Chapter 5 Overview
Global financial markets promote the exchange of goods and services across national
borders. The price of goods and services exchanged is based on supply and demand in
the global markets. In additio
...
Chapter 5 Overview
Global financial markets promote the exchange of goods and services across national
borders. The price of goods and services exchanged is based on supply and demand in
the global markets. In addition to numerous industrial products exchanged within the
global financial market, various types of commodities and resources are bought and
sold including food, shares of stock, national currencies, gold, and even labor services.
Buyers and sellers negotiate the quality and quantity of a particular product, what
buyers are willing and able to pay for the product, and the commissions paid for
conducting the transactions.1
Global financial markets include both physical and virtual market places that make the
cross-border exchange of goods and services between buyers and sellers possible. This
exchange is accomplished by using a monetary unit of account to pay for various
transactions. In most cases, these transactions are executed via the foreign exchange
market-a global market in which people trade one currency for another. Major financial
markets are located in cities throughout the world. The most prominent are located in
New York City, Tokyo, and London.
The Importance of Global Financial Markets
The economies of the world have become highly interdependent because of improvements
in communication and transportation technologies and the lowering of barriers to trade.
This increase in the marketing of goods and services has contributed to standard of living
improvements across national economies, most notably in developing nations. Specific
goods produced in one nation are offered for sale in the world market and compete against
products produced in other nations. This competition allows buyers and sellers to juxtapose
quality and prices in their respective currency to other national currencies2. The end result
of the global competition is higher quality products and lower prices for consumers.
Mechanisms, such as the foreign exchange market, facilitate global financial market
activities. Global financial markets involve both borrowers and lenders.
Importance to Borrowers
Global financial markets are important to borrowers for two reasons such as (1) to
expand the supply of money, and (2) reduce the cost of money. The supply and cost of
money has a powerful effect on economic activities. Borrowers use the lending options
of financial institutions to make major purchases of goods, property, and business
ventures. The increased capital that borrowers acquire from financial institution s
supplements disposable income, which encourages increased spending. Businesses
react to increased spending by ordering more raw materials to increase the production
of goods. This stimulation of business activity increases the demand for labor and raises
the demand for capital goods.3
The quantity of money in a nation can affect the price of goods and services and
employment. In the United States, the Federal Reserve Bank is responsible for regulating
the growth of the economy, which is accomplished by the increase or decrease of money
supply.4 Other nations and economic unions have similar institutions such as the Bank of
England, the Bank of Japan, and the European Central Bank.
The overspending of money by borrowers (both consumer and industrial) helps
perpetuate the expansion of the money supply. The public begins to experience the
effects of inflation with an expanding money supply. Inflation essentially decreases a
consumer 's purchasing power by making goods and services more expensive, which
leads to wage price spirals because too much money is circulating. Consumers attempt
to offset inflation by exchanging the lower value currency for something that is
perceived to hold a value better such as property, gold, or foreign currencies.
Importance to Lenders
Global financial markets are important to lenders for two major reasons: (1) expanding
lending opportunities and (2) reducing risk. Financial institutions (commercial banks,
credit unions, life insurance companies, and investment companies) are, simply put, in
the business of making money. These institutions make money by accepting customers'
deposits and using these funds for purchasing investments, such as government
securities, or offering loans to businesses and individuals for business start-ups and real
estate purchases. Earnings from the interest and fees charged to business and
individuals on loans, in addition to purchased government securities, enable a financial
institution to pay interest on depositors' accounts for the use of their funds. Conversely,
this permits a financial institution to expand their activities and services to make more
money.5
Lenders expand lending opportunities by offering borrowers different lending options.
Typical options include the following:
• Variable Interest Rate Loans-the borrower and lender share the interest rate risks. Initially,
the lender offers a lower interest rate with the premise of rising along with the prime
interest rate over the term of the loan
• Secured Loan-interest rates on loans secured by some type of collateral property or
savings account shares
• Short-Term Loan - traditionally, short-term loans bear lower interest rates by comparison to
long-term loans
• Up-Front Cash6
Reducing Risk
Minimizing economic risk is a major consideration and task across global financial markets.
In ideal functioning markets, speculation and insurance assist in the reduction of
unavoidable risks associated with uncertainties, such as unemployment, catastrophic
losses, and diminished business revenue. Speculators buy and sell commodities with the
intention of making profits on price differentials across global markets. They are in the
business of moving goods across regions where the price is low to markets where the price
is high. Investors often will buy insurance to reduce the potentially disastrous declines in
utility from natural disasters, death, and the like. Insurance helps spread large risks, to the
extent that they become acceptable to a greater number of investors .7
Foreign Exchange Markets
The Foreign Exchange Market (FX} is a physical and virtual institutionalized structure
through which the currency of one country is exchanged for the currency of another
country, known as exchange rate. It is a market place where the exchange rate is deter
mined and where transactions take place. The progress of trading relations between
nations has enabled international trade to evolve into a multifaceted operation where
conversion of one currency to another is possible. International trade has evolved into
the development of a market through which any currency can be traded or Exchanged.
After the Gold Standard was discontinued in 1971, the FX Market followed the rule of
supply and demand, and currencies started to flow freely between sellers and buyers in
currency markets.
The FX Market has gradually evolved into the largest, fastest, and most flexible currency
trading market in the world. Operations continue around the clock every day with minimal
breaks for weekends. According to the Bank for International Settlements 2016 Triennial
Survey, turnover in traditional foreign exchange instruments is $5.1 trillion per day, which is
down from $5.4 trillion in 20138. The largest trading centers of the FX are located in Tokyo,
London, and New York. Integration of modern technology and globalization of financial
markets provides real-time information and real-time trading; this enables traders,
investors, banks, multinational corporations, and governments to participate in FX daily
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