The Financial Markets

Date: 2015-10-07; view: 404.

In most economies around the world, markets are used to carry out this complex task of allocating resources and producing goods and services. What is a market? It is an institution set up by society to allocate re­sources that are scarce relative to the demand for them. Markets are the channel through which buyers and sellers meet to exchange goods, serv­ices, and resources.

There are essentially three types of markets at work within the economic system: (1) factor markets, (2) product markets, and (3) financial markets. The factor markets allocate factors of production—land, labor, and capital— and distribute incomes in the form of wages and other payments to the owners of productive resources. People use most of their income from the factor markets to purchase goods and services in product markets. Food, shelter, automo­biles, books, theater tickets, gasoline, and swimming pools are among the many goods and services sold in product markets.

The financial markets channel savings. They are composed of the money markets and the capital mar­kets. Money markets are the markets for debt securities that pay off in the short term (usually less than one year). Capital markets are the markets for long-term debt and for equity shares.

The term money market applies to a group of loosely connected markets. They are dealer markets. Dealers are firms that make continuous quotations of prices for which they stand ready to buy and sell money-market instruments for their own inventory and at their own risk. Thus, the dealer is a principal in most transactions. This is dif­ferent from a stockbroker acting as an agent for a customer in buying or selling com­mon stock on most stock exchanges; an agent does not actually acquire the securities.

The financial markets can be classified further as the primary market and the secondary markets. The primary market is where securities are initially issued: a bank lends a household $100,000 to buy a house; the U.S. Treasury raises money by selling a $10,000 bond; a new corporation issues stock. In each case, a financial record of the transaction is created, showing the existence of debt or equity.

If these records of debt or equity are then sold to others, this subsequent trade is said to occur in the secondary market. There are two kinds of secondary markets: the auction markets and the dealer markets.

The equity securities of most large firms trade in organized auction markets, such as the New York Stock Exchange, the American Stock Exchange. The New York Stock Exchange (NYSE) is the most important auction exchange. It usually accounts for more than 85 percent of all shares traded in auction exchanges. Most debt securities are traded in dealer markets. Many bond dealers com­municate with one another by telecommunications equipment. Investors get in touch with dealers when they want to buy or sell, and they can nego­tiate a deal. Some stocks are traded in the dealer markets. When they do, it is referred to as the over-the-counter (OTC) market.

In February 1971 the National Association of Securities Dealers made available to dealers and brokers in the OTC market an automated quotation system called the National Association of Securities Dealers Automated Quotation (NASDAQ) system.