Background of Financial Markets

This report provides an understanding of international trade, finance, and investment matters. It covers the background of financial markets, including capital, derivative, commodity, money, and foreign exchange markets. It also analyzes capital allocation within domestic and international markets, evaluates an emerging economy (China), and discusses the challenges faced by China due to industrialization.

Report

Contents
EXECUTIVE SUMMARY.............................................................................................................1
BACKGROUND OF FINANCIAL MARKETS............................................................................2
Identification and definition of financial marketplaces.........................................................2
Identification and definitions of main financial Instruments................................................3
Identification of key players in the market.............................................................................4
Identification or explanation of financial processes.............................................................4
CAPITAL ALLOCATION WITHIN DOMESTIC ECONOMY...................................................5
Allocation of capital by government of United Kingdom.....................................................5
Allocation of capital by large corporations............................................................................6
CAPITAL ALLOCATION WITHIN INTERNATIONAL MARKETS.........................................7
EVALUATION OF EMERGING ECONOMY.............................................................................8
CRITICAL EVALUATION OF CHALLENGES........................................................................10
CONCLUSION.............................................................................................................................11
REFERENCES............................................................................................................................12

EXECUTIVE SUMMARY
Financial market is a place in which trading and investment of financial instruments
is done. These marketplaces are controlled and operated by key players which are
investors, brokers and financial institutions. The main aim of this report is to build an
understanding about international trade, finance and investment matters. This report
intends to provide advice to potential investor about emerging markets. Background of
financial market is assessed in this report along with covering markets such as capital,
derivative, commodity, money and foreign exchange market. Capital allocation within
international and domestic market is also analysed along with evaluating an emerging
economy which is selected as China. At last, various challenges faced by China due to
industrialisation are discussed. It has been found from this report that China is the most
emerging economy and is a member of Global Value Chain dynamics due to which, it is
profitable to invest in such economy.
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BACKGROUND OF FINANCIAL MARKETS
Identification and definition of financial marketplaces
Financial markets are a marketplace where various securities are traded between
parties. This marketplace is usually known as stock exchange (Wei, 2017). There are
various markets which are classified as elements of stock exchange; these elements
are categorised according to the securities which are traded in it. These markets are
identified and defined as follows:
Capital market – These are the venues where investments and securities for long
time period are traded in order to acquire capital gains. In an economy, the money is
generated by Central Bank and then is circulated by various financial markets. In this
market, companies which require money to expand their business, issues securities
with lock in period of at least one year and then those securities are purchased by
individuals and enterprises who needs to multiply their investments by which money
flows in the market.
Derivative market – In this type of market, securities are traded between two
parties at a mutually agreed price. Only secondary securities are traded at this market
but the values are derived from primary markets. In this market, instead of shares and
stocks; people buy and sell futures and options. By this, people sell their securities at a
time nut for a price of future by which flow of money continues for a longer period.
Commodity market – This marketplace is different from others due to the securities
which are traded here. Instead of securities or bonds, commodities of primary economic
sector are traded here. In this market, people trade in commodities such as sugar, fruit,
cocoa etc. by which their requirements of commodities of people fulfils and the money
also flows in market with low risk.
Money market – This marketplace allows investors and traders to buy or sell short
term investments and securities so that liquid funds can be generated. It is a highly
liquid market; people can buy or sell their securities within days in this market due to the
liquidity of their stocks. This is the major source of money flow in the economy.
Foreign Exchange market – In this type of market, participants can purchase or
sell currencies. This is considered as most liquid market as there is no need to convert
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security into cash (Pilbeam, 2018). Instead of security, currency is exchanged in this
market which is itself a liquid asset by which money supply in an economy enhances.
Identification and definitions of main financial Instruments
Financial instruments refer to the assets which has their own realisable and
resalable value. These assets are traded at different security markets defined above.
These securities benefits by effective flow of capital to its investors. Various financial
instruments are recognised and defined as follows:
Long term debts – These are the securities which has trading lock period of more
than one year. The value of these stocks cannot be realised before one year (Bolton,
Santos and Scheinkman, 2016). These securities are traded on capital market and
includes bonds, debentures, options, futures, swaps etc. These securities are
purchased by individuals and enterprises on which they earn interest and for the lock in
period, security issued company can use those funds to enhance their position in
market. By this, organisations do not have to gain loans from banks by which interest
rates remain stable.
Sort term debts – Securities which are traded for less than a year are short term
debts which includes bills, deposits etc. and are traded at money market. These debts
are applied by using the theory of short term financing. According to this theory, an
organisation should finance their short term assets with short term liabilities. These
liabilities are issued to individual in form of bills and deposits by which money flows in
market.
Equities – These securities are far different from debts and are considered as an
asset for investors on which dividend is earned and not the interest amount. These
securities are traded at both money, derivative and capital market according to the lock
in period. Equity securities, Equity futures and derivatives are examples of these stock.
Company does not consider the amount taken against equity as loan because they
have sell a share in their organisation to the equity holder.
Foreign Exchange – Cash or currency are the only instrument included in foreign
exchange instrument. This instrument is traded at spot rate and realised at future rate;
and are traded at foreign exchange market. People of an economy exchanges their
domestic nation’s currency for other nation’s currency so that when the value of that
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currency increases they can re exchange it and can enjoy remaining value as their
profit.
Identification of key players in the market
Key players are the participants which can be individuals, groups or associations
engaged in trading and controlling of securities using all lawful guidelines. Such players
in context of financial market places are discussed below:
Investors – These are the individuals and associations which buy and sell
securities from financial markets in order to gain relevant profits. This category includes
investors as well lenders which can be financial institutions such as banks as well
(Valdez and Molyneux, 2015). Example: An individual person named ABC (investor)
purchases equity share of Tesco Ltd.
Intermediaries – Unlike above category, intermediaries do not directly trade in
securities. They act as broker and invest their client’s money in market in order to gain
brokerage and commission. Example: The individual ABC does not have knowledge
about securities due to which he consults a broker named Jack (intermediator) for
consultation for which he paid a brokerage of 2.2%.
Regulatory bodies – This category is way different than above two types as
association in this does not trade but control the activities of trade. In case of United
Kingdom, there are three regulatory bodies which are Bank of England (BoE),
Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) (Chuen,
2015). Example: Individual ABC booked the highest profit due to which, FCA (regulatory
body) inspected unusual activity which can be a case of insider trading. FCA
investigated both Jack and ABC.
Identification or explanation of financial processes
All the above elements are connected with each other which can be explained with
an example. When a private individual (key player of market) invests in equity shares
(financial instrument) by using capital market (financial market) is a financial process.
This procedure is controlled and monitored by a regulatory board which is financial
conduct authority (FCA). In this case, theory of financial management is applied in
which a requirement of money of one individual becomes opportunity for investment for
another individual. The constraints of financial management are linked with each other
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in this process. This theory also helps in controlling the inflation in an economy as by
this people can gain legal money which fulfils their requirements of cash flow.
CAPITAL ALLOCATION WITHIN DOMESTIC ECONOMY
Capital allocation refers to the procedure in which an organisation or a country
allocate its funds within the domestic territory. It is an important responsibility of
government of a country and of CEO of a company to effective utilise and allocate its
scare funds for the purpose of investments by considering the expected profit and risks
(Linnerooth-Bayer and Hochrainer-Stigler, 2015). Capital allocation within the domestic
economy refers to the allocation of funds within the domestic territory which in this case
of United Kingdom. UK is a developed nation but it is important for a developed country
as well to effective utilise its capital so that reliable profit can be gained while
considering all the possible risks and their impacts. Allocating of capital is done on both
micro and macro level. At micro level, a company allocates its funds but at a macro
level government of a nation allocate its funds. Both these levels are discussed below:
Allocation of capital by government of United Kingdom
There are three regulatory bodies which overlooks the affairs of capital allocation
in United Kingdom (Fabozzi, 2018). These bodies are Bank of England (BoE),
Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA). BoE has
a fundamental job to allocate the capital in such a way that the money invested must
result in high profit by bearing low risks. Main aim behind the effective capital allocation
is investment, trade and development. In order to effectively allocate the capital,
government of UK prepares monetary and fiscal policy which has elements which helps
in fair trade relationships. According to the monetary policy of UK made by BoE, they
target to control inflation at 2% so that capital which is allocated in investments can
bring profits at inflated rate so that risks can be reduced. Along with this, fiscal policy of
UK is related to taxation. The tax amount which is generated by government of UK is
the capital which is later invested. The framework by which BoE decides their capital
allocation is based on theories.
Keynesianism is a macro economy theory which was developed in 1930 by John
Maynard Keynes (Keynesian Economics, 2019). This theory advocates that if
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government increases its expenditures and lower its taxes then it will lead to depression
as there will be no capital to allocate within the domestic country which can result in
profits. By considering this theory, government of UK has developed above mentioned
monetary and fiscal policies by which it imposes heavy taxes and mind its spending.
This procedure allows them to collect capital and allocate it within domestic economy.
By recent trends, it can be said that long term debt and commodities are the major
areas where UK allocates its capital. The main purposes of this theory is to control the
inflation in the nation as at the time of recession, government will have funds to control
the situation. This theory is often impacted by regulations of the changing political
parties by which situation can be even mismanaged.
Allocation of capital by large corporations
This is a micro level capital allocation in which large corporations mainly public
companies operates and earns profits and then capital which is saved from these profits
are further allocated (Gopinath and et.al., 2017). Thousands of these micro capital
allocation procedures and then lead to effectively macro capital allocation due to which
it is important for every company to allocate its capital by conducting viable research
about market. Large corporations raise their funds and allocate their capital by issuance
of equity shares. This raising of capital is based on a theory of economy which is
Monetarism.
Monetarism is a theory which was pinned by Milton Friedman. According to this
theory, money supply is the most important factor for economic growth as by this money
supply increases by which production enhances and results into more job opportunities
(Monetarism Theory, 2019). Using, this theories large corporations raise their capital by
selling a shares of their company so that more fuds can be acquired and production can
be enhanced. These corporates allocate their capital from the areas of equity share
issuance and issuance of corporate bonds. Large corporations of UK invest their capital
in countries like China due to which in the case of depression or recession, these
companies can utilise their capital invested in China so that the issue of money supply
can be solved. This example is the practical application of monetarism theory.
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CAPITAL ALLOCATION WITHIN INTERNATIONAL MARKETS
Capital allocation within international markets is far different from capital allocation
within domestic markets due to the key participants and regulatory bodies. An individual
cannot invest or allocate its personal capital in international markets (Maggiori, Neiman
and Schreger, 2018). Only large public companies and governmental associations can
involve in the practice of international capital allocation. These process is done by
foreign direct investment (FDI). The regulatory bodies which are involved in this
procedure are World trade organisation, International monetary fund, The World Bank
and External commercial borrowings. It is highly important for a nation of effectively
allocate its capital in international markets so that it can bring high foreign currency in
country’s economy. For example, Toyota is a large Japanese car manufacturing
company which makes its FDIs in UK as it has a stable economy. UK on the other hand,
believes in Global Value Chain dynamics, in which they allocate their capital in countries
which are highly efficient in manufacturing and procurement such as BRICS. Brazil,
Russia, India, China and South Africa; all these countries are in association named as
BRICS. These countries and developing economies which has large population but less
jobs due to which labour rate of these countries is low, benefit of which developed
countries like UK take by investing in these countries. This pattern can be more
effectively understood by a theory named as the Ricardian theory.
The Ricardian trade theory is an international trade specialisation theory which
was developed by David Ricardo. According to this theory, in order to attain competitive
advantage, an organisation or country needs to take advantage of international trade
and must use labour of that country which has lower labour rate as by this, total
production cost will be decreased and capital will be increased (Ricardian trade theory,
2017). Using this theory only, United Kingdom allocate its capital within International
Markets.
Instead of investing developed countries such as United states and Japan, United
Kingdom allocates its earned capital in developing countries. A major part of UK’s
capital is allocated in international markets using the strategy of FDI. FDI is a concept
which allows organisations and government to invest their funds in international market
so that returns can be earned by minimising the risks. Global Value Chain dynamic is a
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theory which various nations come together to develop an association so that financial
assistance can be provided. BRICS is a global value chain which allows its members to
provide financial assistance to each other. Members of this association are Brazil,
Russia, India, China and South Africa. All these countries are manufacturing and
procurement oriented as most of the businesses of these countries are engaged in
manufacturing and logistics sector as the labour in these countries is cheap. By
analysing this situation, United Kingdom allocates its capital in these countries as they
have low labour rate and also these countries have backup of financial assistance which
can be gained by them by using Global value chain dynamics. Market players such as
large companies of UK must consider to import labour of China by which their
manufacturing costs will reduce and they can acquire competitive advantage by selling
their goods at decreased cost but at same quality. But this process using Ricardian
theory has to fulfil the regulation of paying minimum wages to labours.
EVALUATION OF EMERGING ECONOMY
Financial and trade development of an organisation is dependent on various factors
such as governmental policies, stability, FDI etc. It is not important that only developed
countries can be financially growing, developing or emerging countries also has a wide
scope of growth and developing. In order to understand this concept, an emerging
country is selected which is China. China is an East Asian country which has the world’s
largest population. This nation is a member of BRICS which is considered as Global
Value chain dynamics (Bhandari and Javakhadze, 2017). This country is a growing
financial hub which must be evaluated by considering several areas. Areas which are
considered relevant for the evaluation are GDP per capita, trade policies, main exports,
main imports and environmental barriers.
GDP per capita – As per national statistics, GDP per capita of China is rapidly
growing and showing an increasing trend. GDP per capita of China from year 2014 to
2018 are 7701.69, 8166.76, 8115.83, 8677.4 and 9608.42. From this statistics, it can be
observed that every year GDP of this company is increasing with an increasing rate.
Current GDP of this country (year 2018) is 9608.42 US Dollars which is even greater
than most of the countries in Asia as manufacturing and procurement businesses of this
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country allows every individual to have employment by which every individual contribute
towards the economy of this country (Gross domestic product (GDP) per capita, 2019).
Trade policies – Trade policies of China are based on a theory of Neomercantilism
(Neomercantilism theory, 2019). According to this theory, countries like China tend to
seek growth by an aggressive expansion of exports. China is a biggest manufacturer of
most consumer goods which are exported by them throughout the world which allows
them to gain huge foreign currency. Government of China has liberalised all the barriers
which limits the local businesses if China to export their manufactured products in other
nations. China is the biggest manufacturer of Steel which allows them to export their
products by which high funds are generated.
Main exports – China export almost every consumer good throughout the world. But
besides it, there are other products as well which are highly manufactured and exported
by China. Mai exports of the country includes Electrical machineries and equipment by
which China earns revenue of approximately 664.4 billion US Dollars. Furniture and
plastic articles are also a major exported item of China which contributes around 7% of
the total export. Vehicles, clothing, optical, steel items and organic products are few
others products which are heavily exported by China as they are in maximum demand
in international market as skilled labour is required in manufacturing of these products
(China’s Top 10 Exports, 2019).
Main imports – It is important to consider imported products of a country so that
effective evaluation can be conducted. Main imports of China include mineral fuels
including oil, gems and precious metals on which this country has to spend billions of
their funds (China’s Top 10 Imports, 2019).
Environmental barriers – By this area, international trading abilities of China can be
effectively evaluated. Environmental barriers which limits this nation from effective grow
in international trading are restrictions on market access, impact of product
competitiveness and impact of consumer interest. These barriers are related with
economic and social factors of business environment.
From all the above areas, it can be effectively said that China is world’s largest
developing country which is able to trade internationally.
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CRITICAL EVALUATION OF CHALLENGES
China is a developing country which has various barriers and challenges when it
comes to trade internationally. In order to critically discuss these challenges, five areas
are considered as follows:
Restrictions on market access – Unlike developed countries, China does not have
any monopoly advantage due to which small businesses of China has to go through
harsh technical and legal restrictions which limits the market access of China’s foreign
trade and export industry.
Product competitiveness – Among millions of the small businesses of China, only
few thousand make their way to international trade. But, at this stage as well they have
to face limitation of product competitiveness. In international market, numerous
countries like China competes due to which product competitiveness increases. Due to
this limitation, China losses its price advantage.
Consumer interest – Another area of challenge which impacts foreign trade of China
is consumer’s interest towards the products which are imported. Interest of consumer is
directly related with social and environmental factors. China is one of the biggest
producer of products which are made out of plastic. Due to current international forces,
consumers prefers products which created from organic elements and from plastic
which is an on destroyable element (Wei, 2017).
Technology – China is a labour intensive country and not machinery intensive.
Labour rate of China is certainly low due to which, majority of the businesses of this
country are based on manufacturing industry in which labour plays an important role.
Technology of China is not as up to date as of developed countries due to which in
some of the situations, products of China are considered as of low quality which can be
used only for short time period.
Wealth Distribution – Another challenge which is faced by trade of China is its
wealth distribution. Like every developing country, there is unequal distribution of wealth
in China. The international trade of this country is managed by only few large
corporations which are wealthy enough to handle challenges of international trade due
to which small enterprises do not even get a chance to attain growth.
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All the above challenges and restrictions are a major drawback for China as it limits
them to enter in international market. Despite of all these challenges, China has proven
itself to be an abled internationally trading nation as it is considered as world’s one of
the biggest exporter.
Apart from these issues, industrialisation problems of trade surplus and domestic
deficit also restricts China from growing in international market which can result into
consequences of inflation and labour abuse. Besides these restricted trade policies of
China are contributed by the factors of their governmental instability.
CONCLUSION
From the above report, it can be concluded that financial market is a marketplace
where trading of all the financial instruments is conducted by key market leaders and is
controlled and monitored by financial regulators of a nation. The above report
summarises the challenges and emerging areas of a developing country which is China.
It has been found from above analyses that China is a member of Global Value Chain
dynamics and is effective able to trade internationally. Capital allocation within
international and domestic market is also analysed above by which it is has been
summarised that UK uses theories such as Monetarism to allocate their earned capital.
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REFERENCES
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Chuen, D. L. K. ed., 2015. Handbook of digital currency: Bitcoin, innovation, financial
instruments, and big data. Academic Press.
Fabozzi, F. J. ed., 2018. The handbook of financial instruments. John Wiley & Sons.
Gopinath, G., and et.al., 2017. Capital allocation and productivity in South Europe. The
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Linnerooth-Bayer, J. and Hochrainer-Stigler, S., 2015. Financial instruments for disaster
risk management and climate change adaptation. Climatic Change, 133(1).
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Maggiori, M., Neiman, B. and Schreger, J., 2018. International currencies and capital
allocation (No. w24673). National Bureau of Economic Research.
Pilbeam, K., 2018. Finance & financial markets. Macmillan International Higher
Education.
Valdez, S. and Molyneux, P., 2015. An introduction to global financial markets.
Macmillan International Higher Education.
Wei, G., 2017, July. Analysis of Environmental Barriers in International Trade. In 2017
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Management Engineering (ESSAEME 2017). Atlantis Press.
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