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Introduction to Markets

Organised markets enhance the efficiency with which trade in goods; services and assets may take place. This is so whether or not the trade is barter trade, or trade that involves the use of money as a medium of exchange. The introduction of money resulted in greater ease and efficiency in transactions and also facilitated saving by individuals whose current incomes were greater than their current expenditures. With wealth being accumulated in the form of money, specialised markets developed to enable the efficient transfer of funds from savers (surplus entities) to borrowers (deficit entities). Traditionally, those markets that specialise in the transfer of short-term funds are referred to as ‘money markets’, and those involved with longer-term transfers are known as ‘capital market’s.

Money markets and capital markets not only provide the channels for the flow of funds between savers and borrowers, they also create financial instruments that offer to surplus entities a range of combinations of risk, return, liquidity and time-pattern of cash flows. This range of instruments encourages savings. The markets are important also in the allocation of savings to the more efficient users of funds. By encouraging savings, and allocating to the most efficient users, the financial markets have and important rile to play in the economic development and growth of a country.

The financial instruments that are created in the financial markets, and which are central to any financial relationship between two parties, can be distinguished on the basis of the relationship between the deficit and surplus entities. Where the saver acquires an ownership claim on the deficit entity, the financial instrument is referred to as equity. Where the relationship is one that is commonly known as a loan, where the lender does no obtain an ownership claim on the borrower, the financial instrument is referred to as a debt instrument. A third party of instruments has been developed – the derivative (futures, options FRAs). One of the main uses of derivatives is the management of the risk of interest rate, exchange rate and equity price fluctuations

The markets in which debt and equity are created and sold by the creators of the instruments are known as ‘primary markets’. However, since many of the instruments have a very long time to maturity and, in the case of equity, there is no specified maturity date, it is important that the purchasers of instruments are able to sell them when they choose. Transactions in previously issued instruments are carried out in the secondary markets. By providing the facilities for the prematurity sale of instruments, secondary markets serve the most important function of adding liquidity to longer-term instruments

In the primary market, the surplus entities may acquire the assets directly from the issuer. Alternatively, the flow of funds may be through an intermediary, in which case the surplus entity establishes a financial relationship with the intermediary rather than the ultimate borrower. Intermediated flows are attractive to ma many savers since the intermediary provides a range of financial attributes that may not be otherwise available. The advantages of the intermediation process are asset transformation, maturity transformation, credit risk transformation, provision of liquidity to savers and distribution and costs.

Various types of financial institutions and intermediaries have developed, with each type adopting somewhat different approaches to attracting funds from surplus entities, and with specialised preferences for the types of deficit entities that they fund. Some of the institutions specialise in receiving funds in the form of deposits (banks); others enter contractual obligations in which they receive nominated funds for undertaking to pay the saver specified sums in the event of a nominated occurrence (life insurance superannuation); yet others sell debt instruments directly to the surplus entities (finance companies); and money market corporations generally restrict their borrowing to very large short-term deposits.