Financial Markets and Institutions

Financial Markets & Institutions

There are two types of markets, Capital and Money markets. The characteristics include:

Money markets

  1. Deal in short-term lending and borrowing.
  2. Operated by Financial Institutions (Eg Central Banks, building societies etc).

Capital markets

  1. Deal in long-term finance normally via the stock-exchange (Eg in UK London Stock Exchange)
  2. Primary Aim is to raise Finance and the Secondary aim is handling trade of securities such as Euro-bonds, Company Securities etc.

International Money and Capital markets

International money and capital markets are available for large companies who wish to raise a significant amount of finance. They can borrow funds on Euro-currency markets (International Money Markets) and Euro-bonds markets (International Capital Markets). When a company borrows in a foreign currency the loan is referred to as a Euro-currency loan (e.g. UK company borrows in $ = ‘Euro-dollar’ loan).

Companies looking for longer-term finance (10-15 years) can decide to issue bonds. Bonds gained from overseas currencies are called Euro-bonds and can be traded on international capital markets.

Rates of interest and rates of return

The key influencers of interest rates are:

  • Risk the higher the risk to the lender, the higher the rate of interest the borrower will pay (risk-return trade-off). Financial Intermediaries take deposits and pay people interest to compensate and then re-lend the money to borrowers who pay a higher rate of interest than is paid to depositors. This is called the Mark-up.
  • Duration longer-term loans are often at a higher rate of interest than short-term loans (not always).
  • Size bigger loans are often cheaper and intermediaries will often pay higher rates to savers with bigger deposits.

Risk-return trade-off

The bigger the risk, the greater the compensation lenders/investors expect. Note that the ‘return’ incorporates both the income element (e.g. dividends from shares, interest from bonds) and the expected capital gain element (upon sale).