Financial markets can be broadly classified through two major dimensions. Discuss.

Financial markets can be broadly classified through two major dimensions.
i. Primary markets vs. Secondary markets
ii. Money markets vs. Capital markets

i. Primary Markets Vs. Secondary Markets
Primary Markets
Primary markets are markets in which users of funds (such as companies and governments) raise funds through new issues of financial instruments (such as bonds, debentures or stocks). The fund users have new projects or expanded needs but do not have sufficient internally generated funds (such as retained earnings) to support these needs. New issues of financial instruments, also called securities, are sold to the initial suppliers of funds in exchange for money to the issuer.
Most primary market transactions in Kenya are arranged through investment banks, such as Investments and Mortgages Bank (I&M), Dyer and Blair bank and CFC Bank. These banks serve as intermediaries between the issuers (corporations and state authorities) and investors (funds suppliers). Investment banks provide issuers with advice on various matters including the appropriate price at which each security might be sold and the number of securities to issue. They also undertake to buy any securities that are not taken up by the public in addition to marketing the issue – this is called underwriting. By using an underwriter, the security issuer avoids the risk and cost of creating a market for its securities.
Primary market financial instruments include issues of equity by firm’s initially going public, usually known as Initial Public Offerings (IPOs), and issue of additional equity or debt instruments of an already publicly traded firm.

Secondary Markets
This is the financial market in which securities that have been previously issued (and, as such, second hand) can be traded. Buyers of secondary market securities are economic agents (individuals, businesses, governments) with excess funds. Sellers of secondary market securities are economic agents in need of funds. The original issuer of the security is not involved in the transfer of securities in this market.
The secondary market therefore offers an avenue where economic agents to trade amongst themselves in financial instruments quickly and efficiently, and usually with the help of a security broker. Secondary markets serve two prominent functions:
a) They offer buyers and sellers liquidity i.e., the ability to turn a financial instrument into cash quickly.
b) They determine the price of the financial instrument acquired in the primary market by investors.
To the issuing institution, secondary markets ease the measurement of the firm’s value as perceived by investors by providing information about the current market price of its securities. This information enables the issuer to gauge the investors’ perception of how well it is using the funds obtained through the primary markets. The information also enables the issuer to gauge how well subsequent offerings of securities (debt and equity) might do in the terms of raising additional money and the cost at which such funds may be obtained.

ii. Money Markets Vs. Capital Markets
Money Markets
These are markets in which short-term debt instruments are traded. Short-term instruments are those with maturities less than one year. In the money markets, economic agents with short-term excess supplies of funds can lend funds to economic agents who have short-term shortages. Because of their short-term nature, money market securities have small fluctuations in prices, making them relatively safe investments. At the same time, they are widely traded, which makes them more liquid. As a result, business organizations and banks widely use this market to earn an interest on surplus funds that they expect to have only temporarily. The core of the money market consists of banks borrowing and lending to each other. Besides, the instruments below can also be traded by individuals and businesses;
1. Certificate of deposit - a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. Although it is still possible to withdraw the money, this action will often incur a penalty.
2. Repurchase agreements – are Short-term loans—normally for less than two weeks and frequently for one day—arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date.
3. Commercial paper - Unsecured promissory notes with a fixed maturity of one to 270 days; usually sold at a discount from face value. It’s used for the financing of accounts receivable, inventories and meeting short-term liabilities.
4. Treasury bills - Short-term debt obligations of a national government that are issued to mature in three to twelve months.
5. Money funds - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors.
6. Foreign Exchange Swaps - Exchanging a set of currencies in spot date and the reversal of the exchange of currencies at a predetermined time in the future.

Capital Markets
These are the market in which long-term debt (one year or more maturity) and equity or ownership instruments are traded. Given their long term nature, capital market instruments experience greater price fluctuations than their money market counterparts. The major suppliers of these securities are companies and governments while the major buyers are households and financial institutions like pension funds and insurance companies. Majority of these institutional buyers face little uncertainty about the amount of funds they will have available in the future i.e. they can be able to predict their future cash flows with greater accuracy.

---

Lellah answered the question on November 8, 2021 at 06:53