Financial Markets - An Overview

  In common parlance, a market is a place where trading takes place. Whenever we think about markets, a picture that flashes across our minds is of a place which is very busy, with buyers and sellers, some sellers, shouting at the top of their voice, trying to convince customers to buy their wares. A place abuzz with vibrancy and energy.

In the early stages of civilization, people were self-sufficient. They grew every thing they needed. Food was the main commodity, which could be very easily grown at the backyard, and for the non-vegetarians, jungles were open with no restrictions on hunting. However, with the development of civilization, the needs of every being grew; they needed clothes, wares, instruments, weapons and many other things which could not be easily made or produced by one person or family. Hence, the need of a common place was felt, where people who had a commodity to offer and the people who needed that commodity, could gather satisfy their mutual needs.

With time, the manner in which the markets functioned changed and developed. Markets became more and more sophisticated and specialized in their transaction so as to save time and space. Different kinds of markets came into being which specialized in a particular kind of commodity or transaction. In today's world, there are markets which cater to the needs of manufacturers, sellers, ultimate consumers, kids, women, men, students and what not. For the discussion of the topic at hand, the different kinds of markets that exist in the present day can be broadly classified as goods markets, service markets and financial markets. The present article seeks to give an overview of Financial Markets.

WHAT IS A FINANCIAL MARKET?

According to Encyclopedia II, 'Financial Markets' mean:

"1. Organizations that facilitate trade in financial products. i.e. Stock Exchanges facilitate the trade in stocks, bonds and warrants.

2. The coming together of buyers and sellers to trade financial product i.e. stocks and shares are traded between buyers and sellers in a number of ways including: the use of stock exchanges; directly between buyers and sellers etc."

Financial Markets, as the name suggests, is a market where various financial instruments are traded. The instruments that are traded in these markets vary in nature. They are in fact tailor-made to suit the needs of various people. At a macro level, people with excess money offer their money to the people who need it for investment in various kinds of projects.

To make the discussion simpler, let's take help of an example. Mr. X has Rupees 10 lacs as his savings which is lying idle with him. He wants to invest this money so that over a period of time he can multiply this amount. Mr. Y is the promoter of ABC Ltd. He has a business model, but he does not have enough financial means to start a company https://www.bonitrust.de/. So in this scenario, Mr. Y can utilize the money that is lying idle with people like Mr. X and start a company. However, Mr. X may be a person in Kolkata and Mr. Y may be in Mumbai. So the problem in the present scenario is that how does Mr. Y come to know that a certain Mr. X has money which he is willing to invest in a venture which is similar to one which Mr. Y wants to start?

The above problem can be solved by providing a common place, where people with surplus cash can mobilize their savings towards those who need to invest it. This is precisely the function of financial markets. They, through various instruments, solve just one problem, the problem of mobilizing savings from people who are willing to invest, to the people who can actually invest. Thus from the above discussion, we can co-relate how financial markets are no different in spirit from any other market.

The next issue that needs to be redressed is what is the distinction between various financial instruments that are floated in the market? The answer to this question lies in the nature or needs of the investors. Investors are of various kinds and hence have different needs. Various factors that motivate investors are ownership of controlling stake in a company, security, trading, saving, etc. Some investors may want to invest for a long time and earn an interest on their investment; others may just want a short term investment. There are investors who want a diverse kind of investment so that their overall investment is safe in case one of the investments fails. Hence, it is the needs of the investors that have brought about so many financial instruments in the market.

There is one more player in the financial market apart from buyers and sellers. As stated above, the one who wants to lend money and the one who wants to invest the money may be situated in different geographical locations, very far from each other. A common place for this transaction will require the meeting of these persons in person to close the transaction. This may again result in a lot of hardship. It may also be the case that the rate at which the lender wants to lend his money or the duration for which he wants his money to incur interest, may not be acceptable to the borrower of the money. This would result in a lot of glitches and latches for closing the transaction. To solve this problem, we have a body called the Intermediaries, which operate in the financial markets. Intermediaries are the ones from whom the borrowers borrow the harbored savings of the lenders. Their chief function is to act as link to mobilize the finances from the lender to the borrower.

Intermediaries may be of different kinds. The basic difference in these intermediaries is based upon the kind of services they provide. However, they are similar in the sense that none of the intermediaries are principal parties to a transaction. They merely act as facilitators. The kinds of intermediaries that operate in financial markets are:

• Deposit-taking intermediaries,

• Non-deposit taking intermediaries, and

• Supervisory and regulatory intermediaries.

Deposit-taking intermediaries are those that accept deposits from a principal. They accept deposits so that the deposits can be utilized for the purpose of advancing loans to the persons who are in need of it. Example - Reserve Bank of India, Private Banks, Agricultural Banks, Post Office, Trust Companies, Caisses Populaires (Credit Unions), Mortgage Loan Companies, etc.

Non-deposit taking intermediaries are those which only manage funds on behalf of the client. They act as agents to the principal. They merely bring together the borrower and the lender with similar needs. Unit Trusts, Insurers, Pension Funds and Finance Companies are an example of this kind of intermediaries.

Supervisory and Regulatory Intermediaries do not actively participate in the trading of securities in the financial markets as parties. They perform the function of overseeing that all the transactions that take place in the financial markets are in compliance with the statutory and regulatory framework. They step in only when any error or omission has been committed by either of the parties to the transaction, and take steps as is provided by the statutory and regulatory scheme. The Bombay Stock Exchange, National Stock Exchange, etc. are examples of this kind of intermediary.

PRIMARY MARKETS AND SECONDARY MARKETS:

In financial markets, the financial instruments (securities) may be traded first hand or second hand. For example, A wants to invest Rs. 1 million in XYZ Company, which is a newly incorporated company. One share of XYZ Co. costs Rs. 500. In this scenario, A will purchase 2000 shares of XYZ Co. XYZ Co. is issuing shares to A in return to his investment, first hand.

Suppose after purchasing the shares from XYZ Co., A holds the shares for a year and thereafter wants to sell the shares, he may sell the shares through a stock exchange. B wants to purchase 2000 shares of XYZ Co. B approaches the stock exchange and purchases the shares therefrom. In this case, B has not directly purchased shares from XYZ Co., however, he is as good a holder of shares as anyone who purchased the shares from XYZ Co. directly.

In the first example, A purchased the shares of XYZ Co. directly. Hence, he purchased his shares from the Primary market. In the second example, B did not purchase the shares from XYZ directly, however, his title over the shares is as good as A's, even though he purchased the shares from Secondary market.

KINDS OF FINANCIAL MARKETS:

When securities are issued in financial markets, the borrower has to pay an interest on the amount borrowed. Securities may be classified based on the duration for which they are floated. The kinds financial markets that exist based on the duration for which the securities have been issued are:

• Capital Markets: This kind of financial market is one in which the securities are issued for a long-term period.

• Money Markets: In this kind of financial markets, securities are issued for a short-term period.

The trading of financial instruments and the closing of transaction need not necessarily take place at the same time. There may be a time gap between the taking place of a transaction and closing or effectuating the transaction. The kinds of financial markets that can be distinguished on this basis are:

• Spot Markets: The transaction is brought into effect at the time the trading takes place. By the very nature of the transaction, it can be understood that the risk associated with this kind of market is very minimal since the parties have no scope of going back on their promised actions.

• Forward Markets: In this kind of market, the transaction takes place on one date and is effected on some future date, which is mutually accepted between parties to the transaction. As the date on which the mutually accepted transaction is effected is different from the date on which the transaction is mutually accepted, there is a risk that one of the parties may not be in a position; on the date the transaction is to be effected, to honor the transaction. Hence the level of risk in this market is higher than that of spot markets.

• Future Markets: This kind of financial market closely resembles Forward Markets, with the difference that in this market, the quality and the quantity of the goods that are traded are specified on the date the transaction is entered into, though the transaction is to be effected on some future date. There is also an added advantage in this market in comparison to Forward Markets in the sense that there is a security of guarantee in case one of the parties fails to honor his part of the undertaking which he had promised while entering into the transaction. Hence, the level of risk associated with this market is comparatively lower than that of the Forward Markets.

RISKS IN FINANCIAL MARKETS AND HEDGING THEM:

"In this business if you're good, you're right six times out of ten. You're never going to be right nine times out of ten."

~Peter Lynch (Research Consultant, Fidelity Consultant)

When a transaction takes place in financial markets, there is always a risk factor associated with the transaction. The various risks that financial markets are usually associated with are:

• The lender may not repay the money to the borrower,

• There may be an abnormal upward or a downward movement in the price of securities, thereby hampering the interest of the buyer or seller of securities respectively,

• Negative sentiments or expectations may make some financial instruments unattractive or the whole financial market an unattractive place to the investors and force them to withdraw their investments, resulting in deep plunge of prices of the securities which once seemed very luring and attractive,

• Change in the fiscal policies of the government may make the financial markets unattractive for foreign or domestic investors,

• Change in political power in a country may result in a preferential treatment to one industry, and/ or step-motherly treatment to another, which was not foreseeable by the investors, thereby sharply decreasing the value of their securities.

From the above discussion, we can understand that investment in Financial Markets entails a lot of risks. There are other risks associated to investing in financial markets which may be a result of many composite factors which are closely or remotely related; like serious fluctuations in foreign markets or in Indian scenario, failure of monsoons. To tide over this problem, various hedging securities are traded in the financial markets. The holders of these kinds of instrument lower the risk that is associated with financial markets, by purchasing the risk that is associated with a kind of transaction. Therefore, the holders of hedging instruments are not a party to the original transaction. They are merely the ones who minimize the risk in a transaction by purchasing the risk associated with a transaction. Since these financial instruments are derived from another transaction, these instruments are also called 'derivatives'. The ones who buy the risk are compensated in monetary terms. The higher the risk, higher will be the compensation and vice versa.

CONCLUSION:

"An investor without investment objectives is like a traveler without a destination."

~Ralph Seger (Founder, Seger-Elvekrog Inc.)

Financial Markets are complex and unpredictable. The movements in financial markets of one country may be the effect of incidents occurring in some foreign land. It may be difficult to comprehend the financial markets at a given time and place. However, an intelligent player in financial markets always takes decisions by carefully studying the trends in the financial markets and closely following the cues in the domestic and international markets.

One also needs to be clear as to why one wants to enter the financial markets. If one wants to enter as an investor, one should invest in securities which have the potential of returning his investment with interest after the period of time for which one wants to invest. In this case one should generally purchase securities which are safe and have a reputation of giving good returns. On the other hand, if one wants to trade in securities, one should carefully study the trends prevailing in the day to day markets and make an intelligent decision by basing one's judgment on that ground. To minimize risks, one should have a diverse portfolio, so that even if one or some of the investments suffer, the others make good one's loss.

To conclude, the author would like to admit that financial markets are a very interesting playground, in which a player needs to be flexible and patient. There may be initial hiccups when one starts investing, however, with time, as one starts to understand the financial markets, things start falling in place; and a reminder, never under-estimate the result of a remotely connected incident in financial markets.

"It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."

Robert Kiyosaki, author of this text entitled Increase Your Financial IQ is an investor, entrepreneur and educator whose perspectives on money and investing align with conventional wisdom. Kiyosaki has challenged and changed the way many people around the world think about money.

Born and raised in Hawaii, this financial expert is a fourth-generation Japanese-American. After graduating from college in New York, Kiyosaki joined the Marine Corps and served in Vietnam as an officer and helicopter gunship pilot.

On the question of whether money makes one rich, this author says it is not so. He explains that money alone does not make one rich, adding that we all know people who go to work every day, work for money, make more money, but fail to become richer.

This financial expert asserts that ironically, many only grow deeper in debt with the money they earn. Kiyosaki says we have all heard stories of lottery winners, instant millionaires, who are instantly poor again. He adds that again, we have heard stories of real estate going into foreclosure, and instead of making homeowners richer, more financially secure, real estate drives homeowners out of their homes and into the poorhouse.

Kiyosaki says many of us know of individuals who have lost money investing in the stock market. He educates that even investing in gold, the world's only real money, can cost investors money.

According to him, this text is not a get-rich one or a text about some financial magic formula. Rather, he says it is about increasing your financial intelligence, your financial IQ. It is about getting richer by getting smarter and the five basic forms of financial intelligence required to grow richer, regardless of what the economy, stocks, or real estate markets are doing, reveals this author.

Structurally, this text is segmented into ten chapters. Chapter one is interrogatively entitled What is financial intelligence? In this author's words here, "Money alone does not solve your money problems. That is why giving poor people money does not solve their money problems. In many cases, it only prolongs the problem and creates more poor people."

Kiyosaki educates that hardwork also does not solve money problems, stressing that the world is filled with hardworking people who earn money, yet grow deeper in debt, needing to work even harder for more money.

He says education does not solve money problems, adding that the world is filled with highly educated poor people.

According to Kiyosaki, it is only financial intelligence that solves all money problems. In his words, "In simple words, financial intelligence is that part of our total intelligence we use to solve financial problems... Financial intelligence solves these and other money problems. Unfortunately, if our financial intelligence is not developed enough to solve our problems, the problems persist... Many times they get worse, causing even more money problems. For example, there are millions of people who do not have enough money set aside for retirement. If they fail to solve that problem, the problem will get worse, as they grow older and require more money for medical care."

This author reiterates that whether or not you like it, money does not affect lifestyle and quality of life, adding that the freedom of choice that money offers can mean the difference between hitchhiking or taking bus or travelling by a private jet.

Chapter two is based on the subject matter of the five financial intelligence quotients (IQs). Kiyosaki educates that the five basic financial IQs are: Making more money (Financial IQ No 1); protecting your money (Financial IQ No2); budgeting your money (Financial IQ No3); leveraging your money (Financial IQ No4) and improving your financial information (Financial IQ No5).

As regards difference between financial intelligence and financial IQ, he says, "Most of us know that a person with a mental IQ of 130 is supposedly smarter than a person with an IQ of 95. The same parallels can be drawn with financial IQ. You can be the equivalent of a moron when it comes to financial intelligence... Financial intelligence is that part of our mental intelligence we use to solve our financial problems. Financial IQ is the measurement of that intelligence. It is how we quantify our financial intelligence. For example, if I earn $100,000 and pay 20 per cent in taxes, I have a higher financial IQ than someone who earns $100,000 and pays 50 per cent."

Kiyosaki explains that in this example, the person who earns a net of $80,000 after taxes has a higher financial IQ than the person who earns a net of $50,000 after taxes. Both have financial intelligence, but the one that keeps more money has a higher financial IQ, educates this expert.

In chapters three to seven, the five financial IQs already discussed in chapter two, are elaborately examined respectively.

Chapter eight is christened The integrity of money. According to Kiyosaki here, "'Integrity' is an interesting word. I have heard it used in many different ways and in different contexts. I believe it is one of the more misused, confused, and abused words in the English language. Many times I have heard someone say, 'He has no integrity', or 'If they had any integrity, they would be more successful'. Someone else might say, 'That house has integrity of design'."

This author says before discussing the integrity of money, it is necessary to define Integrity. Kiyosaki says "Integrity", according to Webster, can be defined as "Soundness" (an unimpaired condition); "Incorruptibility" (firm adherence to a code of especially moral or artistic values) and "Completeness" (the quality or state of being complete or undivided).

This expert educates that just as health can break down from a literal lack of integrity, so can wealth be compromised by lack of integrity. "Instead of disease or death, which comes from a breakdown in the body's integrity, symptoms of a lack of financial integrity are low income, crippling taxes, high expenses, excessive debt, bankruptcy, foreclosure, increased crime, violence, sadness, and despair," expatiates this author.

He says the integrity of all the five financial IQs is needed to grow rich, stay rich and pass wealth on to generations after you. Kiyosaki asserts that missing one or more of the financial IQs is like someone who does not know how to drive attempting to drive a car that has brakes without pads, and water in the gas line.

In this author's words, "When a person is struggling financially, one or more of these financial intelligences is out of whack, financial integrity is not sound, and the person is not complete. For example, I have a friend who earns a lot of money as a manager of a small business. Her problem is she has no protection against taxes, plus she does not budget wells, spends impulsively to buy clothes and goes up in price. She gets her financial advice from her husband and his (the husband's) financial planner."

In chapters nine and ten, this author beams his intellectual searchlight on the concepts of developing your financial genius and developing your financial IQ.

As regards style, this text is a prototype for stylistic excellence. For instance, most of the illustrations are based on the financial experiences of the author himself, thus lending credibility and conviction to the text. The language is simple and the presentation very didactic. Kiyosaki generously employs graphical embroidery to achieve visual reinforcement of readers' understanding and make the layout of the text eye-friendly.

However, conceptual repetition is noticed in chapters three to seven where the five financial IQs already discussed in chapter two are further examined. One would have expected him to have harmonised chapters two to seven. Probably, Kiyosaki wants to create emphasis through deliberate repetition.

Also, the word "Intelligence" whose grammatical behaviour in the dictionary shows that it is an uncountable noun as reflected by the symbol "U" against it, is still used in this text in a countable way on pages 150 and 151 where we have "Intelligences".

In spite of the few errors, this text is fantastic. It is a must-read for those who want to accomplish financial freedom and abundance through concrete financial education.