Stable Financial Market:

The growth engine of an economy

Dhaka University
Department of International Prepared By:
Business (EMBA Program) Md. Shahriar Alam
Course Title: Principle of Finance (EIB-508) ID: 801723065
Faculty: Mohammad Rakib Uddin Bhuiyan
Submission Date: 18th August,2017 Semester: Fall 2017
FINANCIAL MARKETS
Finance is the pre-requisite for modern business and financial institutions play a vital role in the
economic system. It is through financial markets and institutions that the financial system of an
economy works. Financial markets refer to the institutional arrangements for dealing in
financial assets and credit instruments of different types such as currency, cheques, bank
deposits, bills, bonds, equities, etc.

Financial market is a broad term describing any marketplace where buyers and sellers
participate in the trade of assets such as equities, bonds, currencies and derivatives. They are
typically defined by having transparent pricing, basic regulations on trading, costs and fees and
market forces determining the prices of securities that trade.

Generally, there is no specific place or location to indicate a financial market. Wherever a

financial transaction takes place, it is deemed to have taken place in the financial market.
Hence financial markets are pervasive in nature since financial transactions are themselves very
pervasive throughout the economic system. For instance, issue of equity shares, granting of
loan by term lending institutions, deposit of money into a bank, purchase of debentures, sale of
shares and so on.

In a nutshell, financial markets are the credit markets catering to the various needs of the
individuals, firms and institutions by facilitating buying and selling of financial assets, claims and
services.

CLASSIFICATION OF FINANCIAL MARKETS

Capital Market

The capital market is a market for financial assets which have a long or indefinite maturity.
Generally, it deals with long term securities which have a period of above one year. In the
widest sense, it consists of a series of channels through which the savings of the community are
made available for industrial and commercial enterprises and public authorities. As a whole,
capital market facilitates raising of capital.

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The major functions performed by a capital market are:

1. Mobilization of financial resources on a nation-wide scale.

2. Securing the foreign capital and know-how to fill up deficit in the required resources for
economic growth at a faster rate.

3. Effective allocation of the mobilized financial resources, by directing the same to

projects yielding highest yield or to the projects needed to promote balanced economic
development.
Financial
markets
Capital market consists of primary market and secondary market.

Organized Unorganized
Primary market: Primary market is a market for new markets markets

issues or new financial claims. Hence it is also

Money Lenders,
called as New Issue Market. It basically deals with Capital Markets Money Markets Indigenuos
Bankers
those securities which are issued to the public for
Industrial
Call Money
the first time. The market, therefore, makes Securities
Market
Market

available a new block of securities for public

Commercial Bill
Primary Market
subscription. In other words, it deals with raising Market

of fresh capital by companies either for cash or for

Secondary Treasury Bill
consideration other than cash. The best example market Market

could be Initial Public Offering (IPO) where a firm Government

Securities
offers shares to the public for the first time. Market

Long-term loan
Secondary market: Secondary market is a market market

where existing securities are traded. In other words,

securities which have already passed through new issue market are traded in this market.
Generally, such securities are quoted in the stock exchange and it provides a continuous and
regular market for buying and selling of securities. This market consists of all stock exchanges
recognized by the government of India.

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Money Market

Money markets are the markets for short-term, highly liquid debt securities. Money market
securities are generally very safe investments which return relatively low interest rate that is
most appropriate for temporary cash storage or short term time needs. It consists of a number
of sub-markets which collectively constitute the money market namely call money market,
commercial bills market, acceptance market, and Treasury bill market.

Derivatives Market

The derivatives market is the financial market for derivatives, financial instruments like futures
contracts or options, which are derived from other forms of assets. A derivative is a security
whose price is dependent upon or derived from one or more underlying assets. The derivative
itself is merely a contract between two or more parties. Its value is determined by fluctuations
in the underlying asset. The most common underlying assets include stocks, bonds,
commodities, currencies, interest rates and market indexes. The important financial derivatives
are the following:

Forwards: Forwards are the oldest of all the derivatives. A forward contract refers to an
agreement between two parties to exchange an agreed quantity of an asset for cash at a
certain date in future at a predetermined price specified in that agreement. The
promised asset may be currency, commodity, instrument etc.
Futures: Future contract is very similar to a forward contract in all respects excepting
the fact that it is completely a standardized one. It is nothing but a standardized forward
contract which is legally enforceable and always traded on an organized exchange.
Options: A financial derivative that represents a contract sold by one party (option
writer) to another party (option holder). The contract offers the buyer the right, but not
the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-
upon price (the strike price) during a certain period of time or on a specific date
(exercise date). Call options give the option to buy at certain price, so the buyer would
want the stock to go up. Put options give the option to sell at a certain price, so the
buyer would want the stock to go down.
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 Swaps: It is yet another exciting trading instrument. Infact, it is the combination of
forwards by two counterparties. It is arranged to reap the benefits arising from the
fluctuations in the market either currency market or interest rate market or any other
market for that matter.

Foreign Exchange Market

It is a market in which participants are able to buy, sell, exchange and speculate on currencies.
Foreign exchange markets are made up of banks, commercial companies, central banks,
investment management firms, hedge funds, and retail forex brokers and investors. The forex
market is considered to be the largest financial market in the world. It is a worldwide
decentralized over-the-counter financial market for the trading of currencies. Because the
currency markets are large and liquid, they are believed to be the most efficient financial
markets. It is important to realize that the foreign exchange market is not a single exchange,
but is constructed of a global network of computers that connects participants from all parts of
the world.

Commodities Market

It is a physical or virtual marketplace for buying, selling and trading raw or primary products.
For investors' purposes there are currently about 50 major commodity markets worldwide that
facilitate investment trade in nearly 100 primary commodities. Commodities are split into two
types: hard and soft commodities. Hard commodities are typically natural resources that must
be mined or extracted (gold, rubber, oil, etc.), whereas soft commodities are agricultural
products or livestock (corn, wheat, coffee, sugar, soybeans, pork, etc.)

Absence of Functions that can destabilize the financial market of a country

The financial system is very necessary for allocating all resources provided savings from
households to the business firms and government institutions to produce goods and services
for daily lives. Also, the financial system allows the people to transform the money or the
savings from the lenders to the borrowers through the financial markets. In this system, it

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consists of some components such as the financial institutions, financial markets, financial
instruments, the financial services and financial transactions.

The financial system has great important role in daily lives; there are seven basic functions such
as savings function, wealth and liquidity functions as well as credit and payments functions, risk
protection and policy functions.

1. Saving functions: this function provides the publics with the opportunity to create savings by
investing in bonds or stocks and other financial instruments in the financial markets to make
profit. This flow provided additional cash into investments, especially for entrepreneurs that
can produce more goods and services for livelihood. For any countries that have the savings
flow decreases, in general, it will make their investments and the standard of living of that
country began to decline.

2. Wealth function: this function provides an opportunity for individuals and companies to pick
for property savings through securities investment in the capital markets and money market.
Investments of stocks, bonds and other securities did not lose their value and generally, it has
to make a profit. The risk of loss is less than the retained property in the form of investment in
objects like car, motorbike.etc. that caused to lose their great values and risks in such an
investment.

3. Liquidity function: the financial markets provide investors possibilities to transfer their
financial instruments into cash very easily and at little risk. This operation made through the
sale of securities in order to get their cash back when they need cash to expend.

4. Credit function: Besides, this system facilitated the allocation of savings from householders
and other surplus units to supply financing to corporations and government institutions in
order to expand their business, and investment.

5. Payment function: the financial system provides a mechanism to pay for goods and services.
Financial assets for settlement include currency, current accounts and credit cards including
other accounts that were used for replacing of currency.

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6. Risk protection functions: the financial markets around the world has given business firms,
government institutions and householders to protect against risk who happened to life, health,
property and their income. This function requires policies, which made by the insurance
company. In addition, the companies and individuals can protect themselves against risk
through investment of their properties in the capital markets and the money market in order to
prevent losses that will occur in the future.

7. Policy function: the financial markets provided an important guideline to the government
which is implementing its policies and efforts to make the economy stable avoid inflation and
controlling of interest rates, with credit operation for expenditure and borrowing from publics,
which has an impact on the growth of production growth and job creation.

Function of Financial Markets that can help a financial market to stay in balanced condition

The financial markets have great significant functions in the global economic system4 and it is
an engine for global financial system. The financial market participates in economic growth for
every country in the world by allocating and absorbing the savings from the investment of
financial instruments and then transforms those savings to the business firms and other
institutions needed more funds for their investment and business expansion as well as met
their expenditures5. In economy, the financial markets encourage entrepreneurs and
government for long-term investment projects for technological diffusion, capital allocation,
equities, risk management, corporate governance and human resource management, financial
services and the securities trading and financial industry. In addition, the financial markets as a
mechanism allowing publics to trade the financial instruments such as stocks, bonds and other
securities and other valuable products as energy, precious metal, gold and industrial and
agricultural products as well as other valuable products ....etc. Financial markets can help the
fund raising, the risk deduction and international trade and acting as a facilitator between the
lenders and borrowers, it means that the mobilization of saving from families, companies and
government institutions that have surplus budget given to other institutions that has budget
deficit or needs more funds to expand the business and investment projects (figure 4).

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Issues Bangladesh Financial Market facing and Suggested measures to improve
performance of banks and financial institutions
1. Restructure, Corporatize & Privatize:

a) Nationalized Commercial Banks (NCBs): Sonali Bank, Janata Bank and Agrani Bank have been
corporatized and incorporated as public limited company. Sale of Rupali Bank to a foreign
private entrepreneur is underway. These banks will be more accountable to the central bank.

b) Specialized Banks (SBs): Public sector banks in charge of agricultural and industrial term
lending suffer from poor decision making and low efficiency. In order to make them efficient
and financially viable, restructuring of these institutions is necessary. Otherwise, it will hinder
the overall financial sector stability and soundness

2. Non-bank financial institution (NBFIs): Non-bank financial institution (NBFIs) play a

significant role in meeting the diverse financial needs of various sectors of an economy as well
as to the deepening of the countrys financial system. At present, almost all private commercial
banks are involved in non-bank financial operations. Banks wishing to enter in the leasing
business, which is essentially a core operation of NBFIs, can do so through opening subsidiaries

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so that a level playing field for NBFIs can be maintained. Alternatively, banks can go for joint
financing under syndication arrangements with leasing companies on any project proposal.
Again, banks can concentrate on working capital finance and foreign exchange operations,
which matches more with their asset liability management. Long term investment like financing
capital machineries can be done by NBFIs and in the event when banks want to engage in such
activities they can place their funds with an NBFI to extend lease facility for those machineries.
The success of merchant banking operations is largely linked to the development of the security
market. So NBFIs should concentrate more on their opportunities in the capital market.

3. NGO-MFIs: Microcredit Regulatory Authority should consider the following steps:

The NGO-MFIs may be required by law to disburse a certain percentage of their loan to
agriculture, small, medium and micro enterprises.

The authority can also replicate the wholesale lending approach which is now being executed
by PKSF for microcredit purpose, to reach the farmers, SME and micro entrepreneurs.

Equal access to the services under consideration in terms of geographic location should be
ensured by giving license to NGO-MFIs in such a way that every geographic location be covered
by NGO-MFIs with equal intensity.

A restructuring of regulatory framework, i. e. Microcredit Regulatory Authority Act (MRAA)

may take up measures to introduce simple and conducive regulatory regime for the MFIs.

4. Capital Market: Capital market, comprising of debt and equity instruments, can play a key
role in economic development by channeling surplus resources to the most productive uses.
Though the stock market in our country started its operation some 50 years ago, the
contribution of the capital market towards economic growth in a significant way is yet to make
its mark. The capital market is still having low level of capitalization, liquidity and depth; it lacks
active trading in fixed income securities (bond and debentures). Following steps can be adopted
to develop the capital market of Bangladesh, To raise the market capitalization,

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5. Bond Market: Presently, Bangladeshi Bond Market is not in a good shape. Investors across
the world are using different sources for raising their funds. They may also explore the
possibilities of funds like insurance of commercial paper, certificates of deposits and other
money and capital market instruments. Further steps like developing benchmark yield curve is
also needed in order to ensure the proper development of the bond market. Although a recent
decision of the government to introduced preannounced volume based auctions will definitely
bring more transparency in the countrys money market and avoid mismatch between cash and
debt management. Recently the Cash and Debt Management (CDMC) has agreed in principle
that from the beginning of FY08 the development system will be replaced by a system where
the extra amount will be developed on the primary dealers on the basis of underwriting. This
new system will enthuse the primary dealers to create a secondary market for government
securities.

6. Insurance: Insurance industry is an integral part of the financial system. In our country both
insurance penetration and insurance density is comparatively lower in comparison to other
south Asian countries. Its development and efficient functioning is crucially linked to the growth
and stability of the financial system. Lack of competence from the regulators side can lead to
an unstable industry, with a latent threat to overall financial system. The present regulatory
and supervisory mechanism of the industry remains underdeveloped to manage a sizeable
number of companies in the industry. Lack of proper monitoring mechanism, experienced staff
and inadequate technological support are some of the key problems of the present regulatory
body, limiting its role in the development of the sector.

7. Creating Public-private Partnership for Infrastructure Finance: Public-private partnership

(PPP) describes a government service or private business venture which is funded and operated
through a partnership of government and one or more private sector companies. Investment
Climate Assessment (ICA) by the World Bank and Bangladesh Enterprise Institute (WB and BEI,
2003) shows that poor infrastructure is one of the major obstacles for private sector
development in Bangladesh. Lack of efficiency in public sector services has imposed significant

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costs and hindered the growth of the countrys economy. Already government has taken
several steps.

8. Autonomy of Bangladesh Bank: Former Governor of Bangladesh Bank Dr Salehuddin Ahmed

stressed the need for full autonomy of BB for smooth functioning of the banking sector. He
said, Bangladesh Bank does not enjoy full autonomy like the other central banks in the world.
He also says that, Obviously, full autonomy does not mean lack of accountabilitythere must
be a process to make us accountable.

Concluding remarks:
Today, almost everyone agrees that the financial system is essential for development of a
country. Improving the financial system can lead to higher growth and reduce the likelihood
and severity of crises. While Bangladesh has achieved relatively high economic growth over the
past years with a distorted financial system and in spite of its governance problems, cross-
country experience has shown the importance of financial and institutional development to
sustain long-term economic growth. Faster GDP growth consistent with the poverty reduction
goals cannot be met unless the extent and quality of financial intermediation in Bangladesh
advances significantly. In particular, this would require more competitive banking and
nonbanking financial sectors capable of reaching out to all sections of the community, rural &
urban, catering to all types of marketable financial service. The pro-active measures taken in
the financial sector in recent years have put salutary impact on the financial system. Hopefully,
the on-going reform process in the financial system of Bangladesh will bring more stability and
transparency. In this regard, proper care should be taken in the reform process so that reforms
in the financial sector embrace the socio- economic realities in Bangladesh.

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