Financial Markets can be classified depending on 6 different things.
Asset transformation
How they work
Degree of formalisation (Criteria)
Term of the assets
Phase of negotiation
Types of assets
1. Asset transformation: is the process of creating a new asset (loan) from liabilities (deposits) with different characteristics by converting small denomination, immediately available and relatively risk free bank deposits into loans – new relatively risky, large denomination asset – that are repaid following a set schedule (Website - NC State University, 2020).
You have two possibilities:
With transformation. For example: Transform a loan into a deposit. Some markets/ financial intermediaries transform the assets that they are trading with.
Without transformation. (You do not transform any asset).
2. How they work: (how financial markets work)
Direct research: buy a specific asset without any intermediary.
Broker: It's a kind of intermediary and the main difference with respect to a Dealer is that they execute an order of a client and they have a commission. Example; “etoro”: is a broker specialized in social trading, which operates multiple financial instruments such as stocks, currencies, futures, options and cryptocurrencies. Through this you can buy shares, but eToro can’t buy shares as “eToro”, they have to be the intermediary between the investor (you) and the company.
Dealer: A dealer buys what the client wants, but they can also buy some shares and securities with their name. They have (receive) a mark-up; if you want to buy a share of 10€ and you use an intermediary, they will charge you a mark-up, or mark-down, of X amount that will be settled down by the dealers. Example: CaixaBank could be an example; they can buy for you but also in their name, and sometimes they have the roll of advisor. Differences between a Broker and a Dealer: Broker: - Executes the trade on behalf of others - Buys and sells securities for their clients - Charges a commission Dealer: - Trades on their own behalf - Buys and sells securities on their own account - Charges a mark-up or mark-down
3. Degree of formalisation (Criteria)
Organised: classic markets; NASDAQ, IBEX 35, New York., etc. The transactions are guaranteed by a centralised institution, there is a higher security in the transactions, and tend to happen online. (More secure than in 'over the counter')
Over the counter: OTC pink, OTC QX, OTC QB, etc. The transactions are usually organised through phone calls, e-mails, and actually in the old times were advertised in pink sheets, with the share and the price next to it. In this way, you could arrange a transaction but, it would imply a lower security than in an organised way.
4. Term of the asset
A. Spot contract;
Involves the purchase, or sale, of a commodity, security, or currency for immediate delivery and payment.
The spot price is the current price of the asset (It’s a transaction that happens in the moment when the payment is done, the buyer wants to buy something and they agree the price immediately).
Example: A supermarket wants an immediate delivery of 100.000 litres of orange juice: 1. They pay the spot price to the seller (immediately): 1$ per litre: 100.000$. 2. 1$ per litre is the current market price for a litre of orange juice. 3. They receive the orange juice shortly after their payment.
B. Forward Contract;
Customized contract between two parties to buy, or sell, an asset at a specified price on a future date.
The forward price is set before the transaction happens. It might be very different from the current price of the asset (spot price) when the transaction happens.
Example: A supermarket wants to order 200.000 litres of orange juice for the summer season, which is 6 months away: 1. The supermarket enters into a forward contract with their bank, to buy 200.000 litres of orange juice at a forward price of 2,5$ in six months. 2. In 6 months, the spot price of a litre of orange juice has 3 possibilities: - It is exactly 2,5$. No money is owed by the producer or the bank. - It is lower than 2,5$. For ex; 2$: The supermarket owes to the bank. - It is higher than 2,5$. For ex; 3$: The bank owes to the supermarket.
5. Phase of negotiation
Primary market: When you buy directly - In the primary market, securities are directly purchased from the issuer. - Example: Initial Public Offering (IPO) is an offering of the primary market where a private company decides to sell stocks to the public for the first time.
Secondary market: the transaction doesn’t happen directly between the buyer and seller, the investors will be changing the securities between themselves, and not directly with the company. - In the primary market, investors buy securities directly from the company issuing them. - In the secondary market, investors trade securities among themselves, and the company with the security being traded does usually not participate in the transaction. - Examples: New York Stock Exchange (NYSE), London Stock Exchange or Nasdaq.
6. Types of assets;
A. Money market
Monetary market; the assets that have high liquidity are traded between countries, normally the government. - Where financial instruments with high liquidity and very short maturities are traded.
Interbank; banks changing currencies between themselves. - Foreign exchange market where banks exchange different currencies.
B. Capital market
Bond market (Public Bond market/ Private Bond market): - Where participants can issue new debt, or buy and sell debt securities in the form of bonds. - Goal: provide long-term funding for public and private expenditures.
C. Stock market
Forex market; where participants (investors) can exchange currencies, not countries. (Not countries, but investors). - Market in which participants can buy, sell, exchange, and speculate on currencies.
Derivatives; specific kind of assets. - Market for financial instruments like future contracts or options, which are derived from other forms of assets.
*All content was gathered from Tecnocampus' slides and implemented by my own notes.
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