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Financial Markets: Role in the Economy, Importance, Types, and Examples

Financial Markets: Role in the Economy, Importance, Types, and Examples

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What Are Financial Markets?

Understanding Financial Markets

Types of Financial Markets

Examples of Financial Markets

FAQs

The Bottom Line

Investing

Markets

Financial Markets: Role in the Economy, Importance, Types, and Examples

By

Adam Hayes

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Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

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Cierra Murry

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Cierra Murry

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Cierra Murry is an expert in banking, credit cards, investing, loans, mortgages, and real estate. She is a banking consultant, loan signing agent, and arbitrator with more than 15 years of experience in financial analysis, underwriting, loan documentation, loan review, banking compliance, and credit risk management.

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What Are Financial Markets?

Financial markets refer broadly to any marketplace where securities trading occurs, including the stock market, bond market, forex market, and derivatives market. Financial markets are vital to the smooth operation of capitalist economies.

Key Takeaways

Financial markets refer broadly to any marketplace where the trading of securities occurs.There are many kinds of financial markets, including (but not limited to) forex, money, stock, and bond markets.These markets may include assets or securities that are either listed on regulated exchanges or trade over-the-counter (OTC).Financial markets trade in all types of securities and are critical to the smooth operation of a capitalist society.When financial markets fail, economic disruption, including recession and rising unemployment, can result.

Investopedia / Theresa Chiechi

Understanding the Financial Markets

Financial markets play a vital role in facilitating the smooth operation of capitalist economies by allocating resources and creating liquidity for businesses and entrepreneurs. The markets make it easy for buyers and sellers to trade their financial holdings. Financial markets create securities products that provide a return for those with excess funds (investors/lenders) and make these funds available to those needing additional money (borrowers). 

The stock market is just one type of financial market. Financial markets are created when people buy and sell financial instruments, including equities, bonds, currencies, and derivatives. Financial markets rely heavily on informational transparency to ensure that the markets set prices that are efficient and appropriate.

Some financial markets are small with little activity, and others, like the New York Stock Exchange (NYSE), trade trillions of dollars in securities daily. The equities (stock) market is a financial market that enables investors to buy and sell shares of publicly traded companies. The primary stock market is where new issues of stocks are sold. Any subsequent trading of stocks occurs in the secondary market, where investors buy and sell securities they already own.

Prices of securities traded in the financial markets may not necessarily reflect their intrinsic value.

Types of Financial Markets

There are several different types of markets. Each one focuses on the types and classes of instruments available on it.

Stock Markets

Perhaps the most ubiquitous of financial markets are stock markets. These are venues where companies list their shares, which are bought and sold by traders and investors. Stock markets, or equities markets, are used by companies to raise capital and by investors to search for returns.

Stocks may be traded on listed exchanges, such as the New York Stock Exchange (NYSE), Nasdaq, or the over-the-counter (OTC) market. Most stock trading is done via regulated exchanges, which plays an important economic role because it is another way for money to flow through the economy.

Typical participants in a stock market include (both retail and institutional) investors, traders, market makers (MMs), and specialists who maintain liquidity and provide two-sided markets. Brokers are third parties that facilitate trades between buyers and sellers but who do not take an actual position in a stock.

Over-the-Counter Markets

An over-the-counter (OTC) market is a decentralized market—meaning it does not have physical locations, and trading is conducted electronically—in which market participants trade securities directly (meaning without a broker). While OTC markets may handle trading in certain stocks (e.g., smaller or riskier companies that do not meet the listing criteria of exchanges), most stock trading is done via exchanges. Certain derivatives markets, however, are exclusively OTC, making up an essential segment of the financial markets. Broadly speaking, OTC markets and the transactions that occur in them are far less regulated, less liquid, and more opaque.

Bond Markets

A bond is a security in which an investor loans money for a defined period at a pre-established interest rate. You may think of a bond as an agreement between the lender and borrower containing the loan's details and its payments. Bonds are issued by corporations as well as by municipalities, states, and sovereign governments to finance projects and operations. For example, the bond market sells securities such as notes and bills issued by the United States Treasury. The bond market is also called the debt, credit, or fixed-income market.

Money Markets

Typically, the money markets trade in products with highly liquid short-term maturities (less than one year) and are characterized by a high degree of safety and a relatively lower interest return than other markets.

At the wholesale level, the money markets involve large-volume trades between institutions and traders. At the retail level, they include money market mutual funds bought by individual investors and money market accounts opened by bank customers. Individuals may also invest in the money markets by purchasing short-term certificates of deposit (CDs), municipal notes, or U.S. Treasury bills, among other examples.

Derivatives Markets

A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset (like a security) or set of assets (like an index). Rather than trading stocks directly, a derivatives market trades in futures and options contracts and other advanced financial products that derive their value from underlying instruments like bonds, commodities, currencies, interest rates, market indexes, and stocks.

Futures markets are where futures contracts are listed and traded. Unlike forwards, which trade OTC, futures markets utilize standardized contract specifications, are well-regulated, and use clearinghouses to settle and confirm trades. Options markets, such as the Chicago Board Options Exchange (Cboe), similarly list and regulate options contracts. Both futures and options exchanges may list contracts on various asset classes, such as equities, fixed-income securities, commodities, and so on.

Forex Market

The forex (foreign exchange) market is where participants can buy, sell, hedge, and speculate on the exchange rates between currency pairs. The forex market is the most liquid market in the world, as cash is the most liquid of assets. The currency market handles more than $7.5 trillion in daily transactions, more than the futures and equity markets combined.

As with the OTC markets, the forex market is also decentralized and consists of a global network of computers and brokers worldwide. The forex market is made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors.

Commodities Markets

Commodities markets are venues where producers and consumers meet to exchange 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 known as spot commodity markets, where physical goods are exchanged for money.

However, the bulk of trading in these commodities takes place on derivatives markets that utilize spot commodities as the underlying assets. Forwards, futures, and options on commodities are exchanged both OTC and on listed exchanges around the world, such as the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE).

Cryptocurrency Markets

Thousands of cryptocurrency tokens are available and traded globally across a patchwork of independent online crypto exchanges. These exchanges host digital wallets for traders to swap one cryptocurrency for another or for fiat monies such as dollars or euros.

Because most crypto exchanges are centralized platforms, users are susceptible to hacks or fraudulent activity. Decentralized exchanges are also available that operate without any central authority. These exchanges allow direct peer-to-peer (P2P) trading without an actual exchange authority to facilitate the transactions. Futures and options trading are also available on major cryptocurrencies.

Examples of Financial Markets

The above sections make clear that the "financial markets" are broad in scope and scale. To give two more concrete examples, we will consider the role of stock markets in bringing a company to IPO and the role of the OTC derivatives market in the 2008-09 financial crisis.

Stock Markets and IPOs

As a company establishes itself over time and grows, it needs access to additional capital. It will often find itself in need of much larger amounts of capital than it can get from ongoing operations, traditional bank loans, or venture and angel funding. Firms can raise the amount of capital they need by selling shares of itself to the public through an initial public offering (IPO). This changes the company's status from a "private" firm whose shares are held by a few shareholders to a publicly traded company whose shares will be subsequently held by public investors.

The IPO also offers early investors in the company an opportunity to cash out part of their stake, often reaping very handsome rewards in the process. Initially, the underwriters usually set the IPO price through their pre-marketing process.

Once the company's shares are listed on a stock exchange, and trading commences, the price of these shares will fluctuate as investors and traders assess and reassess their intrinsic value and the supply and demand for those shares at any given moment.

OTC Derivatives and the 2008 Financial Crisis: MBS and CDOs

While the 2008-09 financial crisis was caused and made worse by several factors, one factor that has been widely identified is the market for mortgage-backed securities (MBS). These are OTC derivatives where cash flows from individual mortgages are bundled, sliced up, and sold to investors. The crisis resulted from a sequence of events, each with its own trigger—these events culminated in the banking system's near-collapse. It has been argued that the seeds of the crisis were sown as far back as the 1970s with the Community Development Act, which required banks to loosen their credit requirements for lower-income consumers, creating a market for subprime mortgages.

The amount of subprime mortgage debt guaranteed by Freddie Mac and Fannie Mae continued to expand into the early 2000s when the Federal Reserve Board began to cut interest rates drastically to avoid a recession. The combination of loose credit requirements and cheap money spurred a housing boom, which drove speculation, pushing up housing prices and creating a real estate bubble. In the meantime, the investment banks, looking for easy profits in the wake of the dotcom bust and the 2001 recession, created a type of MBS called collateralized debt obligations (CDOs) from the mortgages purchased on the secondary market.

Because subprime mortgages were bundled with prime mortgages, there was no way for investors to understand the risks associated with the product. When the market for CDOs began to heat up, the housing bubble that had been building for several years finally burst. As housing prices fell, subprime borrowers began to default on loans that were worth more than their homes, accelerating the decline in prices.

When investors realized the MBS and CDOs were worthless due to the toxic debt they represented, they attempted to unload the obligations. However, there was no market for the CDOs. The subsequent cascade of subprime lender failures created liquidity contagion that reached the upper tiers of the banking system. Two major investment banks, Lehman Brothers and Bear Stearns, collapsed under the weight of their exposure to subprime debt, and more than 450 banks failed over the next five years. Several major banks were on the brink of failure and were rescued by a taxpayer-funded bailout.

What Are the Different Types of Financial Markets?

Some examples of financial markets and their roles include the stock market, the bond market, forex, commodities, and the real estate market, among others. Financial markets can also be broken down into capital markets, money markets, primary vs. secondary markets, and listed vs. OTC markets.

How Do Financial Markets Work?

Despite covering many different asset classes and having various structures and regulations, all financial markets work essentially by bringing together buyers and sellers in some asset or contract and allowing them to trade with one another. This is often done through an auction or price-discovery mechanism.

What Are the Main Functions of Financial Markets?

Financial markets exist for several reasons, but the most fundamental function is to allow for the efficient allocation of capital and assets in a financial economy. By allowing a free market for the flow of capital, financial obligations, and money, the financial markets make the global economy run more smoothly while allowing investors to participate in capital gains over time.

The Bottom Line

Financial markets provide liquidity, capital, and participation that are essential for economic growth and stability. Without financial markets, capital could not be allocated efficiently, and economic activity such as commerce and trade, investments, and growth opportunities would be greatly diminished.

Many players make markets an essential part of the economy—firms use stock and bond markets to raise capital from investors. Speculators look to various asset classes to make directional bets on future prices. At the same time, hedgers use derivatives markets to mitigate various risks, and arbitrageurs seek to take advantage of mispricings or anomalies observed across various markets. Brokers often act as mediators that bring buyers and sellers together, earning a commission or fee for their services.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our

editorial policy.

Compare Forex Brokers. "Forex Trading Statistics."

Federal Deposit Insurance Corporation. "Origins of the Crisis," Page 1-6.

Federal Reserve Bank of St. Louis. "Federal Funds Effective Rate (FEDFUNDS)."

Federal Deposit Insurance Corporation. "Bank Failures in Brief – Summary 2001 Through 2022."

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Generic term for all markets in which trading takes place with capital

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A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets as commodities.

The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This may be a physical location (such as the New York Stock Exchange (NYSE), London Stock Exchange (LSE), JSE Limited (JSE), Bombay Stock Exchange (BSE)) or an electronic system such as NASDAQ. Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell the stock from the one to the other without using an exchange.

Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, to stock exchanges. There are also global initiatives such as the United Nations Sustainable Development Goal 10 which has a target to improve regulation and monitoring of global financial markets.[1]

Types of financial markets[edit]

Within the financial sector, the term "financial markets" is often used to refer just to the markets that are used to raise finances. For long term finance, they are usually called the capital markets; for short term finance, they are usually called money markets. The money market deals in short-term loans, generally for a period of a year or less. Another common use of the term is as a catchall for all the markets in the financial sector, as per examples in the breakdown below.

Capital markets which consist of:

Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.

Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.

Commodity markets, The commodity market is a market that trades in the primary economic sector rather than manufactured products, Soft commodities is a term generally referred as to commodities that are grown, rather than mined such as crops (corn, wheat, soybean, fruit and vegetable), livestock, cocoa, coffee and sugar and Hard commodities is a term generally referred as to commodities that are mined such as gold, gemstones and other metals and generally drilled such as oil and gas.

Money markets, which provide short term debt financing and investment.

Derivatives markets, which provide instruments for the management of financial risk.[2]

Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.

Foreign exchange markets, which facilitate the trading of foreign exchange.

Cryptocurrency market which facilitate the trading of digital assets and financial technologies.

Spot market

Interbank lending market

The capital markets may also be divided into primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets, such as during initial public offerings. Secondary markets allow investors to buy and sell existing securities. The transactions in primary markets exist between issuers and investors, while secondary market transactions exist among investors.

Liquidity is a crucial aspect of securities that are traded in secondary markets. Liquidity refers to the ease with which a security can be sold without a loss of value. Securities with an active secondary market mean that there are many buyers and sellers at a given point in time. Investors benefit from liquid securities because they can sell their assets whenever they want; an illiquid security may force the seller to get rid of their asset at a large discount.

Raising capital[edit]

Financial markets attract funds from investors and channels them to corporations—they thus allow corporations to finance their operations and achieve growth. Money markets allow firms to borrow funds on a short-term basis, while capital markets allow corporations to gain long-term funding to support expansion (known as maturity transformation).

Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as banks, Investment Banks, and Boutique Investment Banks can help in this process. Banks take deposits from those who have money to save on the form of savings a/c. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgages.

More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange. A company can raise money by selling shares to investors and its existing shares can be bought or sold.

The following table illustrates where financial markets fit in the relationship between lenders and borrowers:

Relationship between lenders and borrowers

Lenders

Financial Intermediaries

Financial Markets

Borrowers

IndividualsCompaniesBanks

BanksInsurance CompaniesPension FundsMutual Funds

InterbankStock ExchangeMoney MarketBond MarketForeign Exchange

IndividualsCompaniesCentral GovernmentMunicipalitiesPublic Corporations

Lenders[edit]

The lender temporarily gives money to somebody else, on the condition of getting back the principal amount together with some interest or profit or charge.

Individuals and doubles[edit]

Many individuals are not aware that they are lenders, but almost everybody does lend money in many ways. A person lends money when he or she:

Puts money in a savings account at a bank

Contributes to a pension plan

Pays premiums to an insurance company

Invests in government bonds

Companies[edit]

Companies tend to be lenders of capital. When companies have surplus cash that is not needed for a short period of time, they may seek to make money from their cash surplus by lending it via short term markets called money markets. Alternatively, such companies may decide to return the cash surplus to their shareholders (e.g. via a share repurchase or dividend payment).

Banks[edit]

Banks can be lenders themselves as they are able to create new debt money in the form of deposits.

Borrowers[edit]

Individuals borrow money via bankers' loans for short term needs or longer term mortgages to help finance a house purchase.

Companies borrow money to aid short term or long term cash flows. They also borrow to fund modernization or future business expansion. It is common for companies to use mixed packages of different types of funding for different purposes – especially where large complex projects such as company management buyouts are concerned.[3]

Governments often find their spending requirements exceed their tax revenues. To make up this difference, they need to borrow. Governments also borrow on behalf of nationalized industries, municipalities, local authorities and other public sector bodies. In the UK, the total borrowing requirement is often referred to as the Public sector net cash requirement (PSNCR).

Governments borrow by issuing bonds. In the UK, the government also borrows from individuals by offering bank accounts and Premium Bonds. Government debt seems to be permanent. Indeed, the debt seemingly expands rather than being paid off. One strategy used by governments to reduce the value of the debt is to influence inflation.

Municipalities and local authorities may borrow in their own name as well as receiving funding from national governments. In the UK, this would cover an authority like Hampshire County Council.

Public Corporations typically include nationalized industries. These may include the postal services, railway companies and utility companies.

Many borrowers have difficulty raising money locally. They need to borrow internationally with the aid of Foreign exchange markets.

Borrowers having similar needs can form into a group of borrowers. They can also take an organizational form like Mutual Funds. They can provide mortgage on weight basis. The main advantage is that this lowers the cost of their borrowings.

Derivative products[edit]

During the 1980s and 1990s, a major growth sector in financial markets was the trade in so called derivatives.

In the financial markets, stock prices, share prices, bond prices, currency rates, interest rates and dividends go up and down, creating risk. Derivative products are financial products that are used to control risk or paradoxically exploit risk.[4] It is also called financial economics.

Derivative products or instruments help the issuers to gain an unusual profit from issuing the instruments. For using the help of these products a contract has to be made. Derivative contracts are mainly four types:[5]

Future

Forward

Option

Swap

Seemingly, the most obvious buyers and sellers of currency are importers and exporters of goods. While this may have been true in the distant past,[when?] when international trade created the demand for currency markets, importers and exporters now represent only 1/32 of foreign exchange dealing, according to the Bank for International Settlements.[6]

The picture of foreign currency transactions today shows:

Banks/Institutions

Speculators

Government spending (for example, military bases abroad)

Importers/Exporters

Tourists

Analysis of financial markets[edit]

See Statistical analysis of financial markets, statistical finance

Much effort has gone into the study of financial markets and how prices vary with time. Charles Dow, one of the founders of Dow Jones & Company and The Wall Street Journal, enunciated a set of ideas on the subject which are now called Dow theory. This is the basis of the so-called technical analysis method of attempting to predict future changes. One of the tenets of "technical analysis" is that market trends give an indication of the future, at least in the short term. The claims of the technical analysts are disputed by many academics, who claim that the evidence points rather to the random walk hypothesis, which states that the next change is not correlated to the last change. The role of human psychology in price variations also plays a significant factor. Large amounts of volatility often indicate the presence of strong emotional factors playing into the price. Fear can cause excessive drops in price and greed can create bubbles. In recent years the rise of algorithmic and high-frequency program trading has seen the adoption of momentum, ultra-short term moving average and other similar strategies which are based on technical as opposed to fundamental or theoretical concepts of market behaviour. For instance, according to a study published by the European Central Bank,[7] high frequency trading has a substantial correlation with news announcements and other relevant public information that are able to create wide price movements (e.g., interest rates decisions, trade of balances etc.)

The scale of changes in price over some unit of time is called the volatility.

It was discovered by Benoit Mandelbrot that changes in prices do not follow a normal distribution, but are rather modeled better by Lévy stable distributions. The scale of change, or volatility, depends on the length of the time unit to a power a bit more than 1/2. Large changes up or down are more likely than what one would calculate using a normal distribution with an estimated standard deviation.

Financial market slang[edit]

Poison pill, when a company issues more shares to prevent being bought out by another company, thereby increasing the number of outstanding shares to be bought by the hostile company making the bid to establish majority.

Bips, meaning "bps" or basis points. A basis point is a financial unit of measurement used to describe the magnitude of percent change in a variable. One basis point is the equivalent of one hundredth of a percent. For example, if a stock price were to rise 100bit/s, it means it would increase 1%.

Quant, a quantitative analyst with advanced training in mathematics and statistical methods.

Rocket scientist, a financial consultant at the zenith of mathematical and computer programming skill. They are able to invent derivatives of high complexity and construct sophisticated pricing models. They generally handle the most advanced computing techniques adopted by the financial markets since the early 1980s. Typically, they are physicists and engineers by training.

IPO, stands for initial public offering, which is the process a new private company goes through to "go public" or become a publicly traded company on some index.

White Knight, a friendly party in a takeover bid. Used to describe a party that buys the shares of one organization to help prevent against a hostile takeover of that organization by another party.

Round-tripping

Smurfing, a deliberate structuring of payments or transactions to conceal it from regulators or other parties, a type of money laundering that is often illegal.

Bid–ask spread, the difference between the highest bid and the lowest offer.

Pip, smallest price move that a given exchange rate makes based on market convention.[8]

Pegging, when a country wants to obtain price stability, it can use pegging to fix their exchange rate relative to another currency.[9]

Bearish, this phrase is used to refer to the fact that the market has a downward trend.

Bullish, this term is used to refer to the fact that the market has an upward trend.

Functions of financial markets[edit]

Intermediary functions: The intermediary functions of financial markets include the following:

Transfer of resources: Financial markets facilitate the transfer of real economic resources from lenders to ultimate borrowers.

Enhancing income: Financial markets allow lenders to earn interest or dividend on their surplus invisible funds, thus contributing to the enhancement of the individual and the national income.

Productive usage: Financial markets allow for the productive use of the funds borrowed. The enhancing the income and the gross national production.

Capital formation: Financial markets provide a channel through which new savings flow to aid capital formation of a country.

Price determination: Financial markets allow for the determination of price of the traded financial assets through the interaction of buyers and sellers. They provide a sign for the allocation of funds in the economy based on the demand and to the supply through the mechanism called price discovery process.

Sale mechanism: Financial markets provide a mechanism for selling of a financial asset by an investor so as to offer the benefit of marketability and liquidity of such assets.

Information: The activities of the participants in the financial market result in the generation and the consequent dissemination of information to the various segments of the market. So as to reduce the cost of transaction of financial assets.

Financial Functions

Providing the borrower with funds so as to enable them to carry out their investment plans.

Providing the lenders with earning assets so as to enable them to earn wealth by deploying the assets in production debentures.

Providing liquidity in the market so as to facilitate trading of funds.

Providing liquidity to commercial bank

Facilitating credit creation

Promoting savings

Promoting investment

Facilitating balanced economic growth

Improving trading floors

Components of financial market[edit]

Based on market levels[edit]

Primary market: A primary market is a market for new issues or new financial claims. Therefore, it is also called new issue market. The primary market deals with those securities which are issued to the public for the first time.

Secondary market: A market for secondary sale of securities. In other words, securities which have already passed through the new issue market are traded in this market. Generally, such securities are quoted in the stock exchange and it provides a continuous and regular market for buying and selling of securities.

Simply put, primary market is the market where the newly started company issued shares to the public for the first time through IPO (initial public offering). Secondary market is the market where the second hand securities are sold (security Commodity Markets).

Based on security types[edit]

Money market: Money market is a market for dealing with the financial assets and securities which have a maturity period of up to one year. In other words, it is a market for purely short-term funds.

Capital market: A capital market is a market for financial assets that have a long or indefinite maturity. Generally, it deals with long-term securities that have a maturity period of above one year. The capital market may be further divided into (a) industrial securities market (b) Govt. securities market and (c) long-term loans market.

Equity markets: A market where ownership of securities are issued and subscribed is known as equity market. An example of a secondary equity market for shares is the New York (NYSE) stock exchange.

Debt market: The market where funds are borrowed and lent is known as debt market. Arrangements are made in such a way that the borrowers agree to pay the lender the original amount of the loan plus some specified amount of interest.

Derivative markets: A market where financial instruments are derived and traded based on an underlying asset such as commodities or stocks.

Financial service market: A market that comprises participants such as commercial banks that provide various financial services like ATM. Credit cards. Credit rating, stock broking etc. is known as financial service market. Individuals and firms use financial services markets, to purchase services that enhance the workings of debt and equity markets.

Depository markets: A depository market consists of depository institutions (such as banks) that accept deposits from individuals and firms and uses these funds to participate in the debt market, by giving loans or purchasing other debt instruments such as treasury bills.

Non-depository market: Non-depository market carry out various functions in financial markets ranging from financial intermediary to selling, insurance etc. The various constituencies in non-depositary markets are mutual funds, insurance companies, pension funds, brokerage firms etc.

Relation between Bonds and Commodity Prices: With the increase in commodity prices, the cost of goods for companies increases. This increase in commodity prices level causes a rise in inflation.

Relation between Commodities and Equities: Due to the production cost remaining same, and revenues rising (due to high commodity prices), the operating profit (revenue minus cost) increases, which in turn drives up equity prices.

See also[edit]

Common ordinary equity

Cooperative banking

Finance capitalism

Financial instrument

Financial market efficiency

Financial market theory of development

Financial services

Investment theory

Liquidity

Market profile

Mathematical finance

Quantitative behavioral finance

Stock investor

References[edit]

^ "Goal 10 targets". UNDP. Archived from the original on 2020-11-27. Retrieved 2020-09-23.

^ "Understanding Derivatives: Markets and Infrastructure - Federal Reserve Bank of Chicago". chicagofed.org. Retrieved 2017-12-12.

^ The Business Finance Market: A Survey ISR/Google Books, 2013.

^ Robert E. Wright and Vincenzo Quadrini. Money and Banking: "Chapter 2, Section 4: Financial Markets." pp. 3 [1] Accessed June 20, 2012

^ Khader Shaik (23 September 2014). Managing Derivatives Contracts: A Guide to Derivatives Market Structure, Contract Life Cycle, Operations, and Systems. Apress. p. 23. ISBN 978-1-4302-6275-6.

^ Steven Valdez, An Introduction To Global Financial Markets

^ "High Frequency Trading and Price Discovery, Working Paper Series NO 1602 / november 2013" (PDF). Archived (PDF) from the original on 2022-10-09. Retrieved 7 December 2021.

^ Momoh, Osi (2003-11-25). "Pip". Investopedia. Retrieved 2017-12-12.

^ Law, Johnathan (2016). "Pegging". A dictionary of business and management. Oxford University Press. ISBN 9780199684984. OCLC 950964886.

Further reading[edit]

Graham, Benjamin; Jason Zweig (2003-07-08) [1949]. The Intelligent Investor. Warren E. Buffett (collaborator) (2003 ed.). HarperCollins. front cover. ISBN 0-06-055566-1.

Graham, B.; Dodd, D.L.F. (1934). Security Analysis: The Classic 1934 Edition. McGraw-Hill Education. ISBN 978-0-070-24496-2. LCCN 34023635.

Rich Dad Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not!, by Robert Kiyosaki and Sharon Lechter. Warner Business Books, 2000. ISBN 0-446-67745-0

Clason, George (2015). The Richest Man in Babylon: Original 1926 Edition. CreateSpace Independent Publishing Platform. ISBN 978-1-508-52435-9.

Bogle, John Bogle (2007). The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns. John Wiley and Sons. pp. 216. ISBN 9780470102107.

Buffett, W.; Cunningham, L.A. (2009). The Essays of Warren Buffett: Lessons for Investors and Managers. John Wiley & Sons (Asia) Pte Limited. ISBN 978-0-470-82441-2.

Stanley, Thomas J.; Danko, W.D. (1998). The Millionaire Next Door. Gallery Books. ISBN 978-0-671-01520-6. LCCN 98046515.

Soros, George (1988). The Alchemy of Finance: Reading the Mind of the Market. A Touchstone book. Simon & Schuster. ISBN 978-0-671-66238-7. LCCN 87004745.

Fisher, Philip Arthur (1996). Common Stocks and Uncommon Profits and Other Writings. Wiley Investment Classics. Wiley. ISBN 978-0-471-11927-2. LCCN 95051449.

Elton, E.J.; Gruber, M.J.; Brown, S.J.; Goetzmann, W.N. (2006). Modern Portfolio Theory and Investment Analysis. Wiley. ISBN 978-0-470-05082-8. LCCN 2007276500.

Fama, Eugene (1976). Foundations Of Finance. Basic Books. ISBN 978-0-465-02499-5. LCCN 75036771.

Merton, Robert C. (1992). Continuous-Time Finance. Macroeconomics and Finance Series. Wiley. ISBN 978-0-631-18508-6. LCCN gb92034883.

Pilbeam, K. (2010). Finance and Financial Markets. Macmillan Education. ISBN 978-0-230-23321-8. LCCN 2010455281.

Mccarty, Nolan. "Trends in Financial Market Regulation." After the Crash: Financial Crises and Regulatory Responses, edited by Sharyn O’Halloran and Thomas Groll, Columbia University Press, 2019, pp. 121–24, JSTOR 10.7312/ohal19284.10.

GROLL, THOMAS, et al. "TRENDS AND DELEGATION IN U. S. FINANCIAL MARKET REGULATION." After the Crash: Financial Crises and Regulatory Responses, edited by Thomas Groll and Sharyn O’Halloran, Columbia University Press, 2019, pp. 57–81, JSTOR 10.7312/ohal19284.7.

Polillo, Simone. "COLLABORATIONS AND MARKET EFFICIENCY: The Network of Financial Economics." The Ascent of Market Efficiency: Finance That Cannot Be Proven, Cornell University Press, 2020, pp. 60–89, JSTOR 10.7591/j.ctvqc6k17.5.

Abolafia, Mitchel Y. "A Learning Moment?: January 2008." Stewards of the Market: How the Federal Reserve Made Sense of the Financial Crisis, Harvard University Press, 2020, pp. 49–70, doi:10.2307/j.ctvx8b796.6.

MacKenzie, Donald. "Dealers, Clients, and the Politics of Market Structure." Trading at the Speed of Light: How Ultrafast Algorithms Are Transforming Financial Markets, Princeton University Press, 2021, pp. 105–34, doi:10.2307/j.ctv191kx1k.8.

Polillo, Simone. "HOW FINANCIAL ECONOMICS GOT ITS SCIENCE." The Ascent of Market Efficiency: Finance That Cannot Be Proven, Cornell University Press, 2020, pp. 119–42, JSTOR 10.7591/j.ctvqc6k17.7.

Fenton-O'Creevy, M.; Nicholson, N.; Soane, E.; Willman, P. (2004). Traders: Risks, Decisions, and Management in Financial Markets. Oxford University Press. ISBN 978-0-191-51500-2. LCCN 2005295074.

Baker, H.K.; Filbeck, G.; Ricciardi, V. (2017). Financial Behavior: Players, Services, Products, and Markets. Financial Markets and Investments. Oxford University Press. ISBN 978-0-190-27001-8.

Keim, D.B.; Ziemba, W.T.; Moffatt, H.K. (2000). Security Market Imperfections in Worldwide Equity Markets. Publications of the Newton Institute. Cambridge University Press. ISBN 978-0-521-57138-8. LCCN 00698005.

Williams, John C. "The Rediscovery of Financial Market Imperfections." Toward a Just Society: Joseph Stiglitz and Twenty-First Century Economics, edited by Martin Guzman, Columbia University Press, 2018, pp. 201–06, JSTOR 10.7312/guzm18672.14.

QUIGGIN, JOHN. "Market Failure: Information, Uncertainty, and Financial Markets." Economics in Two Lessons: Why Markets Work So Well, and Why They Can Fail So Badly, Princeton University Press, 2019, pp. 214–36, doi:10.2307/j.ctvc77fb7.18.

BAKLANOVA, VIKTORIA, and JOSEPH TANEGA. "MONEY MARKET FUNDS AFTER THE ONSET OF THE CRISIS." After the Crash: Financial Crises and Regulatory Responses, edited by Sharyn O’Halloran and Thomas Groll, Columbia University Press, 2019, pp. 341–59, JSTOR 10.7312/ohal19284.25.

CEBALLOS, FRANCISCO, et al. "Financial Globalization in Emerging Countries: Diversification versus Offshoring." New Paradigms for Financial Regulation: Emerging Market Perspectives, edited by MASAHIRO KAWAI and ESWAR S. PRASAD, Brookings Institution Press, 2013, pp. 110–36, JSTOR 10.7864/j.ctt1261n4.8.

LiPuma, Edward. "Social Theory and the Market for the Production of Financial Knowledge." The Social Life of Financial Derivatives: Markets, Risk, and Time, Duke University Press, 2017, pp. 81–115, JSTOR j.ctv11cw1p0.6.

Scott, Hal S. "Liability Connectedness: Money Market Funds and Tri-Party Repo Market." Connectedness and Contagion: Protecting the Financial System from Panics, The MIT Press, 2016, pp. 53–58, JSTOR j.ctt1c2crp5.9.

Sornette, Didier. "MODELING FINANCIAL BUBBLES AND MARKET CRASHES." Why Stock Markets Crash: Critical Events in Complex Financial Systems, REV-Revised, Princeton University Press, 2017, pp. 134–70, JSTOR j.ctt1h1htkg.9.

Morse, Julia C. "A PRIMER ON INTERNATIONAL FINANCIAL STANDARDS ON ILLICIT FINANCING." The Bankers' Blacklist: Unofficial Market Enforcement and the Global Fight against Illicit Financing, Cornell University Press, 2021, pp. 19–29, JSTOR 10.7591/j.ctv1hw3x0d.7.

Obstfeld, M.; Taylor, A.M. (2005). Global Capital Markets: Integration, Crisis, and Growth. Japan-US Center UFJ Bank Monographs on International Financial Markets. Cambridge University Press. ISBN 978-0-521-67179-8. LCCN 2004051477.

Bebczuk, R.N. (2003). Asymmetric Information in Financial Markets: Introduction and Applications. Cambridge University Press. ISBN 978-0-521-79732-0. LCCN 2002045514.

Avgouleas, E. (2012). Governance of Global Financial Markets: The Law, the Economics, the Politics. Cambridge University Press. ISBN 978-0-521-76266-3. LCCN 2012406001.

Houthakker, H.S.; Williamson, P.J. (1996). The Economics of Financial Markets. Oxford University Press. ISBN 978-0-199-31499-7.

Spencer, P.D. (2000). The Structure and Regulation of Financial Markets. Oxford University Press. ISBN 978-0-191-58686-6. LCCN 2001270248.

Atack, J.; Neal, L. (2009). The Origins and Development of Financial Markets and Institutions: From the Seventeenth Century to the Present. Cambridge University Press. ISBN 978-1-139-47704-8.

Ott, J.C. (2011). When Wall Street Met Main Street: The Quest for an Investors' Democracy. Harvard University Press. ISBN 978-0-674-06121-7. LCCN 2010047293.

Prasad, E.S. (2021). The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance. Harvard University Press. ISBN 978-0-674-25844-0. LCCN 2021008025.

Fligstein, N. (2021). The Banks Did It: An Anatomy of the Financial Crisis. Harvard University Press. ISBN 978-0-674-25901-0.

External links[edit]

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Financial Markets - Overview, Types, and Functions

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Home › Resources › Career Map › Sell-Side Banks › Capital Markets › Financial Markets

Table of contents

What are Financial Markets?

Types of Financial Markets

Functions of the Markets

Importance of Financial Markets

Additional Resources

Financial Markets

A marketplace that provides an avenue for the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.

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What are Financial Markets?

Financial markets, from the name itself, are a type of marketplace that provides an avenue for the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives. Often, they are called by different names, including “Wall Street” and “capital market,” but all of them still mean one and the same thing. Simply put, businesses and investors can go to financial markets to raise money to grow their business and to make more money, respectively.

To state it more clearly, let us imagine a bank where an individual maintains a savings account. The bank can use their money and the money of other depositors to loan to other individuals and organizations and charge an interest fee.

The depositors themselves also earn and see their money grow through the interest that is paid to it. Therefore, the bank serves as a financial market that benefits both the depositors and the debtors.

Types of Financial Markets

There are so many financial markets, and every country is home to at least one, although they vary in size. Some are small while some others are internationally known, such as the New York Stock Exchange (NYSE)  that trades trillions of dollars on a daily basis. Here are some types of financial markets.

1. Stock market

The stock market trades shares of ownership of public companies. Each share comes with a price, and investors make money with the stocks when they perform well in the market. It is easy to buy stocks. The real challenge is in choosing the right stocks that will earn money for the investor.

There are various indices that investors can use to monitor how the stock market is doing, such as the Dow Jones Industrial Average (DJIA) and the S&P 500. When stocks are bought at a cheaper price and are sold at a higher price, the investor earns from the sale.

2. Bond market

The bond market offers opportunities for companies and the government to secure money to finance a project or investment. In a bond market, investors buy bonds from a company, and the company returns the amount of the bonds within an agreed period, plus interest.

3. Commodities market

The commodities market is where traders and investors buy and sell natural resources or commodities such as corn, oil, meat, and gold. A specific market is created for such resources because their price is unpredictable. There is a commodities futures market wherein the price of items that are to be delivered at a given future time is already identified and sealed today.

4. Derivatives market

Such a market involves derivatives or contracts whose value is based on the market value of the asset being traded. The futures mentioned above in the commodities market is an example of a derivative.

Functions of the Markets

The role of financial markets in the success and strength of an economy cannot be underestimated. Here are four important functions of financial markets:

1. Puts savings into more productive use

As mentioned in the example above, a savings account that has money in it should not just let that money sit in the vault. Thus, financial markets like banks open it up to individuals and companies that need a home loan, student loan, or business loan.

2. Determines the price of securities

Investors aim to make profits from their securities. However, unlike goods and services whose price is determined by the law of supply and demand, prices of securities are determined by financial markets.

3. Makes financial assets liquid

Buyers and sellers can decide to trade their securities anytime. They can use financial markets to sell their securities or make investments as they desire.

4. Lowers the cost of transactions

In financial markets, various types of information regarding securities can be acquired without the need to spend.

Importance of Financial Markets

There are many things that financial markets make possible, including the following:

Financial markets provide a place where participants like investors and debtors, regardless of their size, will receive fair and proper treatment.

They provide individuals, companies, and government organizations with access to capital.

Financial markets help lower the unemployment rate because of the many job opportunities it offers

Additional Resources

Thank you for reading CFI’s guide on Financial Markets. To keep learning and advancing your career, the following resources will be helpful:

London International Financial Futures & Options Exchange

New York Mercantile Exchange (NYMEX)

Stock Market

Types of Markets – Dealers, Brokers, Exchanges

See all wealth management resources

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Financial Market: Meaning, Definition, Types, Functions, Example

Financial Market: Meaning, Definition, Types, Functions, Example

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CommerceList of Commerce ArticlesWhat Is Financial Market

What is Financial Market

A financial market is a word that describes a marketplace where bonds, equity, securities, currencies are traded. Few financial markets do a security business of trillions of dollars daily, and some are small-scale with less activity. These are markets where businesses grow their cash, companies decrease risks, and investors make more cash.

Meaning of Financial Markets

A Financial Market is referred to space, where selling and buying of financial assets and securities take place. It allocates limited resources in the nation’s economy. It serves as an agent between the investors and collector by mobilising capital between them.

In a financial market, the stock market allows investors to purchase and trade publicly companies share. The issue of new stocks are first offered in the primary stock market, and stock securities trading happens in the secondary market.

Related link: What are the Financial Statements of a Company?

Types of Financial Markets

Over the Counter (OTC) Market – They manage public stock exchange, which is not listed on the NASDAQ, American Stock Exchange, and New York Stock Exchange. The OTC market dealing with companies are usually small companies that can be traded in cheap and has less regulation.

Bond Market – A financial market is a place where investors loan money on bond as security for a set if time at a predefined rate of interest. Bonds are issued by corporations, states, municipalities, and federal governments across the world.

Money Markets – They trade high liquid and short maturities, and lending of securities that matures in less than a year.

Derivatives Market –They trades securities that determine its value from its primary asset. The derivative contract value is regulated by the market price of the primary item — the derivatives market securities, including futures, options, contracts-for-difference, forward contracts, and swaps.

Forex Market – It is a financial market where investors trade in currencies. In the entire world, this is the most liquid financial market.

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Functions of Financial Market

Mentioned below are the important functions of the financial market.

It mobilises savings by trading it in the most productive methods.

It assists in deciding the securities price by interaction with the investors and depending on the demand and supply in the market.

It gives liquidity to bartered assets.

Less time-consuming and cost-effective as parties don’t have to spend extra time and money to find potential clients to deal with securities. It also decreases cost by giving valuable information about the securities traded in the financial market.

Do you know: What is Stock Exchange?

Classification of Financial Market

The financial market can be classified into three different forms.

1. By Nature of Claim

Debt Market – It is a market where fixed bonds and debentures or bonds are exchanged between investors.

Equity Market – It is a place for investors to deal with equity.

2. By Maturity of Claim

Money Market – It deals with monetary assets and short-term funds such as a certificate of deposits, treasury bills, and commercial paper, etc. which mature within twelve months.  

Capital Market –  It trades medium and long term financial assets.

3. By Timing of Delivery

Cash Market –   It is a market place where trade is completed in real-time.

Futures Market –  Here, the delivery or compensation of products are taken in the future specified date.

4. By Organizational Structure

Exchange-Traded Market – It has a centralised system with a patterned procedure.

Over-the-Counter Market – It has a decentralised organisation with customised procedures

Explore-Top 10 Difference between Money Market and Capital Market

What are Financial Markets and Institutions?

Financial markets dispense efficiently flow of investments and savings in the economy and facilitate the growth of funds for producing goods and services. The right blend of financial products and instruments and financial markets and institutions fuels the demands of investors, receiver and the overall economy of a country.

Financial markets (bonds and stocks), instruments (derivatives, bank CDs, and futures), and institutions (banks, pension funds, insurance companies, and mutual funds) give the investors the opportunities to specialize in specific services and markets. As quoted by Demirgcc-Kunt and Levine “Financial markets and financial institutions together contribute to economic growth and not the relative mix of these two factors”.

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What are financial markets and why are they important? | Bank of England

What are financial markets and why are they important? | Bank of England

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Explainers

What are financial markets and why are they important?

What are financial markets and why are they important?

Financial markets are where people can buy, sell, loan, lend, save, insure or invest.

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This page was last updated on 10 November 2022

What are financial markets?

Think of companies like eBay, which match buyers and sellers to set a price for everything from second-hand furniture to the latest iPhone.

Financial markets match buyers and sellers to set a price for financial assets.

What are the "financial assets" that are exchanged in the financial markets?

Shares Having shares in a company means you own part of it. Companies create shares to raise money so they can invest and grow.

Bonds Governments or large companies can raise money by issuing bonds. These are essentially a future ‘IOU’ that can be bought and sold in the financial markets. Government bonds also known as ‘gilts’ and are a form of government debt.

Currency People can exchange one currency for another in the foreign exchange markets.

How do financial markets help me?

Financial markets can give an opportunity for you to invest money in shares (also known as equities) to build up money for the future.

Over a long period of time, this can often provide a better return than opening a savings account at your bank. But buying shares can be risky. It is important to remember that the value of any investment can go down as well as up, and getting good returns in the past does not always mean they’ll be good in the future.

Financial markets also allow people to take out insurance. Insurance companies need to use financial markets to make sure you will receive a pay-out if you have an accident, such as losing or damaging your mobile phone.

Financial markets enable lenders such as banks to borrow money. They make loans to people who want to borrow – whether that’s attending university with a student loan, say, or buying a house with a mortgage.

Why do financial markets matter?

Play Why do financial markets matter? video

Bank of England's explainer on what are financial markets and why are they important.

Video transcript - Why do financial markets matter?

Hello, my name is Molly and I work at the Bank of England. Here at the Bank of England we always need to keep an eye on what’s happening in financial markets. Financial markets may seem confusing, but essentially they exist to bring people together, so money flows where it is needed the most.  Markets provide finance for companies so they can hire, invest and grow. They provide money for the government to help it pay for new roads, schools and hospitals. And they can help lower the costs you face buying food at the supermarket, taking out a mortgage or saving for your retirement. So when they work well, financial markets can be big drivers of prosperity, but as the financial crisis has shown, markets can get it wrong. That’s why the Bank of England is working hard to ensure that markets are fair, that they’re there when we need them, and that those working in financial markets are held accountable for their actions. Only by doing this, can we build real markets for the good of the good of the people of the United Kingdom.

How do financial markets help businesses?

Financial markets provide finance for companies so they can hire, invest and grow.

For example, Apple started in a garage in California. While it had some great ideas, it needed money to make them happen.

In 1977, it persuaded a single investor to loan the company $250,000. Over time, the company grew and less than five years later it was able to borrow over $100 million from financial markets by selling shares in the company.

Apple is now worth hundreds of billions of dollars and employs over 100,000 people.

So, when they work well, financial markets can make the country much better off.

What is the Bank of England's role in the financial markets?

As the Global Financial Crisis that began in 2007 showed, when markets go wrong they can cause a lot of harm.

At that time, markets proved to be fragile. This fragility spread to the wider economy. Banks were less willing and less able to provide loans to households and companies. This meant lower economic activity and more people out of work.

That’s why it’s important we make sure financial markets operate in a safe way.

We do that in more than one way.

We collect information about financial markets. It’s vital we talk to people working in financial markets so we understand what’s happening, what the risks are and consider how to address them together.

We manage some key financial market operations. This includes buying and selling things owned by the government to change the amount of money available in the economy. A few examples of this are quantitative easing, printing money and managing the UK’s gold and money reserves (our country’s investments) on behalf of the government. We also hold a small number of foreign currency reserves, and carry out payments to other countries for government departments and a small number of their customers.

We set standards for financial firms so they keep providing services when you need them.

Find out more

What do banks do?

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What does the Bank of England do?

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