Financial securities are obligates of a company towards on individual or ownership of an individual towards a company with financial utilities such as bond, shares, mortgages or loans sold it. Financial market is a market where financial instruments or securities can be purchased or sold. The former British Prime Minister William Gladstone suggested that finance is as the stomach of the country to express about the essential of finance for the economic growth (Frank & Pamela, 2009). Financial markets transfer funds from surplus units who have excess funds to the deficit units those who need funds. The surplus participants referred to who receive more than spend while the deficit participants referred to who spend more money than they receive. The transaction of financial securities can be run either in primary or secondary market. Many deficit units like government agencies or firms can issues new securities in primary market while the surplus units like households can purchase the existing securities in secondary market which facilitate the trading and allow the change of ownership of the securities. In general, securities traded in financial market can be classified into three major categories: derivatives securities, money market securities and capital market securities. (refer to Figure 1 in Appendix 1)
The first type of financial securities traded in financial market is derivative securities. There are financial contracts to buy or sell an asset or items such as property and commodity whose values are varies with the underlying assets. There are some common type of derivatives instruments such as the forward contracts, future contracts, caps contracts, options and swaps (Frank and Pamela, 2009, p. 126). Many derivative instruments recognized benefit for investors in price discovery and risk management. The primary role of derivative instrument is to allow the investors to speculate the future market price and do investment for portfolio securities. Information around the world will influence the future cash flow that may influence a stock's future cash flows. There are a lot of factors like environmental health, political situation, debt default and climate condition will impact the supply and demand of asset and also the future prices of underlying asset. Investors receive the information on economic conditions information on industry conditions and the firm-speculation information with a high degree of transparency allow investors to speculate the future movement in the value of underlying assets.
Furthermore, derivative securities are essential for financial institution and other firms for risk management. Financial institution and firms adjust the risk for their existing investment by using derivative securities. Derivatives securities can use to reduce the risk of a firm which invests in a bond. If the bond values declines, a firm can take the positions in derivative securities which will generate a gain to offset the loss on the bond. According to U.S. General Accounting Office (1994), the rapid growth and increasing complexity of derivative increase demand for end-users for better way to manage financial risk associated with their business transaction for the global financial marketplace.
The second type of financial securities is money market. Money market securities are a short term instruments, with a maturity of one year or less. The main money market securities are treasury bills, commercial paper, negotiable certificates of deposit, banker's acceptance, federal funds, and repurchase agreements (Jeff Madura, 2006). All these securities have slightly different characteristics, in order to fulfill the need of investors and borrowers. In general, they are distinguished in terms of risk, rate of return, liquidity, maturity, and also sources of financing. However, all of the money market securities must meet all the requirements for easy secondary trading and, in addition, must carry little market and default risk. Due to its lower risk and short maturities, money market securities offer lower return compared to other market securities.
Since money market securities have a short-term maturity, they can typically be sold in the secondary market, and provide liquidity to the investors. Hence, they are the largest provider of liquidity to businesses, governments, and individuals (Marcin & Philipp, 2013).This characteristic is beneficial for investors because they can meet their short-term needs for cash. In most cases, the receipt of cash inflows does not coincide exactly with the payment of cash outflows. The existence of money market securities with different maturities allows investors to better match their cash inflows with cash outflows. In short, when cash surpluses exist for short periods, short-term instruments are desirable; when cash deficits exist for short periods, short-term loans are desirable (Scott Besley, 2009).
Money market is issued by governments, corporations and financial institutions in the primary markets through telecommunications to obtain short-term funds. Governments issues money market securities to raise money from the public. Corporations issue money market securities to finance their restructuring of their assets and capital structure. Financial institutions issue money market securities to make loans to households or corporations.
An investor's access to money market is limited only by the large denominations involved. Anyone with enough money can buy money market securities. However, there are two types of buyers (George & Jerry, 1995). The first group includes anyone who holds or manages cash. They are willing and happy to invest their cash balances if the rates are high enough to cover transaction costs. These buyers are important because they control a source of funds that would otherwise not available. The second group of investors of money market securities includes banks, financial institutions, corporations, and governments. They use money market securities as part of an investment portfolio to achieve the desired mix of liquidity and yield. These investors provide regular demand for money market securities and absorb the newly issued securities as part of the turnover of their portfolios as their money market investments mature.
The third type of financial securities is capital market. Compared to money market which is a short term debt, capital market is a long term debt securities. There are securities that have a maturity of more than one year. Burton and Lombra (2006) stated that capital market is extremely important because this market increase the funds that needed by deficit unit so that they can carry out spending and investment plans. In capital market, there are 3 common types which are bonds, mortgages and stocks. Bonds are long term debt instrument that issued by corporation and government while mortgages are debt obligations for purchasing real estate. For stock, Madura (2006) defined that they are a partial ownership in the corporations that issue them and are classified in capital market securities because they serve as long term source of funds.
In conclusion, financial securities can be divided into three types which are derivatives, money markets and capital markets. They interact with each other and bring affect to a country negatively causing inflation or positively by providing wealth and stability. Each financial market has its own characteristics to satisfy particular needs of market participants. Financial market participants must decide which financial markets to use to obtain their needed financing and thus achieve their investment goals.