The purpose of this report is to examine significant developments of financial market in the two periods, 1994 – 1996 and 2000 – 2004. It also makes a comparison between the two periods in order to demonstrate some important changes in the world financial markets. The report focuses primarily on financial products. Besides, it also examines the influences of changes in regulations and social issues on financial market. All information used in the report was mainly sourced form on-line references as well as some database information services.
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Also, information and assessments from scholarly journals, newspapers and articles are selectively used. Further, textbooks are used to provide some background information. All information is based on historical or released data, so some information may not fully reflect current changes in the financial market. Furthermore, some information is not available at the moment. Financial markets have three major functions within the economy. First, a financial market is a place where the price of traded assets is established based on the supply and demand.
Second, financial markets provide mechanism for investors to sell a financial asset. Finally, financial markets help investors to reduce transaction costs. There are many ways to classify financial market. It is based on the type of financial claims. A financial market is divided into a fixed dollar amount and residual amount. Another way is based on the maturity of the claims. In this way, a financial market can be either money market or the capital market. The third way is by whether the financial claims are newly issued. This way divides a financial market into the primary market and the secondary market.
Globalization refers to the integration of financial markets throughout the world into an international financial market. As a result of the globalization of financial markets, companies can raise funds offshore with lower costs. There are three main factors contributing to the integration of financial market, including the rapid development of advanced technology for monitoring world markets (). An equity instrument represents an ownership in a firm. A shareholder who has ownership in the firm may have voting right in the firm and when the firm operates well, a shareholder is paid profits.
However, when the firm goes bankruptcy, equity holders’ claims on the assets are residual after the claims of debtholders and preference shareholders. Equity can be either ordinary shares or preference shares. A debt instruments are a written promise to repay the debt (principal and interest) at a certain time. There are many kinds of debt instruments such as bonds, unsecured notes, commercial bills, promissory notes. Derivative instruments are considered as financial instruments for managing risk. They include futures and options.
A futures instrument or contract is an agreement to buy or sell a set number of shares of a specific stock in a designated future month at a price agreed upon today by the buyer and seller. An option is similar to a futures contract, but it gives the buyers (sellers) the right, not obligation, to buy or to sell a financial asset. Derivative instruments have become very significant in the financial markets in recent years. In 1994, volatile financial market conditions led to a mark increase in transactions on organized derivatives market (4).
Overall, the notional principal outstanding of financial futures and options contracts transacted on organized exchanged increased by 14 percent from $7,760. 8 billion in 1993 to $8,837. 8 billion in 1994 (5) ( 1995 (m) p 184). However, there was a decrease in the figure of currency options as a result of the stability of foreign exchange market in 1994 (1995m184). The figure just increased slightly by 4 percent between 1994 and 1995. This was due to some big losses in relation to using highly leveraged derivative instruments of several famous companies such as Orange County, Proctor and Gamble and Barings (icm1996).
From 1995 to 1996, the figure continued to rise by 8 percent (table). There are several new instruments which try to inherit certain features of OTC instruments, including, in November 1994 a new type of currency option was introduced on the Philadelphia Stock Exchange, after that in February 1995 the London International Financial Futures Exchange introduced similar options on its long gilt contracts, but these contracts are monthly expiry rather than the quarterly expiry of standard options contracts.
Credit derivatives are new financial instruments for controlling risk such as interest rate swaps, currency swap (article). It can be seen from the table that there was a dramatic increase in transactions on credit derivatives increased dramatically between 1993 and 1996. The notional amount outstanding of some selected over-the-counter derivative instruments rose considerably about 33 percent, from $8,474. 5 billion in 1993 to 11,303. 2 billion in 1994. After that the figure continued to increase gradually and reached to $25,453. 1 billion in 1996.
In this period, the most significant increase occurred in transactions on interest rate swaps, increasing from $6,177. 3 billion in 1993 to $19,170. 9 billion in 1996. According to BIS annual report (1996), there was an increased interest in the over-the-counter non-deliverable forward (NDF) foreign exchange contract. This product allows users to hedge exposures in emerging market currencies where a conventional forward market does not exist or is restricted. Other innovations are exchange traded emerging market debt derivatives, for example, futures and options on Brady bonds; structured notes;