The Financial Market

Businesses, individuals and governments often need to raise capital. For example suppose Carolina Power & Light (CP&L) forecasts an increase in the demand for electricity in North Carolina and the company decides to build a new power plant. Because CP&L almost certainly will not have the $2 billion or so necessary to pay for the plant, the company will have to raise this capital in the financial markets. Or suppose Mr. Fong, the proprietor for a San Francisco hardware store, decides to expand into appliances. Where will he get the money to buy the initial inventory of TV sets, washers an freezers? Similarly, if the Johnson family wants to buy a home that costs $100,000, but they have only $20,000 in savings, how can they raise the additional $80,000? If the city of New York wants to borrow $200 million to finance a new sewer plant, or the federal government needs more than $100 billion to cover its projected 1997 deficit, they too need access to the capital markets.

On the other hand, some individuals and firms have incomes which are greater than their current expenditures, so they have funds available to inverts. For example, Carol Hawk has an income of $36,000 but her expenses are only $30,000, and in 1997 Ford Motor Company had accumulated more than $19 billion of excess cash, which it needs to invest.

Types of Markets

People and organizations wanting to borrow money are brought together with those having surplus funds in the financial markets. Note that markets is plural there are a great many different financial markets in a developed economy such as ours. Each market deals with a somewhat different type of instrument in terms of the instruments maturity and the assets backing it. Also different markets serve different types of customers, or operate in different parts of the country. Here are some of the major types of markets:

1. Physical asset markets (also called “tangible” or “real” asset markets) are those for such products as wheat, autos, real estate, computers and machinery. Financial asset markets, on the other hand deal with stocks bonds notes mortgages, and other claims on real assets, as well as with derivative securities whose values are derived from changes in the prices of other assets.

2. Spot markets and futures markets are terms that refer to whether the assets are being bought or sold for “on-the-spot” delivery (literally, within a few days) or for delivery at some future date such as six months or a year into the future.

3. Money markets are the markets for short-term, highly liquid debt securities. The New York and London money markets have long been the world’s largest but Tokyo is rising rapidly. Capital markets are the markets for long term debt and corporate stocks. The New York Stock Exchange, where the stocks of the largest U.S. corporations are traded, is a prime example of a capital market. There is no hard and fast rule on this, but when describing debt markets, “short term” generally means less than one year, “intermediate term” means one to five years and “long term” means more than five years.

4. Mortgage markets deal with loans on residential, commercial, and industrial real estate, and on farmland, while consumer credit markets involve loans on autos and appliances as well as loans for education vacations and so on.

5. World national regional and local markets also exist. Thus, depending on an organization’s size and scope of operations, it may be confined to a strictly local even neighborhood market.

6. Primary Markets are the markets in which corporations raise new capital. If Microsoft were to sell a new issue of common stock to raise capital, this would be a primary market transaction. The corporation selling the newly created stock receives the proceeds from the sale in a primary market transaction.  

Secondary markets are markets in which existing already outstanding, securities are traded among investors. Thus if Jane Doe decided to buy 1,000 shares of AT&T stock, the purchase would occur in the secondary market. The New York Stock Exchange is a secondary market, since it deals in outstanding as opposed to newly issued, stocks and bonds. Secondary markets also exist for mortgages, various other types of loans, and other financial assets. The corporation whose securities are being traded is not involved in a secondary market transaction and thus does not receive any funds from such a sale.

7. Private market, where transactions are worked out directly between two parties are differentiated from public markets, where standardized contracts are traded on organized exchanges. Bank loans and private placements of debt with insurance companies are examples of private market transactions. Since these transactions are private, they may be structured in any manner that appeals to the two parties. By contrast securities that are issued in public markets (for example, common stock and corporate bonds) are ultimately held by a large number of individuals. Public securities must have fairly standardized contractual features, both to appeal to a broad range of investors and also because public investors cannot afford the time to study unique, non-standardized contracts. their diverse ownership also ensures that public securities are relatively liquid. Private market securities are therefore, more tailor-made but less liquid, whereas public market securities are more liquid but subject to greater standardization.