Saturday, November 10, 2012

Structure of Financial Markets


Editor Piseth Mao

A firm can obtain funds in a financial market in two ways. 
  1. To issue a debt instrument, such as a bond or a mortgage that is a contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals (interest and principal payments) until a specified date (the maturity date),
Types of Debt instrument 
  • A short-term debt instrument for the maturity is less than a year 
  • Long-term for the maturity is ten years or longer. 
  • Debt instruments with a maturity between one and ten years are said to be intermediate-term.
  2. To issue equities, such as common stock, which are claims to share in the net income   and the assets of a business. If you own one share of common stock in a company that has issued one million shares, you are entitled to 1 one-millionth of the firm’s net income and 1 one-millionth of the firm’s assets. 

Equities often make periodic payments (dividends) to their holders and are considered long-term securities because they have no maturity date. To own stock means that you own a portion of the firm and have the right to vote on issues important to the firm and to elect its directors.

Disadvantages  of  owning equities
  • An equity holder is a residual claimant; the corporation must pay all its
    debt holders before it pays its equity holders.
The advantage of holding equities 
  • Equity holders benefit directly from any increases in the corporation’s profitability or asset value because equities confer ownership rights on the equity holders. Debt holders do not share in this benefit, because their dollar payments are fixed.
Primary market:  A primary market is a financial market that new issues of a security, such as a bond or a stock, are sold to initial buyers by the corporation or government agency or the public investors.

Secondary market:  A financial market that securities have been previously issued (and are thus secondhand) can be resold.

An important financial institution that assists in the initial sale of securities in the primary market is the investment bank or underwriters, for the case in Cambodia, there are 7 underwriters that can assist any company that want to raise fund in financial market. They do this by underwriting securities: It guarantees a price for a corporation’s securities and then sells them to the public. Or we can say Initial Public Offering (IPO).

The New York stock exchanges, NASDAQ, Cambodia Securities Exchange in which issued stocks are traded, are examples of secondary markets, 

Other examples of secondary markets are foreign exchange markets, futures markets, and options markets. Securities brokers and dealers are crucial to a well-functioning secondary market. Brokers are agents of investors who match buyers with sellers of securities; dealers link buyers and sellers by buying and selling securities at stated prices.

When an individual buys a security in the secondary market, the person who has sold the security receives money in exchange for the security, but the corporation that issued the security acquires no new funds. A corporation acquires new funds only when its securities are first sold in the primary market. 

Secondary markets serve two important functions. 
  1. They make it easier and quicker to sell these financial instruments to raise cash; so they make the financial instruments more liquid. The increased liquidity of these instruments makes them more desirable and easier for the issuing firm to sell in the primary market. 
  2. They determine the price of the security that the issuing firm sells in the primary market. The investors that buy securities in the primary market will pay the issuing firm or corporation no more than the price they think the secondary market will set for this security. The higher the security’s price in the secondary market, the higher will be the price that the issuing firm will receive for a new security in the primary market, and the greater the amount of financial capital it can raise. Conditions in the secondary market are the most relevant to corporations issuing securities.

Reference: 
         The Economic of Money,Banking and Financial market by
  • Frederic S. Mishkin
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