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Financial Market

GoldenSource 101: Anatomy of a Financial Market

What is a financial market?

A financial market is the mechanism within which financial instruments are traded, i.e. bought and sold. The term financial market is most often used as a collective term for the buying and selling of securities of a type or geography, e.g. the bond market, the Asian markets. Financial market can also refer to a venue for trading securities, e.g. a stock market, or the New York Stock Exchange.

Markets in their purest form are relatively simple constructs. There are buyers, sellers, ask prices and bid prices. There isn’t much more to them than that. Buyers always have to buy at the price at which the seller is willing to sell (the ask price). And sellers always have to sell at the price at which the buyer is willing to buy (the bid price). These basic concepts apply to anything that is being bought and sold in any marketplace in the world.

What is complicated about it?

Financial markets are like any other market. Exactly the same principles apply as apply for the exchange of goods and services in the rest of the economy. The complexity that many people feel when thinking about financial markets comes from the fact that in financial markets the products that are being traded are less familiar to people. Exchanging money for widgets in a manufacturing environment is a relatively straight-forward concept. Indeed, exchanging money for a bond or an equity is also a relatively straight-forward concept, regardless as to whether you understand what a bond or equity is. For them to be bought and sold they must be perceived by the buyer and seller as having a value.

Conceptualizing payment for an over-the-counter (OTC) derivative that transfers interest rate risk from a fund to an investment bank is more difficult to achieve for most people. Or when a pension fund manager transfers 50 year inflation rate risk to an investment bank via an inflation swap, the concepts become that bit harder to grasp. They become even harder to grasp when non-market practitioners are told that the inflation swap is exposed not just to inflation rate risk but also to interest rate risk, because the future cash flows generated by the inflation swap need to be discounted with an interest rate curve.

Explaining that the interest rate curve that is used to discount the future cash flows of the swap depends on the collateral posted against the swap, can lead to further confusion. And telling someone who doesn’t have experience with derivatives or financial markets that the asset manager who needs to post collateral has an option to post dollars, sterling or US Treasuries as the collateral amounts, will likely lead to that final bit of confusion. And if it doesn’t, it certainly will when you tell them that the optionality the asset manager holds when posting cash or bonds to collateralize to the swap position, means the firm has exposure to volatility rates that need to be derived from the market.

Managing financial market data

Myriad data types are required for financial firms to participate effectively and comply with the regulations in a financial market. Much data needs to be bought in and managed well in order to trade, manage risks, analyse performance, support customer relationships, comply with regulatory requirements and take advantage of new business opportunities, thus remaining competitive. Having automated enterprise data management (EDM) capabilities means that practitioners can focus on understanding the market.

Also, anyone tasked with managing financial market data need not fully understand financial market concepts if their data management platform is run on a data model that natively understands all types of financial instrument and the relationships between all types of financial data.

Fundamentally, all markets operate on the same principles. Financial markets are no different, and the data required to participate in them can be managed well by expert systems without users having to fully understand the nuances and complexities of the market itself.

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