1.0 INTRODUCTION
A financial market is
an institutional arrangement that facilitates the exchange of financial assets
including deposits, loans, corporate stocks and bonds, government bonds, and
securities. The market
may have a physical location such as the bank branches,
or Nigerian Stock Exchange or it may not have a precise physical location such
as overthe- counter (OTC) markets for stocks where transactions are carried out
by brokers via computer and telecommunication lines. In this note, you will be
taught the types of financial market, participants in the market as well as
their instruments.
2.0 OBJECTIVES
By the end of the note, you should be able to:
·
explain the term “financial market”
·
discuss the types of financial market
·
identify participants in the market
·
distinguish between money and capital market
·
outline the advantages of the financial market.
3.0 MAIN CONTENT
3.1 Types of Financial Market
Two types of markets
dominate the financial market. These are the money market and capital market.
The distinction is based mainly on the maturity structure of the instruments
traded in each market. Some instruments are of short-term maturity, usually not
exceeding one year, while others are of considerable long period and could be
classified as being medium or long time.
The categorisation of money and capital markets can be further
extended to primary and secondary markets; the primary market is the market for
new issue of funds and securities. It provides a focal point for lenders and
borrowers to transact businesses in contrast. The secondary market allows the
existing holders of financial claims to sell them to other investors.
3.1.1 The Money Market
The money market is that aspect of financial market that deals
with the sale and acquisition of short-term financial assets and liabilities.
It consists of short-term debt securities that are highly marketable. The term
money market arises from the monetary or liquidity nature of instruments traded
in the market. The relative liquidity of the instrument arises from the fact
that they could be converted into cash through the discount window within a
short period without appreciable loss of value. The various instruments in the
money market include treasury bills, treasury certificates, bankers’
acceptances, commercial papers, short-term credit, promissory note, bills of
exchange, short-term bonds etc.
3.1.2 Capital Market Capital market is a market for long-term funds. It is the market,
which finances long-term investments. It is an institutional arrangement that facilitates
the transfer of medium and long-term funds from the surplus sector to the
deficit sector of the economy. From the perspective of economic development, a
well-developed capital market is essential in that it provides opportunity for
long-term investment. The factor that contributed to the development of capital
market in Nigeria is the need for long-term finance. Most economic development projects
require long-term finance, which commercial banks cannot provide. Hence, there
was a need for institutions, which could provide this kind of finance.
3.2 Participants in the
Financial Market Participants in the financial market are classified based
on the maturity structure of the instruments used in the two types of the
financial market-monetary and capital markets. These include:
A. Monetary Market Participants
·
Federal Government of Nigeria
·
Central Bank of Nigeria
·
Commercial Banks
·
Discount houses
·
Other players include non-banking individuals.
B. Capital Market Participants
·
Nigeria Stock Exchange Commission
·
Development Banks
·
Insurance Companies
·
Pension Funds
·
Investment Companies
·
Finance houses
3. 3 Financial Market Instruments
3.3.1 Money Market Instruments
Financial instruments used in the money market include the
following:
Treasury Bills Treasury Bills are the most marketable and most riskless of all
money instruments. Treasury Bills represent the simplest form of borrowing by the
Federal Government. Public investors buy the bills at a discount for the stated
maturity. At the maturity of the bills, the holder receives from the government
a payment equal to the face value of the bill. The difference between the
purchase price and ultimate maturity value constitutes the investor’s earnings.
Its maturity is usually 91 days. Treasury Bills were first issued in Nigeria in
1960.
Treasury Certificates These are securities of larger maturity. Treasury certificates are
similar to Treasury Bills except that they have longer-term of maturity, mostly
over 180 days. Like the Treasury B ills, Treasury Certificates are of fixed
deposits but could be discounted. They are not as popular as the Treasury
Bills. They were first introduced in Nigeria in 1968.
CBN Certificates This is a novel product introduced by CBN to create alternative
shortterm attractive investment avenue for the investing public. They attract banks’
deposits. Like other instruments of the CBN, CBN Certificates are considered
gilt-edged.
Bank Deposits They are deposits from individuals, firms and governments accepted
by depository institutions such as commercial banks, savings and loans institutions.
These funds are used for making loans or purchasing other debt instruments such
as Treasury bills after meeting the regulatory requirement such as the reserve
ratio. Some deposits attract interest rates. The rates vary from bank to bank
and from product to product. The bank deposits are insured by NDIC.
Bill Discounting This is an instrument used for getting immediate value or future
value of an instrument issued by a reputable buyer or debtors. This implies
that the discount values are received immediately while no mind or face value
is repaid at a fixed determinable date. It provides handy liquidity.
Repurchasing Agreement (REPOS) This is usually an overnight borrowing.
Repurchasing takes place when a dealer sells government securities to an investor
on an overnight basis, with an agreement to buy back those securities the next
day at a slightly higher price. The security serves as collateral for taking
the loan. The increase in the price is called an overnight interest.
Commercial Papers/Bankers’ Acceptance Down the history
lane, well-known companies prefer to issue their short-term unsecured debt
notes rather than borrowing from the bank. The notes issued are referred to as
commercial papers. This represents an unconditional promise to pay to or to the
order of the lender a certain sum at a future determinable date. Issuing a
commercial paper may not carry a bank’s guarantee.
When a bank guarantees or accepts the commercial paper to make it
more marketable, it translates into a Banker’s Acceptance. A Banker’s
Acceptance is more valuable than a commercial paper since a bank guarantees
that a Bankers’ Acceptance will be honored.
3.3.2 Capital Market Instruments The main instruments
of the capital market are stocks and shares, debentures, loans, bonds,
mortgages etc. Funds in this market are of long-term nature. They include loans
raised by a company, government or parastatals for which interest is paid at a
fixed rate.
Some of the capital market instruments are:
Corporate Bonds: These are debenture stocks representing a company’s written
acknowledgement of indebtedness. They are often of a long term of more than
one-year maturity. This instrument is governed by a legal contract called
indenture. An indenture specifies protective provisions that the company
provides for investors.
Mortgages: A mortgage is a debt instrument used to finance the purchase of a
home or other form of real estate with the underlying real estate serving as
collateral for the loan. Mortgage instrument could be fixed rate or adjustable
rate. A fixed rate mortgage specifies an interest rate during the term of the
loan, whereas the rate on an adjustable-rate mortgage can change (usually every
one or three years). Mortgage financing received a boost in Nigeria with the
establishment of the National Housing Fund (NHF) in 1992.
Government Development Bonds: This is a device by the government to
raise money from the public to finance its programmes. This can be at the
Federal, State or Local Government levels. They are usually longdated and
possess the following:
- It is an interest income instrument
- It is redeemable
- As a government debt instrument, it is considered gill-edged. In
other words, the chance of recovering the principal is very sure. To a large
extent, it is risk free.
Development Loans: These are loans, which are of long-term given for the purpose of
development. Development Banks in the country have been restructured to meet
these goals.
3.4 Advantages of the
Financial Market
1. It mobilizes funds from
a surplus sector to a deficit of the economy.
2. It mobilizes the savings
of the economy for development.
3. The market allows the public to participate in the running of
the private sector of the economy.
4. The market gives the government the opportunity to borrow long term
capital required for development.
5. The availability of mobilized funds and redirected to the
deficit note ensures greater production of goods and services and hence, greater
wealth.
6 Transactions in the markets allay the fear of liquidity for investors.
7. The wide scope of opportunities in the money and capital market
facilitates the issuance of instruments or securities of varying maturities.
8. It allows investors the opportunity to invest in a wide range
of enterprises thus allowing them to spread their risks.
4.0 CONCLUSION
The main function of the financial market is the pooling of
savings from investors scattered throughout the country and making funds
available to worthy borrowers. The financial market is made up of money and capital
markets. This note explained the difference between money and capital markets.
It discussed their functions and highlighted various instruments available in
the financial market.
5.0 SUMMARY
In this note, you
were introduced to the Nigerian financial market. We discussed the types of
markets in the financial sector and their various instruments. We also
highlighted the advantages of the financial market.
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