2.      FINANCIAL MARKETS

 

 

The main financial markets are the money, banking, capital, insurance and gold, foreign exchange and commodity markets. The main participants in each market are referred to as financial institutions or financial intermediaries which assist allocate funds and capital within the financial system, moving it from areas of surplus or excess to deficit or need. The main institutions consist of the banks (including building societies), securities firms and traders or dealers, insurance companies and pension firms and other more specialist service providers such as gold or foreign exchange dealers, financial derivatives traders, finance houses, mutual funds and collective investment schemes. While more specialist markets exist for gold, foreign exchange and commodities, the most important larger sets of markets are as follows:

 

(1)    Money Markets

 

The money markets consist of the Primary (or Discount) Market and the Secondary Money Markets for short-term money instruments. These are wholesale markets for short-term money market instruments (MMIs) of less than one year. These principally include government Treasury bills, Local authority or Corporate bills, Bankers’ drafts (promissory notes issued by banks), Certificates of deposit (transferable securities representing underlying deposits) and Commercial paper (short-term marketable unsecured promissory notes), Bankers’ acceptances (accepted bills of exchange) and bank deposits. The central bank uses the Primary Market to increase or decrease the amount of money in the economy by purchasing paper from them (which increases the funds available) or selling paper to them (which increases the funds). The Bank of England of the uses this to set the ‘bank rate’ at which it will deal with the discount houses. The Secondary Markets are specialist markets for money market instruments issued by particular counter parties.  The main principal secondary markets are the Local Authority, Finance House, Inter-company, Sterling Inter-Bank and Sterling Certificate of Deposit and Commercial Paper markets.

 

(2)    Banking Markets

 

The banking markets are longer term credit markets within which banks provide services to corporate and household customers. Banking services include deposit taking, wholesale lending, the provision of payment services, corporate and consumer finance and financial advice and trade finance services (including letters of credit, accepting or discounting bills of exchange and factoring (purchasing accounts receivable) or forfaiting (discounting instruments without recourse)). Investment banking functions including underwriting, broking, trading, asset management and the provision of corporate advice (below).

 

While banks are the main operators in the money markets, the banking markets refer to the separate sectors within which banks provide their services for corporate entities, households and individuals. These include deposit taking (savings), corporate lending, commercial and residential mortgage financing as well as credit card and consumer credit facilities. These are the main sectors through which companies and individuals borrow short and longer-term funds on either a secured or unsecured basis.

 

The banking markets may also be considered to include the trade finance markets which provide funds for national and international trade purposes. These were essentially based on bills of exchange, letters of credit and documentary credits (with payment being exchanged in return for bills representing underlying goods), forfaiting (purchasing notes or bills at discount) and other forms of receivables financing (funding or collecting company trade debts). British banks that provided deposit taking as well as trade financing services have traditionally been referred to as merchant banks. 

(3)    Capital Markets

 

The capital markets are the market in which governments and corporate entities raise funds for longer-term investment or shorter working capital purposes. These are essentially securities markets including shares (equity), debentures (bond or debt instruments), warrants (certificates entitling the holder to subscribe for additional shares or debentures) and convertible or other hybrid instruments. A primary securities market is for the initial issuance of such stock and the secondary market for its subsequent trading either on a formal exchange or over-the-counter (OTC) basis. OTC markets were essentially carried on over telephone lines but now most commonly use the internet or other digital devices. The capital markets include the Eurobond market (debt instruments in a currency other than the country of issuance) as well as other corporate equity or debt instruments listed on more than one exchange. Investment banking refers to US and international securities firms that provide capital market related services including underwriting (initial stock issuances), broking (buying and selling securities on behalf of clients), proprietary trading (on the firm’s own account), asset management and providing corporate advice. Investment banks are not legally banks insofar as they cannot accept deposits. Deposit taking and securities activities were separated in the US under the Glass Steagall provisions of the Banking Act 1933 which was enacted after the Stock Market Crash in 1929.

 

(4)    Financial Derivatives Markets

 

Financial derivatives are specialist financial contracts that derive their value from some other asset or index. These can either be used for risk management or trading (speculation) purposes. The three main forms are swaps (exchanges of currencies, interest rates or other commitments), futures (obligations to buy or sell at an agreed future time and price) and options (the right or election to purchase or sell at a specified future time and price). Derivatives now also include credit derivatives which provide protection against another party’s payment default with the main instruments consisting of credit default swaps (CDSs), total return swaps (TRSs) and credit spreads swaps (CSSs). Derivatives are issued and traded both on formal exchanges as well as on an OTC basis. They may be considered to form part of the capital markets or to constitute distinct national and international markets.

 

(5)    Insurance Markets

 

Insurance markets provide for the sale of protection cover in the event of defined events arising in return either for a single initial or continuing premium payment. These include both contingent liability (accident or non-life) insurance and non-contingent life insurance (or assurance). Assurance provides for payment on retirement or on death. Reinsurance involves the transfer or subcontracting of all or part of an insurable risk to another party. This provides a form of guaranteed payment. The largest single insurance reinsurance market in the world is Lloyds of London.