Financial institutions and financial markets play a massive role in guiding the international economy. The financial industry is the purveyor of credit in the market, allowing individual investors to prepare for their retirement and consumers to purchase homes. The financial industry also works closely with the central banking system of the countries they are located in through legislation and interest rate control, directly relating them to the machinations of the central banking authorities. The roles of financial institutions have changed over time, developing as economics advanced and more needs accrued.
Banking institutions were originally created for people to store their money in, trusting in the safety and reliability of the owners of the bank. Later, banks began lending money to customers seeking loans for various purposes, trusting in the knowledge that every customer was not going to suddenly demand his/her deposits back all in one withdrawal. Financial institutions began generating income based on loan interest, developing the unique role that these institutions play in the economy. Consumers seeking to buy a house go to banks for a mortgage loan, and entrepreneurs go when they need a startup loan. Over many years, other types of financing institutions developed, such as investment banks, which help companies enter publicly traded forums and sell debt (Investopedia.com, 2012). Another key component is the development and advancement of central banks, which regulate a nation’s or monetary union’s money supply, affecting interest rates in loans and inflationary forces.
Financial institutions were responsible for the current recession in the US, as low interest rates in mortgages led many home owners to seek home loans because of the strength of the housing market and the relatively rising price of the housing market. Lending institutions gave out loans even to individuals who had poor credit, as they considered the strength of the collateralized asset to be able to net a profit. The housing market crashed, prices dropped, and financial institutions lost billions of dollars as homeowners defaulted and banks had assets worth a fraction of what they were bought for. Therefore, financial institutions other than the central banks play a large role in determining the strength and viability of a market.
Central banks also play a large role in determining the economic outlook of an economy. Central banks control monetary policy, which is far more effective than a government’s fiscal policy in directing the course of economic development. Central banks control the supply of money on the market, and the Federal Reserve is considered the most famous central bank in the world because of the importance of the US economy in international finance and economics.
The Federal Reserve uses the buying and selling of treasury backed securities to manipulate the federal funds rate, which controls inflation and interest rates in an inverse relationship that can often times be difficult to control. The Fed also controls the excessive reserve requirement, controlling how much money banking institutions must keep on hand in the form of cash to pay their customers who want to withdraw their money. Traditional central banks have on primary goal: reduce inflation to controllable levels. The Federal Reserve has two: reduce inflation and reduce unemployment, which appear contradictory and often fight each other in the realm of monetary policy. These goals appear contradictory because the Federal Reserve increases interest rates to decrease inflation. The resulting increase in interest rates makes it more difficult for employers and entrepreneurs to find methods of credit, and it makes it more difficult for home buyers to finance a mortgage. Therefore, spending on employment growth typically decreases and the unemployment may rise accordingly. The role of the central banks in this sphere are absolutely crucial in growing and controlling the economy, making central banks one of the most important aspects of the financial world.
The primary and secondary markets refer to two different type of security trading platforms. Primary markets are new securities that are issued directly from the buyer, while secondary markets are securities bought from a former primary market. Essentially, a secondary market is the used car dealership of the financial world (Finance, 2016).
In primary markets, companies create their initial public offerings in order to raise capital to invest in whatever they feel the need to. Money goes directly to the company’s investors, which is an important flow. Primary markets usually utilizes the help of intermediaries, such as brokerage firms, to attract clients to purchase a company’s securities. Receiving loans is not considered part of the primary market (Pujari, 2013). Primary markets are the reason secondary markets are possible.
The secondary market consists of stock exchanges, where investors who purchased on the primary markets may sell their securities to other investors. The secondary market is influenced by interest rates, which fluctuate depending on the corresponding monetary policy. In contrast to primary markets, where the company receives the funds directly from the investor, companies do not receive any funding from their securities sold on the secondary market. Thus, the analogy of a used car dealership is very similar to what the secondary market is. The secondary market exists primarily to make it easier for investors to finance their future retirements or to help them provide a steady income for several years, as stocks can be relatively reliable and consistent forms of income. Therefore, both markets are very important financial markets, and primary markets allow secondary markets to exist.
Capital markets and money markets are also noticeably different. Money markets are where organizations borrow or invest for a short period of time, usually no more than thirteen months. Money markets handle certificates of deposits, home loans, auto loans, repurchase agreements, etc. Certificates backed by an asset are also commonly traded on money markets. Most of the activity in money markets is bank to bank lending (Staff, 2016), with interest rates controlled by the monetary policy conducted by central banks. Central banking directly controls interest rates by controlling the reserve requirements of banks and by controlling the purchases of market securities.
The capital market consists of the primary and secondary market. Capital markets focus, therefore, on raising capital for businesses seeking to expand and increase their scope of operations. Therefore, capital markets focus on more long term trading opportunities and the most common commodities sold on them are stocks, bonds, and other securities (Staff, 2016), though some investors do purchase stocks in the short run when expecting the price of stock to dramatically increase, so that they may reap a generous profit. The main sources of income from investors on this market are dividends paid out by companies investors have stock in. Companies and even the government can sell shares to investors seeking to increase their portfolio, though this varies from country to country, and the level of state control in the market system.
Essentially, the main differences between the two markets are that capital markets are for long-term investing, while money markets are for more short term investing (Staff, 2016). Capital markets are the results of companies selling stock in an attempt to raise money to purchase assets. Money markets, on the other hand, are the result of banks buying and selling to each other for various reasons while also financing to finance companies. Money market debts are typically paid back within thirteen months, which is actually quite short in the long term financial world. Either way, both markets are essential in developing liquidity and financing the international need for credit and capital investments.
Works Cited:
Investopedia.com (2012). Complete guide to corporate finance. In . Retrieved from http://www.investopedia.com/walkthrough/corporate-finance/1/financial-institutions.aspx
FinanceWorld—. (2016). Primary vs. Secondary market. Retrieved June 19, 2016, from http://finance.mapsofworld.com/capital-market/primary-vs-secondary.html
Pujari, S. (2013, September 16). Components of capital market: Primary market and secondary market | company management. Retrieved June 19, 2016, from Market, http://www.yourarticlelibrary.com/economics/market/components-of-capital-market-primary-market-and-secondary-market-company-management/8758/
Staff, I. (2016). Difference between the money market and the capital market. Retrieved June 19, 2016, from http://www.investorguide.com/article/15433/difference-between-the-money-market-and-the-capital-market-igu/
