Financial Markets

Financial Market and Capital Financing

The financial market, also known as the capital market, includes the money market and the capital market. It is a market for capital financing. The so-called capital financing refers to the activities of adjusting the surplus of funds by various financial instruments between the supply and demand sides of funds in the process of economic operation. It is the general term for all financial transaction activities. Various financial instruments are traded in the financial market, such as stocks, bonds, savings certificates, etc.

Direct vs. Indirect Financing

Capital financing is referred to as financing, which is generally divided into direct financing and indirect financing. Direct financing is the activity of direct capital financing between the supply and demand sides of funds, that is, the capital demanders directly raise funds from institutions and individuals with surplus funds in the society through the financial market; correspondingly, indirect financing refers to the capital financing activities carried out through banks, that is, the capital demanders raise funds by applying for loans from banks and other financial intermediaries.

Impact of the Financial Market

The financial market has a direct and profound impact on all aspects of economic activities. For example, personal wealth, corporate operations, and the efficiency of economic operations are all directly dependent on the activities of the financial market.

Structure of the Financial Market

The structure of the financial market is very complex. It is a huge system composed of many different markets. However, generally speaking, according to the maturity of the trading instruments in the financial market, the financial market is divided into two categories: the money market and the capital market.

Money Market

The money market is a market for short-term (less than one year) funds, and the capital market is a market for long-term (more than one year) funds. Both markets can be further divided into several different sub-markets. The money market includes

• Interbank lending market
• Repurchase agreement market
• Commercial paper market
• Bank acceptance bill market
• Short-term government bond market
• Large-denomination transferable certificate of deposit market, etc.

Capital market

The capital market includes the medium- and long-term credit market and the securities market. The medium- and long-term credit market is a loan market between financial institutions and industrial and commercial enterprises. The securities market is a market for financing through the issuance and trading of securities like:

• Bond market
• Stock market
• Fund market
• Insurance market
• Financial leasing market, etc.

Compared with other markets, financial markets have their unique characteristics:

First

The financial market is a market where funds are traded.

Second

Transactions in the financial market are not simply buying and selling relationships but, more importantly, lending and borrowing relationships, which embody the principle of separation of ownership and use rights of funds.

Third

Financial markets can be either tangible or intangible.

Form

Credit instruments were created long before the formation of financial markets. They are the product of the development of commercial credit. However, due to the limitations of commercial credit, these credit instruments can only exist between commodity buyers and sellers. And do not have extensive liquidity with the further development of the commodity economy. Bank credit and financial markets emerged based on commercial credit.

The emergence and development of bank credit and financial markets, in turn, promoted the development of commercial credit. Making credit instruments a trading tool in the financial market and stimulating the potential importance of credit instruments. In modern financial markets, credit instruments are still the main trading tools. Stocks that reflect equity or ownership relations and other financial derivatives that have extensive liquidity also have market financial trading tools. Therefore, they are collectively referred to as financial instruments.

Formation conditions

1. The commodity economy is highly developed, and there is a huge demand and supply of funds in society.
2. Have a complete and sound financial institution system.
3. There are abundant financial transaction tools and diversified transaction forms.
4. There is sound financial legislation.
5. The government can manage the financial market reasonably and effectively.

Form

There are two forms of financial markets.  Tangible & Intangible

One is the tangible market, that is, the market where traders are concentrated in places with fixed locations and trading facilities to conduct transactions. The stock exchange, before the electronicization of securities trading, was a typical tangible market. However, all stock exchanges in the world have adopted digital trading systems. So, the tangible market has gradually been replaced by the intangible market.

The second is the intangible market, that is, the market where traders are scattered in different locations (institutions) or use telecommunications to conduct transactions. Such as the over-the-counter market, the global foreign exchange market, and the stock exchange market are all intangible markets.

System

1. Risk (uncertainty): such as the risk of the stock market and the risk of the foreign exchange market.
2. Prices are based on value and are affected by supply and demand: fluctuations in stock prices and bond prices ultimately reflect their value and are affected by supply and demand.
3. Fundamental analysis of factors that affect bond circulation prices, stock prices, exchange rate fluctuations, etc., must take into account both macroeconomic impact and microeconomic impact.

Related, similar, or different content in the financial market system:

1. Functions of financial markets, functions of interbank lending markets, functions of bond markets, functions of stock markets, functions of foreign exchange markets, functions of futures markets, etc.
2. Participants in the foreign exchange market, futures market, and interbank lending market.
3. Discount, rediscount, and rediscount.
4. The differences and similarities between bills of exchange, promissory notes and checks, etc.

• Money Market

• Capital Market

Classifications

Financial markets can be classified from different perspectives as follows:

Financial Markets

(1) According to geographical scope, it can be divided into:

① The international financial market is composed of financial institutions that conduct international monetary business, and its business content includes fund lending, foreign exchange trading, securities trading, fund transactions, etc.

② Domestic financial market, which is composed of domestic financial institutions, handles various monetary, securities, and other business activities. It is divided into urban financial markets and rural financial markets, or national, regional, and local financial markets.

(2) According to the place of business, it can be divided into:

① Tangible financial market refers to a financial market with fixed locations and operating facilities;

② Intangible financial market: a market that exists in the form of an operating network and conducts transactions through electronic telecommunications means.

(3) According to the financing transaction period, it is divided into:

① Long-term capital market ( capital market ), mainly providing medium- and long-term funds of more than one year, such as the issuance and circulation of stocks and long-term bonds ;

② The short-term capital market ( money market ) is a financing market for short-term funds of less than one year, such as interbank lending, bill discounting, and the buying and selling of short-term bonds and transferable certificates of deposit.

(4) According to the nature of the transaction:

① The issuance market, also known as the primary market, is the market for new securities issuance ;

②The circulation market, also known as the secondary market, is the trading market for securities that have been issued and are in circulation.

(5) Based on the transaction objects,

The market can be divided into the interbank lending market, the discount market, the large-denomination time deposit market, the securities market (including the stock market and the bond market ), the foreign exchange market, the gold market, and the insurance market.

(6) According to the delivery period, it can be divided into:

① In the financial spot market, payment and delivery are made immediately after the financing activity is completed ;

② In the financial futures market, after the investment and financing activities are completed, payment and delivery are made on the specified date according to the contract. Scientific and systematic division of financial markets according to the above internal connections is the basis for effective management of financial markets.

(7) According to the subject matter of the transaction, it is divided into:

① Money market

② Capital Market

③Financial derivatives market

④Foreign exchange market

⑤ Insurance market

⑥ Gold and other investment products market

(8) According to the financing method, it is divided into:

① Direct financing market

② Indirect financing market

(9) Classification based on specific trading instrument types:

①Bond market

②Bills market

③Foreign exchange market

④Stock market

⑤ Gold market

⑥Insurance Market

Function of Financial Market

Simply put, it has four major functions:

1. Financing
2. Regulation
3. Hedging
4. Signaling

1. Financial markets can quickly and effectively guide the rational flow of funds and improve the efficiency of fund allocation.

1. It has expanded the opportunities for contact between the supply and demand sides of funds, facilitated financial transactions, reduced financing costs, and improved the efficiency of fund use.
2. Financial markets have opened up broader financing channels for fundraisers and investors.
3. Financial markets provide the necessary conditions for the conversion of financial instruments of different maturities and contents.

2. Financial markets have pricing functions, and the fluctuations and changes in financial market prices are a barometer of economic activities.

1. All financial assets have a par value.
2. The intrinsic value of an enterprise’s assets, including the value of its debts and the value of its shareholders’ equity, can only be “discovered” through the interaction between buyers and sellers in financial market transactions. That is, the valuation must be based on the price of the enterprise’s related financial assets formed by market transactions rather than simply calculating based on the book figures in the accounting statements.
3. The pricing function of the financial market also depends on the market’s degree of perfection and efficiency.
4. The pricing function of the financial market helps to realize the market’s resource allocation function.

3. Financial markets provide conditions for financial management departments to conduct indirect financial regulation.

1. The indirect financial regulation system must rely on developed financial markets to transmit the central bank’s policy signals, guide the behavior of various microeconomic entities through price changes in the financial market, and realize the intention of monetary policy adjustment.
2. Within a developed financial market system, there is a high degree of correlation between various sub-markets.
3. As the reserve positions and liquidity reserve ratios of various financial assets in financial institutions increase, financial institutions will be more widely involved in the operation of financial markets. The scope and intensity of the central bank’s indirect regulation will continue to be strengthened with the development of financial markets.

4. The development of financial markets can promote the innovation of financial instruments.

1. A financial instrument is a set of standardized contracts that combine expected returns and risks.
2. Diversified financial instruments enable investors with different risk and return preferences to find the investment that best suits their needs by providing a more refined classification of the risks inherent in various investments in the economy.
3. Diversified financial instruments can also meet the diverse needs of financiers to the greatest extent possible.

5. Financial markets help to achieve risk diversification and risk transfer.

1. The development of financial markets has led to the diversification of residents’ financial assets and the dispersion of financial risks.
2. The development of financial markets has paved the way for the diversification of residents’ investments, the diversification of financial assets, and the dispersion of bank risks, thus providing conditions for the sustained and stable development of the economy.
3. Residents have enhanced their investment and risk awareness by choosing a variety of financial assets and flexibly adjusting the form of saving their surplus money.

6. Financial markets can reduce the search and information costs of transactions.

1. Search costs refer to the costs incurred in finding a suitable transaction partner.
2. Information cost is the cost incurred in the process of evaluating the value of financial assets.
3. The function of financial markets in helping to reduce search and information costs is mainly performed through professional financial institutions and consulting agencies.

Characteristics of the Financial Market

First

Second

(1) Fund suppliers and fund demanders.

(2) Credit instruments.

(3) Credit intermediaries.

(4) Price.

Components

The components of financial markets

1. Participants in the Financial Market

1. 1. Government departments: raising funds by issuing bonds.
   2. Industrial and commercial enterprises: They are both fundraisers and providers of funds.
   3. Financial institutions: They are the most important participants in the financial market, mainly including deposit-taking financial institutions, non-deposit-taking financial institutions, and central banks.
   4. Individuals: They are the providers of funds in the market.

2. Financial instruments

Characteristics of financial instruments:

1. 1. Repayment: refers to the time that the debtor must spend before repaying the principal.
   2. Liquidity refers to the ability of financial instruments to be quickly converted into money without incurring losses.
   3. Risk (safety) refers to the degree of risk or the degree of safety of the principal and expected returns of the purchased financial instrument.
   4. Yield ( profitability ): refers to the ratio of the income obtained by a financial instrument to the principal.

3. Organizational forms of financial markets

Refers to the method used to conduct financial transactions.

1. 1. An organized and centralized trading method conducted in a fixed place. “Double-side auction”                                                                                                        The highest bid from the buyer = the lowest asking price from the seller
   2. Decentralized transaction methods conducted through the counters of financial institutions. A transaction made through “bargaining” is also called an over-the-counter transaction.
   3. OTC trading methodComplete transactions with the help of advanced communication methods.

4. Management of financial markets

1. 1. Principles of Management

1. 1. Management of the securities market

• • (1) Restricting speculative activities

• (2) Prohibition of improper trading practices

Spreading false information manipulation

Joint Manipulation

Wash sale:

It involves the practice of a securities seller buying back the securities they have sold right away.

Insider Trading

Securities firms’ cheating

2. Management of the bill market

Management of the issuance, acceptance, discount, and use of bills

Management of market access, use and term of borrowed funds, etc.

Financial Relations

Under the market economy, various markets play a fundamental role in resource allocation, and these markets together form a complete, unified, and interconnected organic system. The market system is divided into product markets (such as consumer goods markets, means of production markets, tourism service markets, etc.) and factor markets that provide production conditions for these products (such as labor markets, land markets, capital markets, etc.).

The financial market is an important part of the unified market system and belongs to the factor market. It is interconnected and interdependent with various markets. Such as the consumer goods market, the means of production market, the labor market, the technology market, the information market, the real estate market, and the tourism service market. Together they form an organic whole of the unified market.

In the entire market system, the financial market is one of the most basic components and is the link between other markets. In the modern market economy, whether it is the sale of consumer goods and means of production or the flow of technology and labor. All trading activities in various markets must be realized through the circulation of money and the movement of funds, and they cannot be separated from the close cooperation of the financial market.

The development of the financial market plays a vital role in restricting the development of the entire market system. The development of other markets in the market system provides conditions and possibilities for the development of the financial market.

Market Position

The status of financial markets in a market economy :

1. Markets for various production factors under a market economy

The market economy is a huge market entity composed of many different sub-markets. In the process of social production, each factor of production forms its market system in the process of exchange.

Key Markets in the Market Economy

• • Goods market
  • Labor market
  • Technology market
  • Property market
  • cultural market
  • Manager market, etc.

These markets realize normal social production and consumption through the exchange of products. In today’s economy, the interchange of the above various production factor markets required the form of money instead of barter.

Monetary Economy and Credit Economy

The contemporary economy is a monetary economy and a credit economy. It is precisely driven by monetary credit that the rapid allocation of material resources is realized, making credit funds commodity-like. Funds not only reflect their commodity attributes in the transmission to industrial sectors. But also carry out the buying and selling of financial products under the impetus of the transaction medium-financial instruments.

Money in the Exchange of Production Factors

Generally speaking, financial products, that is buyers or demanders of monetary funds, obtain funds for investment, development of production, and circulation.

However, for various purposes, different financial products will also be traded with each other. In this way, the criss-crossing circulation of financial products constitutes a relatively independent market – the financial market, which has also become an indispensable production factor market and an indispensable link in the communication of various factor markets under the market economy.

Funds in Capitalism

Marx believed that monetary funds are the first driving force and continuous driving force for the development of capitalism. Through the financing function of this market, funds are transferred from the hands of owners to the hands of demanders. Realizing the reconfiguration and optimization of funds, giving full play to the liquidity and efficiency of funds. Thus promoting the development of the commodity market.

Organic Part of the Market System

It can be seen that the financial market is an organic part of the entire market system.

2. The relationship between the financial market and other markets

The financial market is a place for trading monetary funds or financial products and also a place for financing. It is mainly a place for currency lending and various bills, securities, gold, and foreign exchange trading.

The relationship between supply and demand for funds is given and financed through financial market trading activity. The financial market is both related to and different from other commodity markets.

(A) The connection between financial markets and other markets is specifically manifested in the following aspects:

First

Financial markets provide a medium for transactions in commodity markets, enabling commodity exchanges to proceed smoothly.

Second

Financial markets can effectively promote the development of commodity markets, thus promoting the development of commodity markets in terms of their breadth;

Third

Through the promotion and regulation of financial markets, commodity markets can flow and combine, thereby causing a reconfiguration of resources.

(B) The difference between financial markets and other markets is manifested in the following aspects:

First

Second

Third,

Fourth

How financial markets work

Regulatory of Funds Movement

The Role of Banks

Indirect Financing through Banks and Creation of Derivative Deposits

Circulation of Financial Instruments

How big is the scope of the financial market?