A financial market is a market in which financial assets are traded. In addition to enabling exchange of previously issued financial assets, financial markets facilitate borrowing and lending by facilitating the sale by newly issued financial assets. Examples of financial markets include the New York Stock Exchange (resale of previously issued stock shares), the U.S. government bond market (resale of previously issued bonds), and the U.S. Treasury bills auction (sales of newly issued T-bills). A financial institution is an institution whose primary source of profits is through financial asset transactions. Examples of such financial institutions include discount brokers (e.g., Charles Schwab and Associates), banks, insurance companies, and complex multi-function financial institutions such as Merrill Lynch. Introduction to Financial Markets and Institutions:
Financial markets serve six basic functions. These functions are briefly listed below: •Borrowing and Lending: Financial markets permit the transfer of funds (purchasing power) from one agent to another for either investment or consumption purposes. •Price Determination: Financial markets provide vehicles by which prices are set both for newly issued financial assets and for the existing stock of financial assets. •Information Aggregation and Coordination: Financial markets act as collectors and aggregators of information about financial asset values and the flow of funds from lenders to borrowers. •Risk Sharing: Financial markets allow a transfer of risk from those who undertake investments to those who provide funds for those investments. •Liquidity: Financial markets provide the holders of financial assets with a chance to resell or liquidate these assets. •Efficiency: Financial markets reduce transaction costs and information costs. In attempting to characterize the way financial markets operate, one must consider both the various types of financial institutions that participate in such markets and the various ways in which these markets are structured What Types of Financial Market Structures Exist?
The costs of collecting and aggregating information determine, to a large extent, the types of financial market structures that emerge. These structures take four basic forms: •Auction markets conducted through brokers;
•Over-the-counter (OTC) markets conducted through dealers; •Organized Exchanges, such as the New York Stock Exchange, which combine auction and OTC market features. Specifically, organized exchanges permit buyers and sellers to trade with each other in a centralized location, like an auction. However, securities are traded on the floor of the exchange with the help of specialist traders who combine broker and dealer functions. The specialists broker trades but also stand ready to buy and sell stocks from personal inventories if buy and sell orders do not match up. •Intermediation financial markets conducted through financial intermediaries; Financial markets taking the first three forms are generally referred to as securities markets. Some financial markets combine features from more than one of these categories, so the categories constitute only rough guidelines. Auction Markets:
An auction market is some form of centralized facility (or clearing house) by which buyers and sellers, through their commissioned agents (brokers), execute trades in an open and competitive bidding process. The "centralized facility" is not necessarily a place where buyers and sellers physically meet. Rather, it is any institution that provides buyers and sellers with a centralized access to the bidding process. All of the needed information about offers to buy (bid prices) and offers to sell (asked prices) is centralized in one location which is readily accessible to all would-be buyers and sellers, e.g., through a computer network. No private exchanges between individual buyers and sellers are made outside of the...