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The capital markets may also be divided into primary markets and secondary marke
ts. Newly formed (issued) securities are bought or sold in primary markets, such
as during initial public offerings. Secondary markets allow investors to buy an
d sell existing securities. The transactions in primary markets exist between is
suers and investors, while secondary market transactions exist among investors.
Liquidity is a crucial aspect of securities that are traded in secondary markets
. Liquidity refers to the ease with which a security can be sold without a loss
of value. Securities with an active secondary market mean that there are many bu
yers and sellers at a given point in time. Investors benefit from liquid securit
ies because they can sell their assets whenever they want; an illiquid security
may force the seller to get rid of their asset at a large discount.
Raising capital[edit]
Financial markets attract funds from investors and channel them to corporations th
ey thus allow corporations to finance their operations and achieve growth. Money
markets allow firms to borrow funds on a short term basis, while capital market
s allow corporations to gain long-term funding to support expansion (known as ma
turity transformation).
Without financial markets, borrowers would have difficulty finding lenders thems
elves. Intermediaries such as banks, Investment Banks, and Boutique Investment B
anks can help in this process. Banks take deposits from those who have money to
save. They can then lend money from this pool of deposited money to those who se
ek to borrow. Banks popularly lend money in the form of loans and mortgages.
More complex transactions than a simple bank deposit require markets where lende
rs and their agents can meet borrowers and their agents, and where existing borr
owing or lending commitments can be sold on to other parties. A good example of
a financial market is a stock exchange. A company can raise money by selling sha
res to investors and its existing shares can be bought or sold.
The following table illustrates where financial markets fit in the relationship
between lenders and borrowers:
Relationship between lenders and borrowers
Lenders Financial Intermediaries
Financial Markets
Borrowers
Individuals
Companies
Banks
Insurance Companies
Pension Funds
Mutual Funds
Interbank
Stock Exchange
Money Market
Bond Market
Foreign Exchange
Individuals
Companies
Central Government
Municipalities
Public Corporations
Lenders[edit]
The lender temporarily gives money to somebody else, on the condition of getting
back the principal amount together with some interest/profit or charge.
Individuals & Doubles[edit]
Many individuals are not aware that they are lenders, but almost everybody does
lend money in many ways. A person lends money when he or she:
puts money in a savings account at a bank;
international trade created the demand for currency markets, importers and expor
ters now represent only 1/32 of foreign exchange dealing, according to the Bank
for International Settlements.[4]
The picture of foreign currency transactions today shows:
Banks/Institutions
Speculators
Government spending (for example, military bases abroad)
Importers/Exporters
Tourists
Analysis of financial markets[edit]
See Statistical analysis of financial markets, statistical finance
Much effort has gone into the study of financial markets and how prices vary wit
h time. Charles Dow, one of the founders of Dow Jones & Company and The Wall Str
eet Journal, enunciated a set of ideas on the subject which are now called Dow t
heory. This is the basis of the so-called technical analysis method of attemptin
g to predict future changes. One of the tenets of "technical analysis" is that m
arket trends give an indication of the future, at least in the short term. The c
laims of the technical analysts are disputed by many academics, who claim that t
he evidence points rather to the random walk hypothesis, which states that the n
ext change is not correlated to the last change. The role of human psychology in
price variations also plays a significant factor. Large amounts of volatility o
ften indicate the presence of strong emotional factors playing into the price. F
ear can cause excessive drops in price and greed can create bubbles. In recent y
ears the rise of algorithmic and high-frequency program trading has seen the ado
ption of momentum, ultra-short term moving average and other similar strategies
which are based on technical as opposed to fundamental or theoretical concepts o
f market Behaviour.
The scale of changes in price over some unit of time is called the volatility. I
t was discovered by Benot Mandelbrot that changes in prices do not follow a Gauss
ian distribution, but are rather modeled better by Lvy stable distributions. The
scale of change, or volatility, depends on the length of the time unit to a powe
r a bit more than 1/2. Large changes up or down are more likely than what one wo
uld calculate using a Gaussian distribution with an estimated standard deviation
.
Financial market slang[edit]
Poison pill, when a company issues more shares to prevent being bought out by an
other company, thereby increasing the number of outstanding shares to be bought
by the hostile company making the bid to establish majority.
Bips, meaning "bps" or basis points. A basis point is a financial unit of measur
ement used to describe the magnitude of percent change in a variable. One basis
point is the equivalent of one hundredth of a percent. For example, if a stock p
rice were to rise 100bps, it means it would increase 1%.
Quant, a quantitative analyst with advanced training in mathematics and statisti
cal methods.
Rocket scientist, a financial consultant at the zenith of mathematical and compu
ter programming skill. They are able to invent derivatives of high complexity an
d construct sophisticated pricing models. They generally handle the most advance
d computing techniques adopted by the financial markets since the early 1980s. T
ypically, they are physicists and engineers by training.
IPO, stands for initial public offering, which is the process a new private comp
any goes through to "go public" or become a publicly traded company on some inde
x.
White Knight, a friendly party in a takeover bid. Used to describe a party that
buys the shares of one organization to help prevent against a hostile takeover o
f that organization by another party.
round-tripping