Introduction to Financial Markets
Financial Market is a marketplace where the creation and the trading of financial assets take place. Financial assets include shares, bonds, derivatives, commodities, currencies, etc. The financial market of any country plays a crucial role in the allocation of the limited resources available in the economy of any country. Some of the financial markets are very small with a little amount of activity, while some of the financial markets trade trillions of amounts of securities daily. It acts as an intermediary between savers and the investors by mobilizing the funds between them. So, the financial market gives a platform for buyers and sellers to meet in order to trade in the assets at the price which is determined by the market forces, i.e., demand and supply in the market.
Types of the Financial Markets
There are different types of financial markets, which are as follows:
1. Money Markets
A money market is basically for short-term financial assets that can be turned over rapidly at a minimum cost that instruments are quickly convertible into money with the least transaction costs. The operations in the money market are for a duration that can be extended u-to one year, and it deals in short-term financial assets. This market is an institutional source of working capital for the companies. These participants of this market are commercial banks, RBI, large corporate, etc.; the instruments in the money market are commercial bills, commercial paper, certificates of deposit, treasury bills, etc.
2. Over-the-Counter Markets
This market is a decentralized market not having a centralized physical location. It is basically the secondary market. Here, the participants of the market trade with each other by using different modes of communication like electronic mode, telephone, etc. companies that are traded in the OTC market are small companies. This market has less transparency, fewer regulations, and is inexpensive.
3. Derivatives Market
The derivatives market is the financial market that trades in securities that derive their value from some specified underlying asset. Derivatives do not have a physical existence but emerge out of the contracts between two parties. These underlying assets may be debentures, shares, currencies, etc. The derivative contracts’ value is determined by the market price of an underlying item. This market trades in derivatives which include futures and forward contracts, swaps, options, etc.
4. Bonds Market
The bond is the debt security where an investor loans the money for a specific time period and at a definite coupon rate, i.e. interest rate. These bonds include Corporate Bonds and municipal bonds from all over the world. All kinds of securities like bills and notes issued through the United States Treasury are sold in the bond market.
5. Forex Market
The forex market is not a physical entity but is a network of communication among banks, brokers, and forex dealers. This is the market where all kinds of currencies are traded. It is the highest liquid market as cash is liquid. It includes market dealings like spot market, forward market, etc.
Example of the Financial Markets
For example, Company XYZ Ltd. wants to raise capital of $100,000 by way of issuing equity in the financial market. The company is issuing the shares first time for the common public, so it will have to issue the shares in the primary share market as in case new issues of the stocks are firstly offered, then they are to be issued in the primary share market. Any of the subsequent tradings in the stock securities will happen in the secondary market.
Advantages and Disadvantages
Some of the advantages and disadvantages of the financial markets are as follows:
- It gives a platform for buyers and sellers to meet in order to trade in the assets. The prices for trading are determined by the market forces, i.e., demand and supply in the market. So It helps in the determination of the prices of securities.
- It helps in the mobilization of the savings of the investors as the investor can put his money in the most productive uses.
- For the traders, the financial market platform provides the potential buyer and seller of their securities, which helps them in saving their time and money in finding the potential buyer and seller.
- In the financial market, investors can sell their securities readily and convert them into cash, thereby providing liquidity to the tradable assets.
- Prices in the financial market may not indicate a stock’s true intrinsic value because of some macroeconomic forces like taxes etc.
- There are certain factors that change the prices of securities suddenly. So there is a risk involved when trading in the financial market. Like if any negative news about the company comes, then its price may decrease to a great extent causing loss to the person holding its shares.
Important Points of the Financial Markets
- It is the market, an arrangement, or institution which facilitates the exchange of financial instruments and financial securities.
- It may have or not have a physical location. The assets can be exchanged between the parties over the phone or the internet as well.
- Some of the financial markets are very small with a little amount of activity, while some of the financial markets trade trillions of amounts of securities daily.
Thus it can be concluded that the Financial market is the market where the traders are involved in the buying and selling of financial assets like shares, bonds, derivatives, commodities, currencies, etc. It is an arrangement or institution which facilitates the exchange of financial instruments and financial securities. It may have or not have a physical location. The assets can be exchanged between the parties over the phone or the internet as well. From the last few years, the role of the financial market has seen a drastic change because of a number of factors such as low transaction cost, investor protection, high liquidity, pricing information transparency, legal procedures easiness for the settling of disputes, etc.
This has been a guide to the Financial Markets. Here we discuss the types, examples, advantages, and disadvantages of the financial market along with the Important points. You can also go through our other suggested articles to learn more –