Financial Markets and Instruments
The core distinction
Financial markets channel savings from surplus units to deficit units. Start every answer by separating primary markets (new securities issued; the issuer receives cash) from secondary markets (investors trade existing securities among themselves; the issuer receives nothing, but the market supplies liquidity and price discovery). Then separate money markets (short-term instruments of one year or less: Treasury bills, commercial paper, certificates of deposit, repurchase agreements, interbank deposits) from capital markets (long-term: bonds, equities, mortgages, leases).
Instruments and participants
Know the cash-flow logic of each instrument: Treasury bills are sold at a discount and redeemed at face value; bonds pay coupons and repay principal; equities carry a residual claim and variable dividends; derivatives (forwards, futures, options, swaps) derive value from an underlying asset. Participants include issuers (government, corporates), investors (retail and institutional), intermediaries (brokers, dealers, investment banks, custodians) and regulators such as the Capital Markets Authority and the Central Bank.
Traps candidates fall into
- Claiming the secondary market raises new capital - it does not.
- Confusing the discount rate with the yield; they differ because the discount is taken off face value while yield is measured against the price paid.
- Treating a coupon rate as the investor's return, ignoring capital gains or losses.
- Forgetting that exchange-traded contracts are standardised and cleared, while OTC contracts are bespoke and carry counterparty risk.
Worked example
A 91-day Treasury bill with face value 100,000 is quoted at a 16% p.a. discount rate. Price = 100,000 × [1 − (0.16 × 91/365)] = 100,000 × 0.96011 = 96,011. The discount of 3,989 is the investor's return over the holding period. Rule of thumb: discount is always applied to face value, annualised on a 365-day basis.