WHY WE NEED TO UNDERSTAND BANKING, AND FINANCIAL MARKETS?
In August 2007, the United States witnessed a subprime financial crisis as a result of asset-price bubble following the housing market crisis. At the beginning, Financial institutions' holdings in mortgage-backed securities dropped. Eventually, the crisis raised the unemployment rates above predictions level, not just in the Unites States but encompassed Europe and the rest of world. A global recession occurred as a result of fraudulent activity of mortgage-backed securities brokers and the lack of transparency in most financial institutions. All over the world, governments were working on multibillion-dollar banks bailouts to rescue their economies. This brief introduction about one of the world historic financial crisis can give us a good beginning to understand why everyone, business student or layman, needs to understand money, banking and financial market nature.
According to the nightly news, we hear that The Bank of Brooklyn is hiking the bank rate by one third a percentage point, so a layman may wonder if this slight rise can affect the interest rate charged by a real-estate loan, and if this means a condominium price, for instance, can fluctuate or not. The answer expected by most people who do not belong to financial markets will be “definitely no”, how can a one third of a percentage point lead to prices rise, but in most scenarios, the answer can be “definitely YES”. Credit unions, chartered banks, insurance firms, trust and mortgage lending companies, mutual fund firms, and other institutions constitute what is known as Financial Market. To understand financial markets you need to figure out how these institutions work and under which protocols they operate their everyday tasks.
Financial markets institutions are financial foundations where funds are transferred from people who have excess, in the form of savings for instance, available to other people or entities who need these funds. These funds are transferred in different forms:
- Bank deposits
- Derivatives
- Debt securities
- Stocks
- Hybrid securities
Using these types of securities, along with bank deposits, money can generate additional income to savers and solve solvency problems to investors. Money market institutions work as intermediaries between them. But you may wonder, what is security? What’s its job? And how it works?
WHAT ARE THE TYPES OF SECURITIES?
Known as financial instrument, a security is a claim on the borrower, known as the asset issuer, to the lender, known as underwriter. Both parties make benefit from securities based on the face value and the interest rate it bears. The issuer is supposed to pay the security face value in addition to interest rate at the maturity date. Maturity date refers to the date of repaying the full value of a certain security or financial instrument.
There are four commonly known types of securities;
- Debt Securities: know as fixed-income securities, this type of money that has been borrowed and must be repaid based on determined terms that specify the amount borrowed, the interest rate, and the maturity date, debt securities are financial instruments that can be traded between parties, such as bonds or Certificates of Deposit “CDs”. Debt Securities implies that the holder makes regular interest payments in addition to return of the principle amount, as well as any other contractual rights that may be stipulated.
- Equity Securities: through equity securities, shareholders' ownership interests in a corporation are represented, it's an investment in an organization's equity shares that allows you to become a shareholder. If a company files for bankruptcy, equity investors can only share the interest that remains after all debt security holders have been paid. Dividends are frequently distributed to shareholders, who share the produced earnings from fundamental business operations, however this is not the case for debt holders.
- Derivative Securities: are the type of financial instruments whose value is determined by a set of fundamental variables, such as assets, bonds, stocks, interest rates, market indices, currencies, and goods. Previously, derivatives main job was to ensure that goods sold abroad had balanced exchange rates. International traders by then required an accounting system that would allow them to lock in a set exchange rate for their various national currencies. Futures, forwards, options and swaps are the four common types of derivative securities.
- Hybrid Securities: As the name suggests, hybrid means a tool that combines characteristics of both equity and debt securities. They usually offer to pay a higher interest rate, either fixed or floating, for a set period of time, same scenario applied with bonds. Unlike a bond, however, the volume and timing of interest payments are not guaranteed.
WHY WE STUDY FINANCIAL INSTITUTIONS AND BANKING?
With various types of securities, financial institutions and terms used to govern both, financial system seem more complex, comprising many types of interest bearing equations, banking accounts and investing scenarios, in both private and public sectors. Regulated by governmental agencies, financial intermediaries extend available credit to one party using detailed legal documents. All mentioned elements of financial system comprise a coherent framework that analyzes the financial structure of financial markets all over the world.
