds are obtained, financial markets are classified into debt markets and equity markets; according to an organization of markets they are classified into exchange and over-the-counter markets; according to maturity of financial assets traded, financial markets are classified into money markets and capital markets; and according to the political boundary, they are classified into domestic and international financial markets. We discuss all these categories of markets below.
Debt and Equity Markets
Business firms and individuals can obtain funds from financial markets in two ways. Individuals may borrow funds from financial markets or s/he may raise funds from her/his friend as equity capital. Individuals may agree to invest jointly in the business and raise the funds as per the mutual agreement between/among them. Business firms, in general, raise funds by issuing shares in the markets. Business firms, the federal government, and local governments may raise funds by issuing different types of debt instruments in the financial markets. Thus, on the basis of the ways of raising funds in the financial markets, financial markets are classified into debt markets and equity markets.
This is the market where different types of debt instruments are sold and bought. Companies issue bonds, debentures, and other hybrid debt instruments and raise funds from financial markets. There are different types of debt instruments. As per the maturity of debt instruments, they are classified as short-term debt instruments, intermediate-term debt instruments, and long-term debt instruments.
Short-term debt instruments such as commercial papers, and Treasury bills have a maturity period of less than one year. Similarly, some debt years. instruments’ maturity period may extend from one year to less than 10 For example, Himalayan Bank Limited (HBL) issued 3 million units of debenture par value of Rs 1,000 each to raise debt worth Rs 3,000 million in July 2019 with a maturity period of 7 years. We call such instruments intermediate-term debt instruments.
Some other debt instruments may have a maturity period of 10 years or longer. We can take NIC Asia Debenture 2083/84 and 10.25%, Machhapuchhre Bank Debenture 2085 as examples of long-term debt instruments. Both banks issued the debenture with a maturity period of 10 years to raise debt capital of Rs 4,400 million and Rs 3,000 million funds, respectively. The fundamental features of debt instruments are the fixed maturity period and fixed coupon rate, In our example, HBL debentures have a maturity period of 7 years and both NIC and MBL debentures have a maturity period of 10 years.
The coupon rate on HBL debenture is 10 percent and on NIC and MBL is 10.25 percent. Thus, debt instruments, in general, mature in the specified period and commit to pay specified interest income but such instruments do not have voting power in the annual general meeting of the company. We call markets of all these types of debt instruments debt markets. Business firms, the federal government, local government, and households raise short-term, medium-term, and long-term funds. Dealers and sales agents assist in trading debt securities in the market. For example, Nepal Rastra Bank has licensed 37 institutions (mostly commercial banks and development banks) to make market in government securities.
Business firms raise funds by issuing equity such as common stock in the financial markets. We call such markets equity markets. The fundamental features of common stock are perpetual maturity, no fixed return, and representation of ownership of the issuing firm. So, stockholders do not get a fixed return on their investment but they get dividends and voting rights in the general meetings. They are the real owners of the issuing company and the residual claimants on the profits and value of assets on the liquidation of the concerned company.
Primary and Secondary Markets
We classify the financial markets into primary markets and secondary markets. Primary markets are those markets where financial instruments are sold for the first time. In the primary markets, a company issuing the financial securities receives the funds invested by the investors. Investment banks manage the issue of the securities for the first time by underwriting the securities. They guarantee the sale and price of the issued securities in the financial markets but they charge underwriting commission. They first purchase the securities at a lower price and then sell them to the general public at a higher price.
Once financial assets are sold and bought in the primary markets, they are traded in the financial markets. In other words, if investors need funds they can sell their securities in the markets to other investors. We call the markets for already issued securities as the secondary markets. In other words, secondary markets are the markets for already issued securities. The fundamental function of secondary markets is to provide investors with the liquidity of their investments. In the secondary markets, funds are transferred from one investor to another investor but they do not go to the issuing entity.
In our example of HBL debenture, MBL debenture, and NIC debenture, these banks receive the funds raised by selling in the primary markets, but they do not receive any funds if owners of their debentures sell them in the secondary markets. In the secondary markets, one investor sells her/his securities to another investor. Brokers and dealers facilitate the investors (both seller and buyer of already issued securities) to sell and buy the securities in the secondary markets. It is notable that brokers bring buyers and sellers of securities together but dealers buy the securities from sellers and sell the securities to the buyers in the financial markets. They make the markets for securities. Dealers, brokers, sellers, and buyers of securities are the participants of the secondary markets. In mid-July 2019, 49 brokers assisted in securities trading in the Nepal Stock Exchange.
Exchange and Over-the-Counter Markets
On the basis of ways of organization of securities markets, we classify the secondary markets into exchanges and over-the-counter (OTC) markets. Exchanges are the central location where buyers and sellers or their brokers and dealers meet to conduct the trade of securities. New York Stock Exchange, London Stock Exchange, and Tokyo Stock Exchange are well-known world exchanges. Bombay Stock Exchange, Shanghai Stock Exchange, and Singapore Stock Exchange are remarkable stock exchanges in Asia. Nepal Stock Exchange Limited (NEPSE) is the only stock exchange in Nepal. Only those securities which are listed in the exchange are traded there.
Another way of organizing the secondary markets is the over-the-counter market. In OTC markets, dealers located in different locations are interconnected in computers; they have an inventory of securities and are ready to sell and buy the securities over the counter. In OTC markets, dealers are contacted each other on the computer and know the prices set by one another. So, OTC markets are more competitive and prices in OTC markets are not very much different from the organized exchanges. In Nepal, the Nepal Stock Exchange
operates over-the-counter market as well.
Money and Capital Markets
Financial markets on the basis of the maturity of securities traded in the markets. are classified into money markets and capital markets.
This is the financial market where securities having a maturity period of less than one year are traded. So, money markets are the markets for selling and buying securities having a maturity period of less than one year. In other words, all securities having an original maturity period of less than one year are traded in the money markets. Commercial paper and Treasury bills are examples of money market instruments.
These are the markets where securities having an original maturity period of more than one year are traded. Debentures, corporate bonds, al municipal bonds, and securities issued by federal governments are debt instruments traded in capital markets. Common stocks and preferred stocks also are capital market instruments.
Domestic and Foreign Markets
Financial markets on the basis of trading place of securities are classified into a) domestic markets and b) foreign markets.
The domestic market is the market where issuers domicile in a country and securities are traded in the same country. For example, the markets for securities issued by all commercial banks in Nepal are domestic markets. Since all commercial banks are domiciled in Nepal and all securities issued by them are traded in Nepal.
In the foreign market, issuers of securities do not domicile in the country where the securities are traded. The issuers of the securities must follow the rules of the countries where securities are issued and traded. For example, if a Japanese company is issuing securities in the US market, it is issuing securities in foreign markets and must follow the rules of the US securities markets.
What is the Debt Market?
Markets where different types of debt instruments are sold and bought.
What is Equity Markets?
A Market in which equity securities are traded.
What is Primary Markets?
Those markets are where the financial instruments are sold for the first time.
What is Secondary Markets?
The markets for already issued securities.
What is Exchanges?
The central location where buyers and sellers or their brokers and dealers meet to conduct the trade of securities.
What is a Money Market?
The Financial Markets where securities having a maturity period of less than one year are traded securities.
What is a Capital Market?
The Markets where securities having an original maturity period of more than one year are traded.
What is the Domestic Market?
The markets where issuers domicile in a country and Securities are traded in the same country.
What is a Foreign Market?
The Markets where issuers of securities do not domicile in the country where securities are traded.