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What is Financial Management ? Financial System, Its types

Financial management is mainly concerned with the proper management of funds and making financial decisions to maximize the value in the areas of investment, financial, and dividend.

Objectives of financial management

  • To mobilize resources effectively
  • To maintain proper coordination and financial discipline
  • To reduce operating cost
  • To reduce the cost of capital
  • To ensure the survival of a company
  • To prepare an optimal capital structure

Scope of financial management

  • Anticipation: estimates financial needs of the company
  • Acquisition: collects finance for a company from different sources.
  • Allocation: efficient use of economic resources
  • Appropriation: divides the company profits among the shareholders, stakeholders, etc.
  • Assessment: control all the financial activities of the company

What are the financial system and its functions?

A financial system is a system that allows the exchange of funds between lenders, investors, and borrowers. The components of the financial system consists of:-

  1. Financial market
  2. Financial institutional
  3. Financial instruments

1.What is Financial Market? 

The financial market is a market where different financial instruments like shares, debentures, bonds, government securities etc. are traded. A financial market helps the economy through saving mobilization, investment, facilitating national growth and industrial development

Financial Market

Function of financial market

  • Financial forecasting
  • Designing the capital structure
  • Determination of the proper source of finance
  • Investment decision
  • Working capital management
  • Dividend decision

Types of Financial Market 

A) Capital market: Capital market is a market which deals with financial assets and securities which have a maturity period of more than one year. In other hands, it is market where long-term securities are traded such as T-Notes and T-Bonds, Corporate bonds, Municipal bonds, Common stocks and Preferred stock etc. The capital markets can be divided into primary markets and secondary markets.

Primary Market: Primary market is the market that deals with those securities which are issued to the public for the first time. Initial public offering (IPO) is an example of a primary market.

Secondary Market: Secondary market is the market that deals with those securities which are already issued in the market. NEPSE is an example of a secondary market in Nepal.

B) Money market: Money market is a market which deals with financial assets and securities which are high liquidity and have a maturity of less than one year. In other hands, it is a market where short-term securities are traded such as T-bills, Certificates of deposits, Banker’s acceptance, Commercial paper, Repurchase agreement etc. The money markets can be divided into organized markets and unorganized markets.

Organized Market: Organized market is a formal market where there is a specific place for buyers and sellers to trade according to agreed rules and procedures. Stock exchanges, financial futures exchanges, and commodity markets are examples of organized markets.

Unorganized Market: Unorganized market is an informal market where there is no specific place for buyers and sellers to trade according to agreed rules and procedures.

C) Commodity markets: A commodity market is a physical or virtual marketplace for buying, selling and trading raw or primary products. A commodity market includes soft and hard commodities. Soft commodities are agricultural products such as wheat, coffee, fruit, sugar etc. Hard commodities such as gold, silver, oil etc The commodities market in Nepal include Commodities and Metal Exchange (COMEN), Mercantile Exchange (MEX) Nepal Ltd., Nepal Derivative Exchange Ltd. etc

D) Derivative markets: The derivatives market is the financial market for financial instruments such as forward contract, futures contract, swaps, options etc. whose value is derived from the value of another asset The derivatives market can be classified as:

Exchange-traded derivatives: Exchange-traded derivatives are those derivatives instruments that are traded via specialized exchanges or other exchanges. A derivatives exchange is a market where individual’s trade standardized contracts that have been defined by the exchange

Over-the-counter derivatives: Over the counter derivatives are contracts that are traded directly between two parties without going through an exchange or other intermediary. Products such as swaps, forward rate agreements and other derivatives are almost traded in this way.

E) Insurance Market: The insurance markets deal with various insurance products of life insurance and non-life insurance. It provides protection from financial loss.

F) Foreign Exchange Market: The foreign exchange market is the 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.

G) Debt Market: Debt market is the market in which long term instruments are traded such as government and corporate bonds whose maturity are more than one year. 8. Equity market: An equity market is a market in which shares are issued and traded, either through exchanges or over-the-counter markets. Also known as the stock market.

Comparison between Money Market and Capital Market

Money Market Capital Market
It deals with short term securitiesIt deals with long term securities
It is informal nature of marketIt is formal nature of marker
It includes financial instruments such as T-bills, commercial paper, banker acceptance etc.It includes financial instruments such as common stock, debenture, bonds, etc.
The major institutions that work in money market are the central bank, commercial bank, non-financial institutions etc.The major institutions that work in capital market are a stock exchange, commercial bank, non-banking institutions etc.
Money market instruments have low-risk factors.Capital market instruments have high-risk factors.
Money market instruments are high liquidityCapital market instruments are low liquidity
Money market instruments have maturity period within one year.Capital market instruments have a maturity period of more than one year.
Money market fulfils short-term requirements of the companies.Capital market fulfil long-term credit requirements of the companies
It has a low return on investment.It has a high return on investment.

Participants in the financial market/ Securities market

  • Buyers and sellers of securities
  • Financial intermediaries such as banks, insurance companies, saving and loan association etc.
  • Individuals and institutions facilitate the trading or exchange process in the system.
  • Stock exchange that deals with already issued securities such as Nepal stock exchange.
  • A depository institution which dematerializes physical certificates and transfers ownership through electronic book entries.
  • Brokers who are registered members of the stock exchanges
  • Merchant bankers that specialize in managing the issue of securities
  • Mutual funds for collective investment that manage and pools funds of investors

2. What is financial institution?

Financial institutions denote commercial banks, saving and loan association, insurance companies, a central bank, cooperatives, market broker, stock exchange, investment bankers, leasing companies etc.

3. What Is Financial instruments?

Financial instruments include money market instruments, capital market instruments, derivatives securities such as forward, futures, options, swaps etc.