A Financial Market is an institution or arrangement that facilitates the exchange of financial assets. They are mechanisms in our society for converting public savings into investments such as buildings, machinery,
infrastructure and inventories of goods and raw materials. This enables the economy to grow, new jobs to be created and living standards to rise.
Financial markets therefore perform the essential economic function of channelling funds from economic units which have surplus funds (net savers) to economic units with a net deficit of funds (investors). There are several
basic methods of classifying financial markets as follows:
1. A classification of the markets based on the type of instrument or service as follows:
i. Debt Markets
ii. Equity Markets
iii. Financial services Markets
2. A broad classification that distinguishes between
i. Primary &
ii. Secondary Markets
3. A classification of markets based on the term to maturity and liquidity of the instrument. This method categorizes financial markets into
i. Money Markets &
ii. Capital Markets
4. A classification of markets according to when the financial instruments being traded will be delivered. This classification categorizes markets into:
i. Spot markets
ii. Futures or forward markets
iii. Option markets
5. A classification of markets into open and negotiated markets.
i. Auction market
iii. Over-the-counter market
6. Financial markets can also be classified in terms of the extent of financial intermediation involved in the sale of the financial instruments as follows:
i. Direct finance markets
ii. Semi-direct finance markets
iii. Indirect finance markets
Money markets and Capital markets
Money markets are financial markets that are used for the trading of short-term debt instruments, generally those with original maturity of less than one year. The money market is the place where individuals and institutions with
temporary surpluses of funds meet the needs of borrowers who have temporary fund shortages. Thus, the money markets enable economic units to manage their liquidity positions. For example, a security or loan with a
maturity period of less than one year is considered a money market instrument. One of the principle functions of the money market is to finance the working capital needs of corporations and to provide governments with short-term funds in lieu of tax collections. The money market also supplies funds for speculative buying of securities and commodities.
The capital market is designed to finance long-term investments by businesses, governments and households. Capital market instruments are mainly longer term debt securities (generally those with original maturities of
more than one year) and equities. Examples include bonds and shares traded on the stock exchange.
2.1.3 Money market and Capital market financial instruments
A financial instrument is defined as, a claim against the income or wealth of a business firm, house hold or unit of government, normally represented by a certificate, receipt or other legal document, and which is usually created by
the lending of money. Financial Assets are by therefore nature intangible assets e.g
i. Treasury Bills
Financial assets have played the following roles:
1. Transfer funds from surplus units to deficit units to invest in intangible assets.
2. Transfer funds in such a way as to redistribute the unavoidable risk associated with the cash flow generated by tangible assets among those seeking and those providing the funds.