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Introduction To Financial Markets Essay

3327 words - 13 pages

1 Introduction to Financial Markets1.1 The financial system - financial institutions, markets and instruments supervised by a prudential regulator. Financial system provides economic and financial information to the markets. An efficient FS absorbs and reflects new information into the price of financial instruments.To understand the nature of financial markets it is first necessary to understand the overall financial system that comprises, inter alia, financial markets.The main functions of a nation's financial system are to facilitate the:transfer of funds from surplus to deficit economic units, in primary financial markets, by the creation of new financial assetstrade of existing financial assets in secondary financial marketsfacilitate portfolio structuring - Combination of assets and liabilities each comprising of return, risk, liquidity and timing of cash flows that best suit each saver's particular needs.A nation's financial system comprises surplus economic units (lenders), deficit economic units (borrowers), financial institutions, financial markets and financial assets.1.1.1 Surplus economic unitsThese are individuals or small groups (eg individual households or business firms) who have more funds available than they require for immediate expenditure. That is, they represent savers and potential lenders of their surplus funds.1.1.2 Deficit economic unitsThese are individuals or groups (eg individual households or business firms) who require additional funds to meet their expenditure plans. That is, they represent potential borrowers of funds.1.1.3 Financial institutionsThese are organisations whose core business involves the borrowing and lending of funds (financial intermediation) and/or the provision of financial services to other economic units.1.1.4 Financial assetsFinancial assets represent a claim or right that a surplus economic unit holds over a deficit economic unit. They provide the surplus economic unit with a store of value or future consumption or investment. To the deficit economic unit financial assets they have issued represent a liability or obligation.Whenever, funds are lent and borrowed, financial assets (also referred to as financial instruments) are created. Primary market financial transactions involve an exchange as funds are exchanged for financial assets. Lenders of funds are also buyers of financial assets and borrowers of funds are sellers of financial assets.All financial assets have four different attributes which can provide a basis for comparison between different types of financial assets. viz.:return or yield - Total financial benefit received (interest and capital gain) from an investment.risk - Possibility/Probability that an actual outcome (return) will vary from expected outcome; uncertainty.liquidity - Access to sources of funds to meet day to day expenses and commitments.time pattern of return or cash flow - Frequency of periodic cash flows (interest and principal) associated with a financial...

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