By definition, the term financial market refers to any marketplace where financial products are traded. These include the stock market, bond market, foreign exchange market and derivatives market, among others. Financial markets have a key role in capitalist economies and their smooth operation as they distribute resources and generate liquidity for companies and businessmen. They serve as a platform for sellers and buyers to connect and transact in their chosen financial assets at market-determined prices.
Financial markets develop securities products that create a return for investors or lenders with extra funds and make these resources available to borrowers who require more funds.
More about the financial markets
Financial markets are formed by the purchase and sale of various financial products such as stocks, bonds, currencies, and derivatives. They largely rely on the transparency of information to maintain efficient and reasonable pricing. Due to macroeconomic factors such as taxes, the market value of securities may not be representative of their true worth.
Some financial markets are small, without much activity going on. Others, however, such as the New York Stock Exchange (NYSE), exchange trillions of dollars in securities daily.
The type and maturity of claims, timing of delivery and organisational structure may all be used to categorise these markets.
Types of financial markets
Below are some of the most popular types of markets:
- Stock market. The stock market is one example of a financial market in which investors may purchase and sell shares of publicly listed companies. The primary stock market is where new stock issues, known as initial public offerings (IPOs), are sold. The secondary market is where investors acquire and sell securities they already hold.
- Forex Market. The FX market is a market in which traders can buy, sell and speculate on currency exchange rates. Since money is the most liquid asset of all, the foreign exchange market is, therefore, the most liquid market around the globe. There is a daily trading volume of $7.5 trillion, which is higher than the value of the futures and stock markets together. The forex market, like the over-the-counter (OTC) markets that we will see below, is decentralised and comprises a worldwide network of computers and brokers. Banks, commercial companies, central banks, investment management firms, hedge funds, retail forex brokers and individual investors make up the currency market.
- Over-the-counter (OTC) market. As previously mentioned, an over-the-counter (OTC) market is a decentralised market with no physical locations but rather trading is done electronically. Participants exchange securities directly between two parties without the need for a forex brokerage. While OTC markets may cover trading in some securities, like for example smaller or riskier businesses that do not fulfil exchange listing standards, exchanges handle the majority of stock trading. Some derivatives markets, on the other hand, are entirely OTC and hence constitute a significant component of the financial markets. In general, OTC markets and the transactions that take place in them are significantly less regulated, less active, and more obscure.
- Commodity Markets. Commodity markets are where buyers and sellers meet to trade physical commodities like corn and soybeans, which are agricultural products, oil or gas, which are energy products, gold, silver or platinum, which are precious metals or “soft” commodities. They are all called spot commodity markets, and they are where actual things are traded for money. Yet, the majority of trade in these commodities occurs on derivatives markets, which use spot commodities as the underlying assets. Commodity forwards, futures, and options are traded on both OTC and listed exchanges across the world, including the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE).
- Bond Markets. A bond is a security in which an investor lends money for a certain period at a fixed interest rate. Consider a bond to be an agreement between a lender and a borrower that describes the loan and its instalments. Bonds are issued to finance projects and operations by companies, municipalities, states, and sovereign governments. The bond market offers securities such as notes and bills which are issued by the United States Treasury, for example, and it is sometimes known as the debt market, credit market, or fixed-income market.
- Derivatives Markets. A derivative represents a contract between two or more parties, the value of which is determined by a settled underlying financial asset, such as a security, or a group of assets, such as an index. Derivatives are secondary securities whose value is determined purely by the value of the underlying security. A derivative is useless by itself. Rather than trading stocks directly, a derivatives market deals with futures and options contracts, and other complex financial products, that draw their value from underlying assets including bonds, commodities, currencies, interest rates, market indexes, and stocks.
- Futures markets are where futures contracts are published and exchanged. In contrast to OTC forwards, futures markets are well-regulated, employ defined contract specifications, and use clearinghouses to resolve and verify trades.
- Options markets, like the Chicago Board Options Exchange (CBOE), display and monitor options contracts similarly. Contracts on numerous asset classes, such as stocks, fixed-income securities, commodities, and many more, may be listed on futures and options markets.
- Cryptocurrency Markets. Cryptocurrencies such as Bitcoin and Ethereum, which are decentralised digital assets based on blockchain technology, have gained increasing popularity in recent years. Thousands of cryptocurrency units are now easily accessible and traded internationally on a network of independent online crypto exchanges. The latter offers digital wallets where traders may exchange one cryptocurrency for another or fiat currency like dollars or euros. Users are sensitive to hackers or fraud because the majority of cryptocurrency exchanges are centralised systems. Decentralised exchanges, which function without a central authority, are also accessible. These exchanges enable direct peer-to-peer (P2P) trading of digital currencies without the requirement for an official exchange operator to conduct the transactions. Major cryptocurrencies also support futures and options trading.
What do financial markets do? Benefits
There are numerous reasons why financial markets exist, the most basic of which is to facilitate the efficient distribution of money and assets in a financial economy. Financial markets enable the smooth operation of the global economy by permitting a free market for the flow of capital, monetary obligations, and money, At the same time it also allows investors to engage in financial returns in the long term. Capital could not be distributed properly in the absence of financial markets, and economic activities such as commerce and trade, investments, and growth potential would be substantially reduced.
