International Financial Market Instruments

Financial Markets

Financial markets are markets for financial assets or liabilities. A useful way to categorize financial market is according to maturity.

Financial markets are categorized into money markets and capital markets.

Money markets are markets for financial assets and liabilities of short maturity, usually considered to be less than one year. The market for short-term Eurocurrency deposits and loans is an example of a money market. Capital markets are markets for financial assets and liabilities with maturities greater than one year. These markets include long-term government and corporate bonds as well as common and preferred stock.

Capital Markets Vs Money Market

The most important difference between short-and long-term versions of a particular financial asset is in the liquidity of the asset. Liquidity refers to the ease with which you can exchange an asset for another asset of equal value. Consider the floating-rate Eurocurrency market. There is an active Eurocurrency market for major currencies for maturities of one year or loss. At longer maturities, liquidity in the Eurocurrency markets dries up even for the most actively traded currencies. There is very little liquidity in Euro dollar deposits and loans with maturities greater than two years, and most other currencies have low liquidity beyond one year. Similarly, although there are forward markets for major currencies in maturities up to ten years, liquidity is poor and bid-ask spreads are large at distant forward dates. Covered interest arbitrage is quite effective at enforcing interest rate parity over long short maturities, but it is much less effective at enforcing interest rate parity over long maturities because of poor liquidity in the long-term forward currency and Eurocurrency markets.

Despite the apparently arbitrary classification of financial markets according to maturity, the distinction is important because market participants tend to gravitate toward either short or long-term instruments. Bond investors match the maturities of their assets to those of their liabilities, and so have strong maturity preferences. Commercial banks tend to lend in the short-and intermediate-term markets to offset their short-and intermediate- term liabilities. Like insurance companies and pension funds invest in long-term assets to counterbalance their long-term obligations. The distinctions between capital and money markets are also often encoded in national regulations governing public securities issues.

International Money and Capital Markets

International money and capital markets are for lending and borrowing moneys or claims to money in various currencies in demand outside the country of origin. By far the most important of such money markets are located in Europe called the Euro- currency markets. Asian currency market located in the East. Although US dollars are most frequently traded in these markets, any internationally convertible currency which has a demand and supply can also be traded.

As in the case of international money markets represented by Euro-currency markets or Asian currency markets, there are international capital markets as well, represented by Euro-bond or Asian-bond markets, which reflect the lendings or borrowings at the long- end of the liquidity spectrum of five years and above. While such international money markets have developed in the fifties, the corresponding capital markets have grown in the sixties.

Both the money and capital markets of this type for off-shore funds were of recent vintage, when the old sources of funds under the pre-war system of borrowing from the domestic money and capital markets of New York and London etc., had dried up. Domestic money markets in the post-war world were greatly insulated from foreign money markets in most cases due to the prevailing exchange controls in the interest of pursuit of independent domestic monetary policy, but the interactions and effects of one on the other could not be completely ruled out. Trading in these currencies is both for short-term and long-term and in any of the currencies which are convertible. The bonds or certificates can be denominated in any convertible currency in which the borrower and the lender have confidence in terms of the stability of the currency, its future value and intrinsic strength of the economy.