The structure of Financial

Markets
Primary and Secondary Markets
 Primary market: is a financial market in which new
issues of a security (eg. stocks or bonds), are sold to initial
buyers by the company or the government agency that is
borrowing the funds. However, the initial sale of securities
tend to not be well known to the general public, in fact, for
operative reasons, it often t akes place behind closed doors.
In this initial phase, the actor that issues the new security is
generally assisted by investment banks, that by
underwriting securities, are able to guarantee a price for
those securities, and then sell them to the general public.

 Secondary market: it is a financial market in which the

securities that have been previously issued can be sold
again. Some of the best-known examples of secondary
markets are the New York Stock Exchange or the
NASDAQ. When an individual purchases a security in the
secondary market, the corporation that has issued the
security (in the primary market) acquires no new funds, but
only the seller of that security does. In the secondary
market, we see the presence of two new figures that are
very important for the functioning of the secondary
market, brokers, and dealers. Brokers have the role of
matching buyers with sellers, while dealers, on the other
hand, link buyers and sellers by buying and selling
securities at stated prices. Secondary markets serve
another crucial function, they make financial instruments
more liquid, which means that selling financial instruments
to raise cash becomes easier and quicker, and therefore
makes them more desirable, because in any moment you
know that if you need some money, you can sell a certain
number of shares of a company and in a matter of minutes
you can have that money on your bank account, while with
other assets it is not so easy. For example, think of
someone that buys a house, if for any reason he needs
money with urgency, he will have to sell that house at a
price that is below the market value in order to find more
easily a buyer, and even if he is able to find a buyer it is
 unlikely that the entire procedure will take a short time to be
settled, especially when the economy is not doing well. On
the other hand, if that investor has the same amount of
money invested in securities, in normal times he just has to
make an order from his computer or through an
intermediary and he has the money on his account.

Debt and Equity Markets

Debt and equity markets are the two ways that are available to
individuals and firms to obtain funds to finance their operations,
whether it is investments or consumption.

 They can issue a debt instrument, such as a bond or a

mortgage, which is a contractual agreement by the borrower
(the actor that needs funds) to pay the holder of the
instrument fixed amounts of money at regular intervals,
composed by interest and principal payments, until the date
when the final payment is made, the maturity date. Debt
instruments can have very different maturities (the time until
that instrument’s expiration date), in fact, they can be short-
term if the maturity of the debt instrument is less than a
year, intermediate-term, if the maturity is between one and
ten years, or long-term if its maturity is ten years or longer.
 The second method available to raise new funds is
through the issuance of equities, which are claims to share
in the net income (income after expenses and taxes) and
the assets of a business, owning shares in a company
means owning a small part of that company, thus being
entitled to profits of that company (if business is good), in
exchange for the investment made. In addition, owning a
portion of the firm means that you have the right to vote on
issues important to the firm and to elect its directors.
Shareholders earn a return from their investments
through dividends, which are periodic payments that
equities make to their holders.

Exchanges and Over-the-Counter Markets

Exchanges and over-the-counter (OTC) markets are two ways
in which secondary markets can be organized.
On the one hand, exchanges, are central locations where
buyers and sellers of securities or intermediaries (agents and
brokers) meet to conduct trades.

On the other hand, secondary markets can be organized in

another way, the over-the-counter (OTC) market, in which
dealers with the use of computers and the internet are able to
buy and sell securities “over the counter” to anyone that comes
to them and is willing to make a transaction that satisfies their
prices. With OTC markets there is not one physical place
where transactions take place.

Money and Capital Markets

Money and capital market are another way of distinguishing
between markets on the basis of the maturity of the securities
traded in each market.

In fact in the money market, only short-term debt instruments

are traded which makes it a more liquid market because the
securities traded in this market tend to be more widely traded
than long-term securities.

While the capital market is the market in which longer-term

debt instruments and equity instruments are traded, these
securities tend to have larger fluctuations in price than those
traded in the money market, and therefore some investors that
look for stability prefer to operate in the money market rather
than in the capital market.
Structure of Financial Markets

Debt Markets

•Short-term (maturity < 1 year) – the Money Market

•Long-term (maturity > 10 year) – the Capital Market

•Medium-term (maturity >1 and < 10 years)

•Equity Markets - Common stocks

–Some make dividend payments

–Equity holders are residual claimants

•Primary Market - New security issues sold to initial buyers

•Secondary Market - Securities previously issued are bought and sold

•Brokers and Dealers

Exchanges

•Trades conducted in central locations (e.g., Toronto Stock Exchange and

New York Stock Exchange)

Over-the-Counter (OTC) Markets

•Dealers at different locations buy and sell

Money and Capital Markets

•Money market – trade in short-term debt instruments (maturity < 1 year)

•Capital Market – trade in longer term debt (maturity > 1 year)

Structure of financial markets

● We can classify markets into two:

○ Primary market: Is a financial market in which new issues of a security

such as bonds or stock are sold to initial buyers by the corporation or
government agency borrowing the funds.

■ The issuer corporation acquires new funds here

○ Secondary market: Is a financial market in which securities that

have been previously issued can be sold.

■ The issuer corporation acquires NO new funds here

● These two types of markets can either trade:

○ Debt instruments: The most common method for an individual or a firm

to obtain funds. It’s a contractual agreement by the borrower to pay the
holder of the instrument fixed dollar amount at regular intervals, until a
specified date, the maturity date, when a final payment is made.

■ Maturity: (of a debt instrument) is the number of years until

that instrument’s expiration date.

● Short-term if maturity < 1 year

● Intermediate if maturity is between 1 and 10 years

● Long-term if maturity ≥10 years

○ Equities: second method of raising funds by a firm or individual. These

are claims to share in the net income and the assets of the business.

■ Dividends: Periodic payments from the firm to shareholders.

Not all firms pay dividends.

■ Equities are long term securities because they have NO maturity date,
so we see it as is infinite years.

■ Equities are residual claimant that is, the corporation must pay all its
debt holder before it pays its shareholder. Shareholders are the last to get
paid if the company defaults (goes bankrupt).

● Why are secondary markets important?

○ Not because they generate funds for enterprises because they

don’t. In the secondary market the stocks are just being resold.
○ The secondary market makes it easier to sell and buy these equities,
a.k.a more liquid. This makes it easier for the enterprises to sell their
stocks in the primary market.

○ The secondary market determines the price of security that the

issuing firm sells in the primary market.

○ For all of this reason, this is the most relevant for the firm.

● What are the types of secondary markets?

○ Exchanges: Buyers and seller of security meet in one central location to

conduct trades.

■ It’s centralized

■ All the prices the same.

■ New York Stock Exchange es un ejemplo

○ Over the counter (OTC) market: Market in which dealers at different

locations who have an inventory of securities stand ready to buy and sell
securities “over the counter” to anyone who comes to them is willing to
accept their prices.

■ It’s not centralized

■ Prices vary from dealer to dealer

■ Un buen ejemplo son currencies en un aeropuerto

● Difference between “dealers” and “brokers”?

○ Dealers buy and sell

○ Brokers simply represent buyer, compran a su nombre

Financial Market Instruments

● Money market: is a financial market in which only short-term debt

instrument (generally those with maturity of less than one year) are traded.

○ More liquid than capital markets

○ Less price fluctuations than capital markets

● Money market instruments:

○ Government of Canada treasury bills

■ No interest payment but they effectively pay interest by selling at a

discount.
■ The most liquid instrument in the money market.

○ Certificates of deposit

■ Pays annual interest

■ Negotiable CD: they can be traded

● Also known as bearer deposit notes

● Offers the purchaser both yield and liquidity

■ Non-negotiable CD

● Also called term deposit receipts or term notes