Financial Market Script

Money market The euro money market is the market for euro-denominated short-term funds and related derivative instruments (i.e., contracts, such as options and futures). Market participants: Credit institutions (i.e., banks) account for the largest share of the euro money market. Other important market participants are money market funds, other financial intermediaries, insurance companies, pension funds, as well as large non-financial corporations. The euro money market is strongly influenced by monetary policy of ECB.

Bond markets The increased role of the euro as an international investment currency has made the market in euro-denominated debts attractive for both investors and issuers. The bulk of euro-denominated debt securities is issued by euro-area issuers. Debt securities issued by public authorities form the most important market segment. Bonds are the main instrument of governments within the euro area to finance their budget deficits. Furthermore, government bonds often serve as a benchmark for pricing other assets and they are also frequently used as collateral in various financial transactions. Follow main issuers are financial institutions and those issued by non-financial corporations. Actually, the non-government bond market is dominated by bank debt securities. After 10 years of virtually no differences among sovereign bond yields of euro area countries, a substantial divergence has been observed in this market since 2008, especially during 2010.

Equity markets EU equity market plays an important role in the world stock market, which is reflected in the relative size of European equity markets. In the period 2008 2009, EU contributed 25% to the worlds Stock Market Capitalisation. The EU stock market is highly concentrated. Measured by trading activity, the market share of the five largest stock exchanges in Europe around 90 percent in 2008, with the LSE standing out with around 39 percent share of total EU turnover. There has been an intensive regional cross-border consolidation. For example: Euronext resulted from a merger of the Paris, Amsterdam, Brussels, and Lisbon stock exchanges during 20002002. An advantage of consolidation is the economies of scale that reduce trading costs, which in turn attracts more traders and listed companies. However, it may also reduce competition and thus lower an exchanges incentive for financial innovation.

Derivatives markets

Derivatives are traded on organised exchanges or over-the-counter. The global notional amount outstanding in OTC markets is higher than the exchanges-traded amount. As for the location of trading, United Kingdom is the leading OTC derivative market in the world with an average daily share of total global turnover of 43 per cent. However, the traditional distinction between exchange-based and OTC derivatives has become less clear with the standardization and the clearing trades through clearinghouses in much the same way as exchange-based contracts. The most important derivatives are interest-rate derivatives, i.e., derivatives whose value is linked to interest rates Financial innovation and increased market demand led to a rapid growth of derivatives trading in the last decade

Main market failures A market failure occurs when the private sector left to itself (i.e., without government intervention) would produce a sub-optimal outcome. Main market failures are: 1. Asymmetric information: customers are less informed than financial institutions. This issue arises in two cases: First, customers are generally unable to properly assess the safety and soundness of a financial institution as that requires extensive effort and technical knowledge. This creates problems that a riskier financial institution may make a more attractive offer to potential customers and also a financial institution may increase its risk after it has collected funds from customers. Prudential supervision aims to protect customers by ensuring the soundness of financial institutions. Second, customers may not be in a position to assess properly the behavior of a financial institution. Conduct-of-business supervision focuses on how financial institutions conduct business with their customers and how they behave in markets. Archana will about conduct-of-business supervision later.

2. Externalities If there is a bad rumor about a bank, depositors may withdraw their deposits and the bank may need to sell its assets at fire-sale prices leading to insolvency of the bank. There is a risk that a sound financial institution may fail when another financial institution goes bankrupt. This externality is not incorporated in the decision making of the financial institution. Failure of multiple banks may lead to a banking crisis. Systemic supervision aims to foster financial stability and to contain the effects of systemic failure.

3. Market Power In a monopoly or an oligopoly (a few firms which may collude), firms can raise and maintain the price above the level that would prevail under competition. The exercise of market power by firms is to provide consumers with higher prices and less choice of products or services. Competition policy aims to ensure effective competition by taking a strong line against price fixing, market-sharing cartels, abuse of dominant market positions, and anti-competitive mergers.