The Key Players in Financial Markets



In continuation to our previous publication covering Overview of the Financial Markets , we now look at the key players in financial markets, their structures, differences and role of each participant in detail.



Key Players in Financial Markets: Roles
There are various kinds of participants in financial markets who assume different kinds of roles. They may be issuers, investors or other intermediaries. Some of the prominent ones have been provided below.
Issuers

Markets bring together buyers and sellers: either directly or through intermediaries. In this context, the seller is called the issuer and the price of what is sold is called the Issue price. There are two broad categories of issuers in financial markets; government (including municipal bodies and governmental agencies) and corporates.

Governments and municipal bodies need money to spend on public goods : roads, defense, health, social security and so on : and they generally face a fund deficit. They can not issue equity- you can not take an ownership interest in a government and so apart from taxation and selling public assets (privatization) , borrowing money is one of the options. Governments generally cannot borrow directly from consumers.

So, central government securities (primarily debt securities like bonds) are issued and traded in a wholesale market through financial intermediaries.

Corporates are legal entities (such as an association, turn, government, government agency, institution) identified by a particular name. They sell three categories of investment propositions in the primary market:
  • Short-term debt (less than one year)
  • Long-term debt (more than one year)
  • Equity
Investors
Investors are the lenders in any market. Investors can be of two kinds:

Retail Investors
Retail investors: Retail investors are those individuals who participate in markets for their personal account and not for another company or organization.

Institutional Investors
Institutional investors: An institutional investor is an entity, company, mutual fund, insurance corporations, brokerage, or other such group that has a large amount of money or assets to invest. These firms typically represent investors who might be retail or other firms.

Financial Intermediaries
These are institutions or individuals which facilitate to channel funds between surplus and deficit agents and thus often act as middlemen.
Bank
A Bank is a financial institution which:
  • Accepts demand and time deposits
  • Provides loans to individuals and organizations, and
  • Provides services such as documentary collections, international banking, trade financing.
Brokers
A broker is a commissioned agent of a buyer (or seller) who facilitates trade by locating a seller (or buyer) to complete the desired transaction. A broker does not take a position in the assets he or she trades in – that is, the broker does not maintain inventories in these assets. The profits of brokers are determined by the commissions they charge to the users of their services (the buyers, the sellers, or both).

For example, if seller X wants to sell 100 shares of Reliance but does not know where to find a buyer who will be willing to buy 100 shares at the price he is offering, X can contact a broker. The broker will find a seller who is willing to buy 100 shares of Reliance at the price being offered. Once the transaction is completed the broker will get a commission for brokering the deal. However the broker will not hold any inventories i.e., the broker will not buy shares either from the market or from other sellers and hold them till he gets a buyer to offload the same. If contacted by a buyer or seller, he will have located a corresponding buyer or seller to complete the transaction.

Dealers
The Dealer
Like brokers, dealers facilitate trade by matching buyers with sellers of assets. Unlike brokers, however, a dealer can and does take positions (i.e., maintain inventories) in the assets he trades. This permits the dealer to sell out of inventory rather than always having to locate sellers to match every offer to buy. Unlike brokers, dealers do not receive sales commissions. Dealers make profits by buying assets at a price which is lower than the price at which they are sold.

The price at which a dealer offers to sell an asset is called as the offer price or ask price. The price at which a dealer offers to buy an asset is called as the bid price. The difference between the bid price and ask price is called the bid-ask or the bid-offer spread and represents the dealer profit margin.

Mutual Funds
You can think of a mutual fund as an organization that brings together a group of people and invests their money in stocks, bonds, and other securities. Each investor owns units, which represent a portion of the holdings of the fund. In a mutual fund, the financial risk of the investment belongs to the investor. The fund charges a small fee for managing the fund.

Investment Banks



An investment bank primarily conducts following functions:

Provides advice to clients: Advising corporations on various aspects during mergers & acquisitions as well as capital structures. Advising on capital structures includes advice on whether they should raise capital by issue of bonds or stock, or any other mezzanine structures. They charge the client fees for their advisory role.
Helps clients raise money: It assists in the initial sale of newly issued securities by engaging in different activities:
Assistance in legal and procedural formalities: Before securities are issued, there are a lot of legal formalities which need to be carried out. These include preparing the prospectus, submitting the same to the regulator, book running, etc.
Advice on pricing: Investment bankers help the issuer get an optimum price for the security which is being issued.

Underwriting: Guaranteeing corporations that the securities on offer will be fully subscribed to. This is in return for what is called as underwriting fees. For example, if company A wants to go public, it can directly go to the end investors with their shares. However there is no guarantee that it will be able to find investors who are willing to buy their shares (especially if the company is not well known or new). Here the investment bank steps in and agrees to buy all the shares at an agreed price if people do not subscribe to the same. They will then sell these shares in the market (using their distribution chain) for a higher price making a profit on the margin.

Market Makers
A market maker is an intermediary who is willing and ready to buy and sell securities. The market maker provides a two way quote in the market, thus creating a market for the securities.
Let us imagine a hypothetical situation where there is only one buyer and one seller for security X on any given day. If this security is traded on the exchange, and the exchange is open for 6 hours, then for the trade to happen, the buyer and seller need to meet at a common time on the exchange If the timing does not match, then the trade will not take place, even though a buyer and a seller exist for the security.
It is in these cases that a market maker is useful. By providing a two way quote, he buys from the seller and later during the day, he sells the securities to the buyer, thus creating a market. The market maker earns from the Bid-Ask spread. The more liquid the security, the narrower is the Bid-Ask spread. Thus market makers help to create liquidity and efficiency in the market.
Infrastructure Providers

Stock Exchanges

Stock is a share in the ownership of a company. Stock represents a claim on the company assets and earnings. Whether you say shares, equity or stock, it all means the same thing.
Most stocks are traded on exchanges. Exchanges are places where buyers and sellers meet and decide on a price. Retail Investors get access to the exchanges through brokers, who are members of the exchange. Some of the major exchanges in the world are the New York Stock Exchange, NASDAQ, Bombay Stock Exchange, etc.

Some exchanges are physical locations where transactions are carried out on a trading floor. The other type of exchange is a virtual kind; composed of a network of computers where trades are made electronically. The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers. Actual trades are based on an auction market model where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means you will accept any ask price or bid price for the stock, respectively.) When the bid and ask prices match, a sale takes place.

Depositories
A bank or company which holds securities deposited by others, and where exchanges of these securities take place is defined as a depository. It can also be defined as an organization where the securities of an investor are held in electronic form, at the request of the investor through the medium of a Depository Participant.
A depository can be compared to a bank for shares. Just as a bank holds cash in your account and provides all services related to the transaction of cash, a depository holds securities in electronic form and provides all services related to transaction of shares / debt instruments. A depository interacts with clients through a Depository Participant (DP) with whom he client has to maintain a Demat Account. When a transaction happens in the security exchange, the depository is instructed to transfer the shares from the sellers account to the buyers account (this is similar to the payment process in a bank where the payment is transferred from the buyers account to the sellers account).

Clearing House
A clearing house takes responsibility for settling the obligations for the respective counter-parties on maturity of the trades as well as during their tenure. This ensures that trades done through exchanges have a very low settlement risk.
Information Providers
Information providers provide live and historical quotes for all exchanges, newsroom information, technical charts, financial analyses, etc. Reuters and Bloomberg are major information providers across the world for financial data. Live information on prices and market movements helps to make the markets more transparent by providing reliable information to investors, on the basis of which they can take decisions.
Regulators
A regulator is an official or body that monitors the behavior of companies and the level of competition in particular markets. Financial regulations are a form of regulation or supervision, which subjects market participants to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system.
Securities & Exchange Commission (SEC)
The US Securities and Exchange Commission (commonly referred to as SEC is an independent agency which holds primary responsibility for enforcing the federal securities law/and regulating the securities industry, the nations stock and options exchanges, and other electronic securities markets in the United States. Similarly, regulators are present m different countries like the Financial Services Authority (FSA) in UK and the Securities Exchange Board of India (SEBI) in India.
The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. Here the SEC is concerned primarily with promoting the disclosure of important market related information, maintaining fair dealing, and protecting against fraud.

The Federal Reserve
The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) is the central banking system of the United States. Other central banks around the world include the Reserve Bank of India in India, Bank of England in England. Its functions fall under four major areas:
Formulating and implementing the nations monetary policy

Supervising and regulating banking institutions to ensure the safety and soundness of the nations banking and financial system, and protecting the credit rights of consumers.
Maintaining stability of the financial system and containing systemic risk that may arise in financial markets.

Providing financial services to depository institutions, the US government, and foreign official institutions including playing a major role in operating the nations payments system.

Rating Agencies

A credit rating agency is an organization that rates the ability of a person or company to pay back a loan. These are independent professional firms that conduct in depth research on companies and securities issued by them. The rating given by a credit rating agency is important because it affects the perceived risk element incorporated into interest rates that are applied to loans. For example, if the bonds of company A have a low rating then the company will have to give a higher interest payout on these bonds in order to compensate for the risk an investor takes by investing in a bond with low rating (indicating higher risk of default by issuer).
Ratings are done at three levels:
  • Firm level rating: Rating of the entity itself
  • Rating of it long-term debt
  • Rating of its short-term debt
The global players in credit ratings are S&P, Fitch and Moodys.
Hope you got some insights into the world of key players in  financial markets. We will continue to focus on many more important aspects of the financial markets in our subsequent articles, till then stay tuned to careeranna.com


MBA, Finance, Financial Markets

18-01-2015  23:29:46



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