Chapter 2: Financial
Market
Dr. Phuong
Nguyen
Agen
da
Overview of Financial
1 Markets
Concepts, functions, roles, and market
participants
Structure of Financial Markets
2
Classification by time, capital raising methods, issuance process, government intervention, and organizational
methods
Financial Market Instruments
3
Money market instruments and capital market
instruments
What Are Financial
Markets?
"Financial markets are places where financial instruments
are bought and sold."
Financial markets serve as meeting points between those who
need capital and those who can provide it, facilitated through
financial instruments such as stocks, bonds, and other securities.
These markets play a crucial role in efficiently allocating
financial resources throughout the economy, connecting
capital providers with those who need funding for investment
and development.
Functions of Financial
Markets
Direct Finance Indirect Finance
Capital is transferred directly from surplus entities Capital is transferred from surplus entities to
to those needing capital. those needing capital through financial
intermediaries.
Financial markets play a vital role in efficiently allocating financial resources throughout the
economy.
YouTube
Explaining: Direct Finance vs Indirect Finance Read
more at [Link] What is the difference between direct and indirect finance ?
- Direct Finance : Borrowing money from friends; borrowing money directly from investors &
00:50
The Role of Financial Markets
Promoting Capital Accumulation Improving Capital Efficiency
Creating conditions for small capital sources to be Allocating capital to where it's most needed and
consolidated into larger capital pools for can be used most effectively, optimizing economic
investment and development. benefits.
Implementing Macroeconomic Determining Prices and Enhancing
Policies Liquidity
Serving as a channel for transmitting monetary Helping determine the real value of financial
and fiscal policies into the economy. assets and increasing their convertibility to cash.
These roles collectively contribute to economic growth and stability by facilitating efficient resource
allocation.
Key Participants in
Financial Markets
Businesses Financial Government
Intermediaries
Raise capital and invest in Raises capital for the state
production development. Connect those with surplus budget and regulates the
They issue securities to fund capital to those needing market through policies
operations and expansion. capital. Include banks, and oversight agencies.
investment funds, and
insurance companies.
Structure of Financial
Markets
Debt Markets vs. Equity
Markets
Based on capital raising methods
Equity Markets
Debt Markets Where shares of joint-stock companies
are exchanged and traded
Where debt instruments (loans, bonds)
are exchanged and traded Buyers become partial owners of the company
Borrowers have the obligation to repay principal with rights to dividends
and interest as agreed Returns depend on company performance
and market valuation
Fixed income securities with predetermined
payment schedules
Dr. Phuong Nguyen
Primary and Secondary
Markets
Based on the issuance and circulation process of financial
instruments
Primary Market Secondary Market
Where newly issued securities are traded Where previously issued securities are traded
Companies directly sell securities to Investors trade securities with each other
investors Companies raise capital from the Issuing companies receive no funds from
market these transactions
The primary market creates new financial instruments, while the secondary market provides liquidity for existing
ones, allowing investors to buy and sell without involving the original issuer.
YouTube
Primary vs Secondary Market - Primary Markets and Secondary Markets Explained
NEW! Access our Investing Website & Private Community: [Link] Stock Market
Basics: Primary vs secondary market. In this video I walk through the basics of the primary market vs&
03:18
Formal and Informal
Markets
Based on government intervention and regulation
Formal Markets Informal Markets
Markets that fully comply with regulations and are Markets that do not fully comply with regulations,
under strict supervision of the government and with less stringent supervision from the government
regulatory agencies. and regulatory agencies.
Transparent operations Less transparency
Comprehensive legal Incomplete legal
framework Protected investor framework Higher risks for
rights investors
Centralised and Decentralised Markets
Based on market organization methods
Centralised Markets Decentralised Markets
Markets that operate according to legal Markets for securities trading outside
regulations, where listed securities are bought exchanges, typically for unlisted securities.
and sold.
No fixed trading location
Fixed trading Transactions through computer networks
location Specific Also known as OTC (Over The Counter)
trading times markets
Transactions through
stock exchanges
Financial Instruments:
Overview
Financial instruments are valuable papers traded in markets, facilitating capital transfer between different entities.
Financial instruments play a crucial role in connecting those with capital and those needing capital, creating
conditions for efficient capital flow in the economy. They represent claims on future cash flows and serve as the
building blocks of financial markets.
These instruments vary in terms of risk, return, maturity, and liquidity, allowing market participants to choose
options that best suit their financial needs and risk tolerance.
Money Market Instruments
Treasury Bills Bank Certifi cates of Deposit
Issuer: Government
(CDs)
Issuer: Commercial banks
Purpose: Short-term funding for state budget
Characteristics: Short-term (under 1 year), low Purpose: Raising capital from depositors
risk, high liquidity Characteristics: Fixed term, higher interest rates
than regular deposits
Money market instruments are characterized by their short-term nature (typically less than one year), high liquidity,
and relatively low risk compared to capital market instruments.
More Money Market Instruments
Commercial Paper Banker's Acceptances
Issuer: Large, reputable companies Purpose: Financing international trade
Purpose: Short-term funding for business Condition: Guaranteed payment by
operations banks
Characteristics: Short-term, unsecured Characteristics: High safety, good
liquidity
These instruments help businesses manage short-term cash flow needs and facilitate international trade
transactions, providing alternatives to traditional bank loans for short-term financing.
Dr. Phuong
Nguyen
Capital Market Instruments: Stock
"A certificate (or book entry) confirming an investor's ownership rights to a portion of a company's assets
and income"
Classifi cation by Registration Classifi cation by Preference
Registered stocks: Clearly state the owner's Common stocks: Voting rights, variable dividends
name Bearer stocks: Do not state the owner's Preferred stocks: Priority for dividends, fewer
name voting rights
Stocks represent ownership in a company and are one of the primary ways businesses raise capital for growth
and expansion.
Comparing Common and
Preferred Stocks
Criteria Common Stocks Preferred Stocks
Management rights Yes No
Dividends Dependent on business performance Fixed
Rights to remaining assets After preferred stockholders Priority claim
Trading and transfer rights Easy Bound by certain principles and regulations
Conversion rights Cannot convert to preferred stocks Can convert to common stocks
Market price More volatile Less volatile
The choice between common and preferred stocks depends on investor priorities regarding risk, income stability,
and corporate governance participation. Common stocks offer greater potential returns but with higher risk, while
preferred stocks provide more stable income with fewer ownership rights.
Capital Market
Instruments: Bond
"A certificate confirming an investor's debt claim against the
issuer"
Classifi cation by Classifi cation by
Issuer Convertibility
Government bonds Convertible bonds
Municipal bonds Non-convertible
Classifi cation by Interest
Corporate bonds bonds
Payment
Coupon bonds
Discount
Classifi cation by
bonds
Interest Rate
Fixed-rate bonds
Floating-rate
bonds
Dr. Phuong
Nguyen
Bond Classifi cation
by Issuer
Government Bonds Municipal Bonds Corporate Bonds
Issued by the government to Issued by local governments Issued by businesses to raise
raise funds for the state budget. to raise funds for public funds for business
projects. operations.
Lowest risk
Lower interest Low risk Higher risk
rates High liquidity Often tax-exempt Higher interest
rates Lower
liquidity
Bond Classifi cation by Interest Rate and
Convertibility
By Interest Rate Change By Convertibility
Fixed-Rate Bonds Convertible Bonds
Interest rate remains unchanged throughout the Can be converted into shares of the issuing company at
bond holding period. a specified ratio.
Stable, predictable cash flow. Offers potential equity upside with debt protection.
Floating-Rate Bonds Non-Convertible Bonds
Interest rate changes according to a reference Cannot be converted into shares, only principal
and interest are repaid at maturity.
index. Flexible, adapts to market fluctuations.
Pure debt instrument with no equity component.
Capital Market Instruments: Mortgages
A mortgage is a loan secured by collateral, typically real
estate.
Market Size Borrowers
In the United States, the mortgage market is the Individuals and companies needing to purchase
largest debt market, with home mortgages four real estate but lacking sufficient cash.
times larger than commercial mortgages.
Purpose Characteristics
Investment in real estate such as homes, Long-term (15-30 years), lower interest rates than
offices, factories, shopping centers, etc. unsecured loans, collateral is the purchased
property itself.
Summary: Financial Markets and
Instruments
Market Money Market
Structure Instruments
Debt vs. Equity Markets Treasury Bills
Primary vs. Secondary Markets Certificates of
Formal vs. Informal Markets Deposit Commercial
Centralised vs. Decentralised Paper Banker's
Markets
Acceptances
Market Capital Market
Functions Instruments
Capital Accumulation Stocks (Common & Preferred)
Efficient Resource Bonds (Government, Municipal,
Allocation Price Discovery Corporate)
Liquidity Provision Mortgages
Financial markets serve as the backbone of modern economies, facilitating the efficient allocation of capital and providing mechanisms for
risk management, investment, and economic growth.
Dr. Phuong
Nguyen