Financial Markets
Financial markets, in general, refer to any marketplace where securities trade, including the stock market, bond market, forex market, and derivatives market, among others. Financial markets are critical to the functioning of capitalist economies. Financial markets are crucial to the smooth operation of capitalist economies because they allocate resources and create liquidity for businesses and entrepreneurs. Buyers and sellers can easily trade their financial holdings thanks to the markets. Financial markets create securities products that provide a return for those with excess funds while also making these funds available to those in need of additional funds.
The stock market is one example of a financial need. Financial markets are created by buying and selling various financial instruments such as stocks, bonds, currencies, and derivatives. Financial markets rely heavily on information transparency to ensure that markets set efficient and appropriate prices.
Some financial markets are small and inactive, while others, such as the New York Stock Exchange (NYSE), trade trillions of dollars in securities every day. The stock market (equities) is a financial market where investors can buy and sell shares of publicly traded companies. The primary stock market is where new stock issues are dealt with, referred to as initial public offerings (IPOs). Any subsequent stock trading takes place in the secondary market, where investors buy and sell securities they already own.
Types of Financial Markets
Stock Markets
Stock markets are perhaps the most common type of financial market. These are places where companies list their shares, and traders and investors can buy and sell them. Companies use stock markets, also known as equities markets, to raise capital through an initial public offering (IPO), with shares subsequently traded among various buyers.
Stocks can trade on listed exchanges like the New York Stock Exchange (NYSE) or the Nasdaq, or they can be traded over-the-counter (OTC). The majority of stock trading occurs on regulated exchanges, which play an essential role in the economy by serving as a gauge of the overall health of the economy as well as providing capital gains and dividend income to investors.
A typical participant in a stock market is an investor or trader (both retail and institutional), as well as market makers (MMs) and specialists who maintain liquidity and provide two-sided markets. Brokers are third-party intermediaries who facilitate trades between buyers and sellers but do not hold stock positions.
Over-the-Counter Markets
An over-the-counter (OTC) market is decentralized (no physical locations and trading done electronically). Market participants trade securities directly between two parties without using a broker. While OTC markets may handle trading in certain stocks (e.g., smaller or riskier companies that do not meet exchange listing criteria), exchanges hold the majority of stock trading. On the other hand, certain derivatives markets are entirely OTC and thus constitute an important segment of the financial markets. In general, OTC markets and the transactions on them are less regulated, less liquid, and more opaque.
Bond Markets
A bond is a security in which an investor lends money at a fixed interest rate for a set period. Consider a bond to be an agreement between a lender and a borrower that contains the loan terms and its payments. Bonds are issued to finance projects and operations by corporations, municipalities, states, and sovereign governments. Bonds are securities sold in the bond market, such as notes and bills issued by the United States Treasury. The bond market is also known as the debit, credit, or fixed-income market.
Money Markets
Money markets typically trade in highly liquid short-term maturities (less than one year) and are characterized by a high degree of safety and a relatively low-interest return. Money markets involve large-volume trades between institutions and traders at the wholesale level. They include money market mutual funds purchased by individual investors and money market accounts opened by bank customers at the retail level. Individuals can also invest in the money markets by purchasing short-term certificates of deposit (CDs), municipal notes, or U.S. Treasury bills, to name a few options.
Derivatives Markets
A derivative is a contract between two or more parties. Derivatives are secondary securities whose value is determined solely by the weight of the primary protection to which they are linked. A derivative is worthless in and of itself. Rather than trading stocks directly, a derivatives market sells futures and options contracts and other advanced financial products.
Futures markets are the locations where futures contracts are listed and traded. Unlike OTC forwards, futures markets use standardized contract specifications and clearinghouses to settle and confirm trades.
Forex Market
The forex (foreign exchange) market is where participants can buy, sell, hedge, and speculate on currency exchange rates. Because cash is the most liquid of assets, the forex market is the most liquid globally. The currency market handles more than $5 trillion in daily transactions, which is more than the combined volume of the futures and equity markets. Like the OTC markets, the forex market is decentralized and consists of a global network of computers and brokers from all over the world. Banks, commercial companies, central banks, investment management firms, hedge funds, retail forex brokers, and investors make up the forex market.
Commodities Markets
Commodity markets are gathering places for producers and consumers to trade physical commodities such as agricultural products (e.g., corn, livestock, soybeans), energy products (oil, gas, carbon credits), precious metals (gold, silver, platinum), or “soft” commodities (such as cotton, coffee, and sugar). These are called spot commodity markets, where physical goods are exchanged for money.
However, most trading in these commodities occurs on derivatives markets, which use spot commodities as the underlying assets.
Cryptocurrency Markets
The introduction and rise of cryptocurrencies such as Bitcoin and Ethereum, decentralized digital assets based on blockchain technology, has occurred over several years. Today, hundreds of cryptocurrency tokens are available and traded on a patchwork of independent online crypto exchanges worldwide. These exchanges provide digital wallets through which traders can exchange one cryptocurrency for another or fiat currencies such as dollars or euros.
Users are vulnerable to hacks or fraud because most crypto exchanges are centralized platforms. There are also decentralized exchanges that operate without a central authority. These exchanges enable direct peer-to-peer trading of digital currencies without a significant exchange to facilitate the transactions. Futures and options trading on important cryptocurrencies are also available.
To sum up
Financial markets exist for various reasons, the most basic of which facilitates the efficient allocation of capital and assets in a monetary economy. Financial markets make the global economy run more smoothly by allowing a free need for the flow of capital, financial obligations, and money while allowing investors to participate in capital gains over time.
