The Structure of Financial Markets


Regardless of what you may think, the financial market is a very large and complex system. It is comprised of different types of markets, including the Money, Debt, Mortgage-backed securities, and Non-bank financial institutions markets.

Money market

Basically, a financial market is a place where money and other financial instruments are traded. It involves transactions between banks, investors and enterprises.

It also acts as a marketplace for short-term loans and borrowings. The financial market is divided into an organized and unorganized sector. The unorganized sector is largely made up of indigenous moneylenders and similar financial institutions. The organized sector, on the other hand, consists of banks, insurance companies, finance companies, stock markets and other financial institutions.

The most prominent investors in the unorganized sector are insurance companies. They park funds in commodities or metals and provide various types of services to their clients. In addition, insurance companies have a strong hold on the global market.

The financial market is not only for short-term borrowing but also for long-term financing. It also serves as a platform for fund raising by companies. The financial market also facilitates transactions for corporate bonds and government bonds.

The unorganized market has a comparative advantage over the organized market because it is not subject to the monetary controls of the Reserve Bank of India (RBI). In addition, the unorganized market is largely decentralized and does not have a centralized control mechanism.

Debt market

Generally speaking, the debt market is defined as a market where companies and governments issue debt securities. They generally pay interest and have a fixed maturity date. The interest rate is based on the perceived ability of the borrower to pay back the debt.

There are a variety of types of debt, including government and municipal bonds. Unlike stocks, debt securities tend to have lower volatility. In some cases, they offer an attractive return on investment.

Debt securities are generally purchased through the secondary market. Individuals may also buy existing bonds from brokers. In the secondary market, prices depend on supply and demand. Some regions allow block trades, while others permit agency transactions.

The most active bond market is the US. The Federal Reserve System publishes the “Flow of Funds” data, which shows that total outstanding debt reached $34,818 billion at the end of 2005.

The interest rate swap market is also important. These instruments allow institutions to switch between fixed and floating rate exposure. They account for $650 billion of market turnover.

Mortgage-backed securities

During the Great Depression, mortgage assets depreciated rapidly. Real estate prices were so low that mortgage certificate holders lost their investments. The government responded to these concerns by offering prepayment risk protection.

To protect investors, the government established a federal insurance program. Mortgage-backed securities were issued by an issuer using mortgages in a pool as collateral. The investor is given the right to receive cash flows from the mortgage as well as the rights to the value of the mortgage and the interest payments.

Mortgage-backed securities are structured as pass-through securities. Each mortgage in the pool is assigned to a separate trustee. The trustee pays the principal and interest to the investor. Each mortgage has a different maturity date.

Mortgage-backed securities were originally backed by government guarantees. The government provided protection from prepayment and default risk. However, the federal government did not regulate the MBS market. The mortgage backed securities market was a competitive one, attracting all types of mortgage lenders. During the 1990s, the government backed MBS market evolved into a pass-through market where government sponsorship was not required.

Non-bank financial institutions

Despite their varying business models, non-bank financial institutions have an important role in managing savings and facilitating real economic activity. They also offer an alternative to bank financing, and can help protect the economy from financial shocks. However, they can also increase systemic risk.

Non-bank financial institutions have taken on substantial credit and duration risks, which can impair the ability of a central bank to implement a single monetary policy. Non-bank financing can also increase the risk of liquidity mismatches and liquidity imbalances, which can impair policy transmission during periods of financial stress.

In recent years, non-banks have become increasingly important sources of financing for the real economy. Their growth has implications for monetary policy transmission, particularly in the euro area, where significant cross-country heterogeneities in financing structures remain. This is largely due to the increasing size of non-bank financial intermediaries.

Non-bank financial intermediaries have been steadily expanding in the most advanced economies. The increased exposure of non-banks to risk increases the likelihood of systemic risk, and could destabilize the entire financial system.

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