Unit - 2

Financial Market

Sitaram Dhakal, Kathmandu College of Management [KCM]

 The Firm and the Financial Markets

Firm Firm issues securities (A) Financial

markets
Invests
Retained
in assets cash flows (F)
(B)
Short-term debt
Current assets Cash flow Dividends and Long-term debt
Fixed assets from firm (C) debt payments (E)
Equity shares

Taxes (D)

Ultimately, the firm must The cash flows from

be a cash generating the firm must exceed
activity.
Government the cash flows from
1-2
the financial markets.
 Financial Market
Bringing buyers and sellers of financial instruments together.
Most firms use financial markets to invest in assets.
The company can raise capital with the help of financial
markets.
Individuals surplus is invested in the financial market.
Financial Market based on life of
securities and Trading procedure
1. Money market and capital market
2. Primary Market and secondary market
FM based on organization structure

Divided into four categories:

Organized stock exchange (NEPSE),
Over-the-counter market
The third &
Fourth markets
 Financial Markets

Stocks and Investors

Bonds
Firms
securities
Money Bob Sue
money

Primary Market

Secondary Market

1-6
Money market and capital market.
Money market, concerned with the buying
and selling of short-term (less than one year
original maturity) government and corporate
debt securities.
The capital market, deals with relatively long-
term (greater than one year original maturity)
debt and equity instruments (e.g., bonds and
stocks).
Primary Market and secondary market
Primary markets are the markets in which corporations raise new
capital.
The corporation selling the newly created stock receives the
proceeds from the sale in a primary market transaction.
The initial public offering (IPO) market is a subset of the primary
market.
Secondary markets are markets in which existing, already
outstanding, securities are traded among investors.
NEPSE is a secondary market, since it deals in outstanding, as
opposed to newly issued, stocks and bonds.
Corporation does not receive any funds from the sale of securities
in the secondary market.
 Difference between primary and secondary markets

Primary Market Secondary Market

Market for new securities Market for existing securities

Corporation/Government involvement is Government involvement is through

direct regulators (indirect)
Issuer gets additional funds on issue of Issuers does not get any additional
new securities. funds when listed in secondary market.
No physical location Physical location exist.

Trading facility is not available in primary It enables trading and provides liquidity
market. to the securities.
 Over-the-counter market

The market for those securities not listed in the

stock exchange.
The-telephone market
Brokers and dealers linked with networks of
telephone to conduct transactions in OTC market.
There are other electronic means to deal the
securities among the investor.
 The third market
Market for securities listed on a stock exchange but traded over
the counter market is the third market.
Institutional investors who need large blocks of securities that is
not possible from organized stock exchange due to certain rigidity
rules are involved.
Lower transaction costs
Trade as quickly as desired by institution.
Those brokers and dealers, who are not the members of exchange,
become the active customer of the third market.
The market makers buy stock for their own account, which is
offered by an institution and will make attempt to resell to other
needy institution.
 The Fourth Market

Direct trading of stocks between two traders

without using of broker.
Bypasses normal dealer services.
Traders make the transaction possible through a
communication network among them.
Trade large blocks securities without the help of a
brokerage house.
 Importance of Financial Market
Accumulation of Public Fund
Liquidation of securities
Corporate fund raising
Economic Growth
Industrialization
Functions of Financial Markets
a. Transfer of funds
b. Providing of liquidity
c. Securities pricing
d. Resource allocation
 Transfer of Funds
Facilitate the transfer of funds from savers and
investors to spenders.
Funds are transferred from a surplus spending
units (SSUs) to deficit spending units ( DFUs )
Fund transfers occur in the primary financial
markets.
SSU = net saver
DSU = net spender
3 Major Sectors
Households - typically net SSUs
Business - typically net DSUs
Government - almost always net DSUs
 Providing Liquidity
Defined as the ease with which we can sell an
asset on short notice without a loss in its value.
Provide liquidity for sellers of securities in the
secondary market.
Assets with good liquidity:
Stock issues included in the Dow Jones Averages or the
NASDAQ 100 index
Options on popular stocks
Gold coins
Treasury Bills, Notes, and Bonds
Assets with poor liquidity:
Common Stock with poor transaction turnover
Russian bonds issued by the Czar in 1905
 Securities pricing
Facilitate pricing of various financial securities.
Accomplished through the supply-demand forces
in a potential market.
Individual investors make decisions about what
they feel are the intrinsic values of different
financial assets.
Where the supply and demand curves meet the
market arrives at an equilibrium price.
 Resource allocation
Firms raising money for investment purposes
must compete with other security issuers ( public
and private ) for available money.
Since the investors who provide these funds are
interested in earning the highest return for a given
level of risk, they have an incentive to evaluate
these different investment opportunities and
choose the best investments.
Through this process, they channel available
investment funds in the economy to their highest
and best possible uses.
Thank You