What is the structure of financial markets?

Today the financial markets are highly articulated and allow families and businesses to do use of many different contractual instruments to obtain financing and to use their resources. This complex and varied structure of the financial markets is the result of an evolution centuries-old. They occur under the pressure of both the changing financing needs of States and of businesses and of the growing wealth of families. It also contributed to its evolution strongly - especially in recent times - the push of technological progress in communications and in computing skills.

To navigate within this complex structure, it can be useful to characterize the market's financials along some essential dimensions. In this article, we will build on two of the possible one's dimensions: 1) the type of contract used for financing and 2) the presence or absence of intermediaries. However, it will also be seen that often the contractual and institutional forms with which performs the loan relationship fulfill the same essential functions. They redistribute resources over time, allocate them among alternative uses, redistribute the risk among economic operators, and aggregate and transmit information.

Structure of the financial markets

The main task of finance is to allow those who have a surplus of resources to transfer them to those who have a deficit of resources, in exchange for a promise from the funded entity to return resources in future to your lender. For example, the bond market allows a family to do that want to save 1,000 dollars to transfer this sum to a company that wants to invest 1,000 dollars and need to borrow them. In exchange, they will repay this sum, plus interest, in the future. The financing relationship provides a dual flow of resources. Today, a flow of resources from the financier to the financed entity; is tomorrow, a flow of resources from the funded subject to the financier. The relationship can though differentiate both on the basis of the type of contract that governs the relationship between these two subjects, and on a depending on the intervention of an intermediary in their relationship.

Loan agreement

The resources to be returned to the lender in the future vary according to the contract on the basis on which the financing is made. A debt contract (for example, a mortgage) generally provides that the capital increased by interest is repaid. Therefore it clearly establishes the sum to be returned and the date on which it must be returned. The issue of shares, instead, allows companies to raise capital, which will be remunerated through the payment of dividends (and possibly the final liquidation value of the shares themselves), which, however, are not. Obviously, this does not exclude that there are other useful dimensions to characterize and classify the financial markets. For instance, you can say that the degree of liquidity of the financial instruments or the degree of centralization of the market.

Generally predetermined, but depend both on the company's future profits and on the percentage of these profits that the company's executives will decide to distribute in the form of dividends. Then the first important distinction between financial instruments is between fixed income instruments (mortgages banking, bonds) and instruments for raising risk capital (shares). They also have hybrid instruments, such as savings shares, which entitle the holder to pay a dividend minimum of 5% of the nominal value or at least 2% more than the ordinary shares. Alternatively, some other preferences can be entitled to the payment of a minimum dividend of 2% of the nominal value and convertible bonds.

In many cases, the transfer of resources from the lender to the financed entity involves the intervention of an intermediary. If the Rossi family invests 1,000 dollars in the form of deposit banking, and the bank uses these 1,000 dollars by providing a loan to Bianchi S.p.A. The bank performs the function of intermediating the financing because it is interposed between the family and the company. This interposition obviously also occurs about the repayment of the loan in the future. It gives rise to the assumption of risk for the bank, as it will have to return to the Rossi family the sum deposited and the respective interests regardless of whether the Bianchi S.p.A., in turn, repay the loan and their interest. 

The intervention of an intermediary also occurs in the case of an insurance company, which issues policies in exchange for payment of an insurance premium and promises to pay compensation if the insured event occurs. But the intervention of an intermediary is not always necessary. ​​Think of the case in which, instead of to invest 1,000 dollars in the form of a bank deposit. The Rossi family decides to buy directly an obligation issued by Bianchi S.p.A., that is, a contract that promises repayment of principal and interest at a future date. It is still a tool a fixed income, like a bank deposit, but in this case, there was no need of bank intermediation. So another important distinction is that based on the presence or absence of an intermediary.

Presence or absence of intermediation

Intermediated finance is carried out essentially by the banks (the credit market) and, to an extent, minor by insurance companies (the insurance market). Banks collect resources financially by households mainly in the form of bank deposits (but sometimes also through the sale of certificates of deposit or bank bonds) and use them mainly in loans (credit lines or credit lines) to businesses to a lesser extent, in loans to households. Non-intermediated finance is carried out by the securities markets, which include the stock market, the fixed income securities market public debt, and bonds issued by private individuals, derivatives (options and futures). Through the securities markets, the subjects they need Loans can issue financial instruments and sell them directly to the public

But the prospect of operators and financial markets is not the same in all countries, nor does it always remain the same over time. There are countries where banks are at the center of the financial system (almost all continental European countries and Japan). And in some other countries, where this central position is occupied by stock and bond markets such as Great Britain, the United States, and, to a lesser extent, the Netherlands. 

More essays about Financial Markets:

Financial Markets and Functions

Economic role of the financial market

Financial market and its types

Author: Vicki Lezama