Market segmentation of financial markets

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Market segmentation of financial markets

Since various investors and borrowers are thought to be restricted by law, preference, or custom to certain maturities which create the market segments. According to Brian Kettell (2002, p.66), some investors may prefer short term securities, other intermediate term securities, whilst others prefer long term securities. And the market segmentation suggests that, spot interest rates are determined by supply and demand conditions in each market. One assumption of the market segmentation theory is that investors and borrowers will not leave their market and enter into a different one even when the current rates suggest to them that there is a substantially higher expected return available by making such a move. Differing investment preferences according to Carlos Correia, David Flynn, Enrico Uliana and Michael Wormald (2007, p.38) could be due to legal, regulatory, business and personal motive variations.

 

Legal restriction: Primary market or secondary market

 

The financial market may be classified as primary market or secondary market depending on whether the securities traded are newly issued securities or securities already outstanding and owned by investors. Private companies and public sector enterprises, in need of money, may issue securities such as shares, debentutes, bonds, commercial papers, etc to raise required capital. Individual investors and institutional investors may invest in these securities. While the primary market deals with the new issues of securities the secondary market on the other hand deals with securities which have already been issued and are owned by investors and are traded between investors (Kevin 2006, p.20). The dividing of primary market and secondary market could be the requirement of the legal systems because in case of a legal dispute the parties involved in the dispute should be identified, hence it is important to understand the related trading is happening in the primary market or the secondary market.

 

Regulatory constrains

 

Regulatory forces play an important role in shaping the market segment especially those divided by country and region boundary. For example, the Chinese stock market had previously operated under very tight capital controls with restrictions on foreign investment in the domestic A stock market. With China’s accession to the World Trade Organization in December 2000, the opening of the B stock market to domestic investors with hard currency holding from February 2001 and the implementation of the Qualified Foreign Institutional Investors (QFII) scheme in December 2002, which enable foreign investors to invest in A Stock markets (Mitchell & Li 2006, p.10).

 

 

Business nature

 

The business nature of an industry or a company could influence its choice of equity financing and debt financing in term of long term or short term basis. For example, commercial banks prefer short to medium term maturities financial products in which they will invest as a result of the short term nature of their deposit liabilities. In comparison, for those companies focusing on long term business relationship such as the life insurance companies, they have long term liabilities to fulfill will prefer longer maturities in investment. At the extreme, according to Arthur J. Keown (2004, p.64), the market segmentation implies that the rate of interest for a particular maturity depends solely by demand and supply for a given maturity and that is independent of the demand and supply for securities having different maturities. The case of commercial banks and life insurance companies are two very extreme cases in term of the demand of the length of the maturities, most business will lies in somewhere in the middle depending on their business nature.

 

Customs

 

The majority of the individual customers usually would only invest in the financial markets that they are familiar with because of several custom reasons: firstly, investors tend to display overconfidence in forecasting returns on familiar assets even in the absence of superior information about these assets. Secondly, some behavior studies also explain this with the terms such as risk avoidance, patriotism and social identification. For example, patriotism is not a reasonable investment factor to be considered but it represent the investors’ political and social idea and also the emotion to the particular country or regions through the purchasing of the relative stocks, bonds and other financial market products.

Different delivery type

 

The claims traded in all financial markets can be delivered in three ways. The first is an immediate exchange of an asset for cash, the second method is an agreement on the price to be paid with exchange taking place at a predetermined time in the future and the last involves a delivery in the future contingent upon an outcome of a financial event (e. g. level of stock price or interest rate) with a fee paid up from for the right of delivery (Fabozzi 2008, p.94).  The difference in the delivery types reflect the the structural distinctions between the different market segments based on how the traded claims would be full-filled. The nature of the delivery type could assist the investors to identify the advantages and disadvantages of the financial products and make comparisons within the market segments.

 

 

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