Introduction to Financial Markets

Who are the lenders and borrowers?

Lenders and borrowers could be anyone! They could be individuals, corporates or governments on either side. 

Individual lenders could be regular retail investors, as well as high net worth individuals. Corporates, charities and endowments all also invest money. Governments can also lend money either directly or through their sovereign wealth funds. 

On the borrowing side, again we have individuals, who may be looking to borrow for a mortgage, or a personal loan. We have corporates looking to raise finance. And some government borrowers, whether that is national, regional, municipal or local governments looking to borrow. 

How do banks connect investors and fund raisers? 

The oldest way of connecting lenders and borrowers is via banks. Investors deposit their money for safekeeping and hopefully to earn interest. Banks use these deposits to lend out money to individuals, for loans or mortgages, and corporates, which could be a small loan, or it could be a corporate borrowing hundreds of millions. 

Banks have to deal with the issue of maturity transformation. They act as an intermediary between lenders and borrowers, and often the deposits placed with them to finance the loans they give out are short term, whereas the loans are typically long term. Therefore the bank is relying on their deposits being replaced when one is withdrawn. 

How do the money markets facilitate the flow of capital between lenders and borrowers? 

Money markets are one of the oldest financial markets and is the market where banks borrow and lend amongst themselves. 

These money markets allow banks to manage their cash balances.  If a bank takes in more money on deposit than they need to lend out, then they can lend the excess funds to another bank through the money markets. These deposits tend to be for a very short period of time, often from 1 day to the next, known as overnight.

The money markets also include markets for governments, and some larger companies, to borrow money by issuing securities - governments may issue short term treasury bills for example. 

How does the FX market facilitate the flow of capital?

The foreign exchange market is the market for exchanging one currency for another. The FX markets are used by all market participants.  

The market for foreign exchange involves both parties paying money to the other one at the same time, but in different currencies. Individuals may use the market when going on holiday, companies will use the market to transact with other companies that use different currencies and the central banks might use them to support their own currencies.