IIMFC201T116-V007500

Summary

This week's course delves into financial markets, which are platforms for trading financial instruments of varying maturities. It distinguishes between short-term (money markets) and long-term (capital markets) markets, highlighting instruments like Treasury bills and corporate bonds. The course will explore specialized markets including foreign exchange, derivatives, private equity, and mortgage markets, examining how they operate and the factors influencing financial instruments' pricing and yields.

Takeaways

• 🏦 Financial markets are platforms for trading financial instruments with varying maturities.
• 📈 These markets facilitate price discovery, determining prices and yields based on factors like cash flows and risk.
• 💼 Markets are categorized into short-term (money markets) and long-term (capital markets) based on the maturity of traded instruments.
• 💵 Short-term markets include instruments like call money, Treasury bills, and commercial paper, with maturities up to one year.
• 🏢 Long-term markets involve government securities, corporate bonds, and equities, with maturities from one year to perpetual.
• 🌐 Specialized markets include foreign exchange, derivatives, private equity, and mortgage markets.
• 🔄 Financial markets are dynamic, influenced by macroeconomic factors, investor sentiment, and issuer risk profiles.
• 🌐 The distinction between short-term and long-term markets is based on the maturity of the instruments, not the holding period of the investor.
• 💹 Equity prices, interest yields, and exchange rates are driven by both fundamental theories and market forces.
• 📚 Upcoming sessions will delve into the nature, composition, and structure of money and capital markets, and how they operate.

Q & A

What are financial markets?

Financial markets are real and virtual marketplaces where financial instruments of varying maturities are traded, including instruments that can be bought and sold such as overnight instruments, short-term instruments, long-term instruments, and perpetual instruments like equity shares.

What is price discovery in financial markets?

Price discovery refers to the process by which markets determine prices and yields for financial instruments based on factors like projected cash flows, risk profile of the issuer, interest rate expectations, liquidity, and news flows in a free and transparent manner.

How are financial markets classified based on the maturity of instruments?

Financial markets are broadly classified into short-term markets (money markets) and long-term markets (capital markets) based on the maturity of the instruments traded, ranging from overnight to a maximum of 180 days in the short term and from one year to perpetuity in the long term.

What are some examples of instruments traded in short-term markets?

Short-term markets, also known as money markets, trade instruments such as call money, Fed Funds, Treasury bills, commercial paper, and certificates of deposits.

What is the significance of long-term markets in financial markets?

Long-term markets, also known as capital markets, primarily include the government securities market, the equity stock market, and the corporate bond market. They facilitate the raising of financial resources used by firms for long-term capital investments and by governments for fiscal deficits and long-term infrastructure investments.

What are specialized financial markets?

Specialized financial markets include the foreign exchange market, the derivatives market, the private equity market, and the mortgage market. These markets deal with specific types of financial instruments and transactions, such as currency trading, complex financial derivatives, private investments, and real estate loans.

What is the role of the private equity market?

The private equity market involves institutional investors and high net worth individuals investing in private equity funds (PE funds), which in turn invest in the equity and sometimes debt of listed and unlisted companies. These investments are typically held for a long period and sold for profit when the firm's financial performance improves.

How does the mortgage market function in the context of financial markets?

In the mortgage market, individuals and organizations take loans to buy property. These loans are then packaged by lenders as mortgage-backed securities (MBS) and sold to financial institutions, which trade these securities.

What factors drive the prices and yields in financial markets?

Equity share prices, yields on interest-bearing instruments, and exchange rates are driven by underlying theories of finance and market forces such as global and country-specific macroeconomic factors, investor sentiments and expectations, risk profiles of issuers, and news flows.

How does the maturity of an instrument differ from the holding period by an investor?

The maturity of an instrument refers to the time until its final payment is due, while the holding period is the duration for which an investor holds the instrument before selling it. An investor can buy a long-term instrument, like a 15-year corporate bond, and sell it after a short period, making a short-term trade.