Financial Market is the market where financial securities like stock and bonds and commodities like valuable metals are exchanged at efficient market prices. Here, by efficient market prices we mean the unbiased price that reflects belief at collective speculation of all inventors about the future prospect. The trading of stocks and bonds in the Financial Market can take place directly between buyers and sellers or by the medium of stock exchange. Financial markets can be domestic or international.
Broad term describing any marketplace where buyers and sellers take part in the trade of material goods such as equities, bonds, currencies and derivatives. Financial markets are normally define by having a transparent pricing, basic regulations on trading, costs and fees and market forces shaping the prices of securities that trade.
Some financial markets only permit participants that meet certain criteria, which can be based on factors like the sum of money held, the investor's geographical place, knowledge of the markets or the occupation of the accomplice.
Financial markets can be found in almost every country in the world. Some are very small, with only a few participants, while others - like the New York Stock Exchange (NYSE) and the forex markets - trade trillions of dollars daily.
Most financial markets have periods of heavy trading and demand for securities; in these periods, prices may rise above past norms. The contrary is also true - downturns may cause prices to fall past levels of native value, based on low levels of demand or other macroeconomic forces like tax rates, national production or employment levels.
Information transparency is important to increase the self-assurance of participants and therefore encourage an efficient financial marketplace.
Types of Financial Markets
Capital Market
Capital Market had a primary and secondary market. In primary market only just issued bonds and stocks are exchanged. In secondary market buying and selling of already existing bonds and stocks to take place. So, the Capital Market can be separate to two into Bond Market and Stock Market. Bond Market gives financing by bond issuance and bond trading. Stock Market gives financing by shares or stock issuance and by share trading. As a whole, Capital Market facilitates rising of:
Money Market
Money Market facilitates short term debt financing and capital.
Derivatives market
Derivatives Market provides instruments which help in calculating financial risk.
Foreign Exchange market
Foreign Exchange Market facilitates the foreign exchange trading.
Insurance Market
Insurance Market helps in repositioning of numerous risks.
Commodity Market
Commodity Market organizes trading of commodities.
Contribution of Financial Markets
Financial Markets are necessary for fund raising. Through Financial Market borrowers can find right and proper lenders. Banks also help in the procedure of financing by working as intermediaries. They use the money, which is saved and deposited by a group of people; for giving loans to another group of people who need it. Generally, banks provide financing in the form of loans and mortgages. Except banks other intermediaries in the Financial Market can be Insurance Companies and Mutual Funds. But more complicated transactions of Financial Market take place in stock exchange. In stock exchange, a company can buy others' company's shares or can sell own shares to raise funds or they can buy their own shares existing in the market.
Basis of Financial Market
Basis of Financial Markets are the Borrowers and Lenders.
Borrowers of the Financial Market can be individual persons, private companies, public corporations, government and other local authorities like municipalities. Individual persons generally take short term or long term mortgage loans from banks to buy any property. Private Companies take short term or long term loans for expansion of business or for improvement of the business infrastructure. Public Corporations like railway companies and postal services also borrow from Financial Market to collect required money. Government also borrows from Financial Market to bridge the gap between govt. revenue and govt. spending. Local authorities like municipalities sometimes borrow in their own name and sometimes govt. borrows in behalf of them from the Financial Market.
In the Financial Market lenders are actually the investors. They invest money is used to finance the necessities of borrowers. So, there is much kind of investments which create lending activities. Some of these types of investments are depositing money in savings bank account, paying premiums to Insurance Companies, investing shares in different kind of companies, investing in government, bonds and investing in pension funds and mutual funds.
Financial Market is nothing but a way to used raise capital. Just like any other tool, it can be beneficial and can be harmful too. So, the ultimate outcome only lies in the hands of the people who use it to serve their purpose.
Categories of financial capital
There are three categories of financial capital that are important to know when analyzing your business or in a potential investment. Each of it has their own benefits and characteristics.
Equity Capital
Also known as "net worth" or "book value", this figure represents assets minus liabilities. There are some businesses that are funded completely with equity capital (cash written by the shareholders or owners into the company that have no offsetting liabilities.) Although it is the favoured form for most of the people because you will not go bankrupt, it can be extremely costly and require huge amounts of work to develop your enterprise. Microsoft is an example of such an business because it generate high enough profits to substantiate a pure equity capital structure.
Debt Capital
This type of capital is infused into a business with the appreciative that it must be paid back at a fixed future date. In the meantime, the owner of the capital (typically a bank, bondholders, or a rich individual), agree to accept interest in switch over for you using their money. Assume of interest expense as the cost of "renting" the capital to develop your business; it is often acknowledged as the cost of capital. For many juvenile businesses, debt can be the easiest way to develop because it is relatively easy to access and is understood by the average American worker thanks to well-known home ownership and the community-based nature of banks. The profits for the owners is the difference between the return on capital and the cost of capital; for example, if you borrow $100,000 and pay 10% interest yet earn 15% after taxes, the profit of 5%, or $5,000, would not have existed without the debt capital infused into the business.
Specialty Capital
This is the gold standard. There are a few sources of capital that consist almost zero economic cost and can take the limits off of growth. They include things such as a negative cash exchange cycle (vendor financing), insurance float, etc.
Negative Cash Conversion (Vendor Financing)
Imagine you own a retail store. To expand your business, you need $1 million in capital to open a new location. Most of this is the result of need to go out, buy your inventory, and stock your shelves with goods. You wait and hope that one day customers come in and pay you. In the meantime, you have capital (either debt or equity capital) tied up in the business in the form of inventory.
Now, imagine if you could get your customers to pay you before you had to pay for your merchandise. This would allow you to carry far more merchandise than your capitalization structure would otherwise allow. AutoZone is a great example; it has convinced its vendors to put their products on its shelves and retain ownership until the moment that a customer walks up to the front of one of AutoZone's stores and pays for the goods. At that precise second, the vendor sells it to AutoZone which in turn sells it to the customer. This allows them to increase far more rapidly and return more money to the owners of the business in the form of share repurchases (cash dividends would also be an option) because they don't have to tie up hundreds of millions of dollars in inventory. In the meantime, the increased cash in the business as a result of more favourable vendor terms and / or getting your customers to pay you sooner allows you to generate more income than your equity or debt alone would permit. Typically, vendor financing can be measured in part by looking at the percentage of inventories to accounts payable (the higher the percentage, the better), and analyzing the cash conversion cycle; the more days "negative", the better. Dell Computer was famous for its nearly two or three week negative cash conversion cycle which allowed it to grow from a college dorm room to the largest computer company in the world with little or no debt in less than a single generation.
Float
Insurance companies that collect money and can generate income by investing the funds before paying it them out in the future in the form of policyholder payouts when a car is damaged, or replacing a home when destroyed in a tornado, are in a very good place. As Buffett describes it, float is money that a company holds but does not own. It has all of the benefits of debt but none of the drawbacks; the most important consideration is the cost of capital - that is, how much money it costs the owners of a business to generate float. In exceptional cases, the cost can actually be negative; that is, you are paid to invest other people's money plus you get to keep the income from the investments. Other businesses can develop forms of float but it can be very difficult.
Sweat Equity
There is also a form of capital known as sweat equity which is when an owner bootstraps operations by putting in long hours at a low rate of pay per hour making up for the lack of capital necessary to hire sufficient employees to do the job well and let them work an ordinarily forty hour workweek. Although it is largely intangible and does not count as financial capital, it can be estimated as the cost of payroll saved as a result of excess hours worked by the owners. The hope is that the business will grow fast enough to compensate the owner for the low-pay, long-hour sweat equity infused into the enterprise.
