SECURITIES MARKETS:

SECURITIES MARKETS:

·         Important part of efficient financial system

·         Offer financial intermediation for debt, equity and other securities instruments ensuring greater competition among financing sources and thereby greater efficiency

·         facilitate the sale and resale of transferable securities

·         Addresses the basic three mismatches among the savers and borrowers (Company) in the economy in the following manner

                1.             Size mismatch:

                                Companies always want to raise large amount (large size) of fund while individual savers always have small amount to invest. Securities market reconciles this mismatch by permitting aggregation of a large number of small investors in to the large sums required by the borrowing companies through securities issue.

                2.             Duration mismatch:

                                Borrowers (entrepreneurs) always want permanent capital or capital for the longer term while savers invest for short period and want to have easy exit or liquidity in the investment. Securities market providing the secondary trading mechanism for the issued securities provides easy exit mechanism for the investors.

                3.             Cost/Return mismatch:

                                Borrowers want to raise funds at low cost while investors want to have high return on their investment. The standardized process in the securities market in one hand reduce the cost of raising fund to the borrowing company to a great extent which in turn will increase corporate profit that ultimately distributed to the investors (Shareholders) in the form of dividend or other means. On the other hand when the corporate profit increases the price of securities of that company will increase in the market thus providing price appreciation to the investors in the securities.

·         Includes both money market and capital market

·         Money market: Market for short term securities;

·         Capital markets: Markets for corporate equities and long term debt

·         Categorized into;

·         Primary market: Market for first hand securities

·         Secondary market: Market for existing securities

·         Major securities markets are;

·         Stock Markets

·         Corporate Debt Markets

·         Government Securities Markets

·         Municipal Bond Markets

·         Depository Receipt Markets

·         Mortgage- and Asset-Backed Securities Markets

·         Financial Derivative Markets

FUNCTIONS OF SECURITIES MARKETS

·         There are three basic functions of securities markets;

·         Price discovery

·         Liquidity provision

·         Minimization of trading cost

1.         Price discovery:

·         Price discovery: process of reaching a fair prices for securities

·         Fair price of securities are discovered by the interaction among the buyer and seller of securities

·         Bid and offer price depends on the expectation of future payments and evaluation of the risk involved in the securities

• basis for expectation and evaluation is information


• market should ensure flow of credible information


• Price of same securities differ due to difference in evaluation and expectation of different people

·         Fair offer price: Lowest price at which any well informed traders is willing to sell the securities

·         Fair bid price: Highest price at which any well informed trader is will to buy the securities

·         Ideal market:

• Market in which all trades takes place at a fair price


• Price change immediately to reflect any new information

·         Price formation in auction market are driven by orders where buy and sell orders compete for the best price

·         In dealer market, price of the securities are quoted; so such markets are often called quote driven markets

2.         Liquidity provision

·         Liquidity is the ease of conversion of assets into cash; more specifically it is the ability to convert an asset into cash quickly and without loss

·         Consists of two basic factors

• marketability: conversion to cash


• Fair price: A fair value of securities on the basis of rational analysis of available information

·         The basic source of liquidity is pooling

• There is diversity among people regarding the holding of securities. Some want to convert their security into cash and some want to convert their cash into securities and to a greater extent these two groups can accommodate each other.


• Securities market pool those preference diversity of people in holding securities and make provision of liquidity

·         A situation where there is imbalance in the desire to cash the securities and the desire to exchange cash for securities, i.e. more of the one groups; is called liquidity imbalance

·         If the securities market provide good liquidity, the market price should not fluctuate in response to the temporary liquidity imbalance because we assume that an ideal market always form fair price of securities.

3.         Minimization of trading cost:

Lower the trading cost easier to trade and better the functions of price discovery and provision of liquidity

·         Various ways to reduce trading cost in an organized market

• Restricted access and rules of conduct


• Only authorized traders are allowed


• Rules governing the conduct of the traders


• Standardization


• Standard process of executing transaction, ownership transfer and payment


• Easy to understand the procedure, traders need to agree only on price and quantity


• Board lots/round lots


• Conflict Resolution


• Dispute are costly but obvious


• Agreement for resolving the conflicts minimizes costs.


• Mechanism for resolving conflicts e.g., Arbitrage Committee in NEPSE


• Guaranteed Execution


• Execution of transaction involves risk


• Cancellation may be costly