- Introduction to securities and markets:
Security is a financial instrument that holds a monetary value and represents some form of ownership. According to (Arnett 2011, p. 4), ‘A security is a manifestation of a promise by an issuer to pay interest and return capital in the case of bonds, or share in the form of ownership of a company in case of stock.’
The Securities and Exchange Act of 1934 of the United States defines securities as;
The term ‘security’ means any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit, for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a ‘security’; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker’s acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.
- What are the different levels of security markets?
Security markets are divided into two major categories, which are primary and secondary markets.
The Primary market is the first market where, when an organization wants to go public, they issue their stocks and bonds through an Initial Public Offering (IPO) to finance their operations. This type of market the individuals interested in investing in the company through the IPO buy the issues directly from the company.
Secondary markets are the markets where the companies that have gone through the primary markets come to trade their shares, also commonly referred to as the stock market. In secondary markets, the securities are traded between market investors without the issuing companies’ involvement.
- Outline the specialized categories of secondary markets and explain the purposes they serve.
Secondary markets can be further classified into two;
- Over-the-counter Markets. Also known as (OTC) these are a decentralized type of markets where participants trade their instruments between themselves without the involvement of a central exchange or third parties. In OTCs, trading is done electronically, and because they are between two participants, it is hard to know the details of such a transaction, which makes a regulation for such markets to be a challenge.
- This is a market place where trading of securities and other financial instruments takes place, but there is no direct contact between the buyer and the seller. An example of such a market is the New York Stock Exchange (NYSE) such markets are heavily regulated to make it safe for investments.
- Describe the financial instruments that are dealt in security markets.
The security markets have many different types of financial products, depending on the investor’s wants. Some products have high risk, while others have a low risk. Some have a more extended period of investment, while others have a shorter period of return on interest. All these factors make it possible for the investors to mix their portfolios to spread out the risk and ensure maximum return on investments. Financial instruments in security markets are divided into two major categories, which are cash instruments and derivative instruments.
Cash instruments- these are financial products whose value is established directly by markets. Such products are easy to transfer from one individual to the next, thus making them highly liquid.
Derivative instruments- these types of financial securities have their values reliant on a form of underlying asset or groups of assets as a benchmark. The types of underlying assets can either be equity-based or debt-based.
The Debt-based derivates are such as;
- Bonds are loans that are made to large organizations. The organizations are then obliged to pay the investors back the invested amount together with interest at a given later date known as maturity period or at intervals.
- Treasury Bills, Notes, and Bonds. These are fixed-income investments made to the government with a promise of pay at a later period. These forms of investments have high security because the government always guarantees them.
Equity-based instruments are such as:
Futures contracts – are agreements made between two parties to buy or sell financial instruments at a predetermined price at a definite future date. The agreed amount to be paid in the future is called forward rate, while the time payment for the instrument is to be done is known as the delivery date. (Gidel, 2000)
- What are some of the essential functions of the security exchange market in an economy?
Security markets serve as an indicator of how the economy of a given country is performing. The rise and fall in the share prices are indicative of the boom or recession cycles of an economy. When there is a rise in the share prices, it shows that the economy is performing well because the individuals in the market place are actively competing for investment opportunities. When there is a fall in the share prices, it indicates that there is a low amount of money in circulation in the economy, and as such, the organizations are not able to raise credit through the sale of shares.
The security markets are tasked with valuing the securities that operate in the economy—based on demand and supply for the securities. This information is vital for the different parties who are interested in the value of the companies. Investors would want to know how much investment to commit to the companies, and creditors are interested to know whether the said companies can be able to pay their debts when they fall due. Governments are interested in this information to help them calculate the tax obligations of the companies.
Security exchange markets are also responsible for ensuring the safety of the transactions. Only companies that are listed are allowed to operate and are governed by strict rules and regulations. These companies have to undergo a background evaluation to determine their soundness. They also promote the habit of savings and investments in an economy through the availability of various investment options.