Financial Markets
What Are Financial Markets?
Financial markets allude broadly to any marketplace where the trading of securities happens, including the stock market, bond market, forex market, and derivatives market, among others. Financial markets are indispensable to the smooth operation of capitalist economies.
Figuring out the Financial Markets
Financial markets play an essential job in facilitating the smooth operation of capitalist economies by dispensing resources and making liquidity for organizations and entrepreneurs. The markets make it simple for buyers and sellers to trade their financial holdings. Financial markets make securities products that give a return to the individuals who have excess funds (Investors/lenders) and make these funds accessible to the people who need extra money (borrowers).
The stock market is just one type of financial market. Financial markets are made by buying and selling various types of financial instruments including equities, bonds, currencies, and derivatives. Financial markets depend intensely on educational transparency to guarantee that the markets set prices that are efficient and suitable. The market prices of securities may not be indicative of their intrinsic value on account of macroeconomic powers like taxes.
A few financial markets are small with little activity, and others, similar to the New York Stock Exchange (NYSE), trade trillions of dollars of securities daily. The equities (stock) market is a financial market that empowers investors to buy and sell shares of publicly traded companies. The primary stock market is where new issues of stocks, called initial public offerings (IPOs), are sold. Any subsequent trading of stocks happens in the secondary market, where investors buy and sell securities that they currently own.
Prices of securities traded in the financial markets may not be guaranteed to mirror their true intrinsic value.
Types of Financial Markets
Stock Markets
Maybe the most ubiquitous of financial markets are stock markets. These are settings where companies list their shares and they are bought and sold by traders and investors. Stock markets, or equities markets, are utilized by companies to raise capital through an initial public offering (IPO), with shares subsequently traded among different buyers and sellers in what is known as a secondary market.
Stocks might be traded on listed exchanges, for example, the New York Stock Exchange (NYSE) or Nasdaq, or, in all likelihood over-the-counter (OTC). Most trading in stocks is done by means of regulated exchanges, and these play an important job in the economy as both a check of the overall soundness of the economy as well as giving capital gains and dividend income to investors, incorporating those with retirement accounts like IRAs and 401(k) plans.
Run of the mill participants in a stock market incorporate (both retail and institutional) investors and traders, as well as market producers (MMs) and experts who keep up with liquidity and give two-sided markets. Brokers are outsiders that work with trades among buyers and sellers yet who don't take an actual position in a stock.
Over-the-Counter Markets
A over-the-counter (OTC) market is a decentralized market — meaning it doesn't have physical areas, and trading is led electronically — in which market participants trade securities directly between two parties without a broker. While OTC markets might handle trading in certain stocks (e.g., smaller or more hazardous companies that don't meet the listing criteria of exchanges), most stock trading is done through exchanges. Certain derivatives markets, notwithstanding, are only OTC, thus they make up an important segment of the financial markets. Broadly speaking, OTC markets and the transactions that happen on them are undeniably less regulated, not so much liquid, but rather more opaque.
Bond Markets
A bond is a security wherein an investor loans money for a defined period at a pre-laid out interest rate. You might think of a bond as an understanding between the lender and borrower that contains the subtleties of the loan and its payments. Bonds are issued by corporations as well as by municipalities, states, and sovereign governments to finance undertakings and operations. The bond market sells securities, for example, notes and bills issued by the United States Treasury, for instance. The bond market additionally is called the debt, credit, or fixed-income market.
Money Markets
Regularly the money markets trade in products with highly liquid short-term maturities (of short of what one year) and are characterized by a high degree of safety and a somewhat low return in interest. At the wholesale level, the money markets include enormous volume trades among institutions and traders. At the retail level, they incorporate money market mutual funds bought by individual investors and money market accounts opened by bank customers. Individuals may likewise invest in the money markets by buying short-term certificates of deposit (CDs), municipal notes, or U.S. Treasury bills, among other models.
Derivatives Markets
A derivative is a contract between at least two parties whose value depends on a settled after underlying financial asset (like a security) or set of assets (like an index). Derivatives are secondary securities whose value is exclusively derived from the value of the primary security that they are linked to. All by itself a derivative is worthless. Rather than trading stocks directly, a derivatives market trades in futures and options contracts, and other advanced financial products, that get 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. Not at all like advances, which trade OTC, futures markets use normalized contract particulars, are all around regulated, and use clearinghouses to settle and confirm trades. Options markets, for example, the Chicago Board Options Exchange (CBOE), comparably list and control options contracts. The two futures and options exchanges might list contracts on different asset classes, like equities, fixed-income securities, commodities, etc.
Forex Market
The forex (foreign exchange) market is the market wherein participants can buy, sell, hedge, and guess 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 $6.6 trillion in daily transactions, which is more than the futures and equity markets combined.
Similarly as with the OTC markets, the forex market is likewise decentralized and comprises of a global network of PCs and brokers from around the world. The forex market is comprised of banks, commercial companies, central banks, investment the executives firms, hedge funds, and retail forex brokers and investors.
Commodities Markets
Commodities markets are scenes where producers and consumers meet to exchange physical commodities like agricultural products (e.g., corn, livestock, soybeans), energy products (oil, gas, carbon credits), precious metals (gold, silver, platinum), or "soft" commodities (like cotton, coffee, and sugar). These are known as spot commodity markets, where physical goods are exchanged for money.
The bulk of trading in these commodities, nonetheless, happens on derivatives markets that use spot commodities as the underlying assets. Advances, futures, and options on commodities are exchanged both OTC and on listed exchanges around the world like the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE).
Cryptocurrency Markets
The past several years have seen the presentation and rise of cryptocurrencies like Bitcoin and Ethereum, decentralized digital assets that depend on blockchain technology. Today, a large number of cryptocurrency tokens are accessible and trade globally across an interwoven of independent online crypto exchanges. These exchanges have digital wallets for traders to swap one cryptocurrency for another, or for fiat monies like dollars or euros.
Since the majority of crypto exchanges are centralized platforms, users are helpless to hacks or fraud. Decentralized exchanges are additionally accessible that operate with practically no central authority. These exchanges allow direct peer-to-peer (P2P) trading of digital currencies without the requirement for an actual exchange authority to work with the transactions. Futures and options trading are likewise accessible on major cryptocurrencies.
Instances of Financial Markets
The above segments clarify that the "financial markets" are broad in scope and scale. To give two additional substantial models, we will think about the job of stock markets in carrying a company to IPO, and the job of the OTC derivatives market in the 2008-09 financial crisis.
Stock Markets and IPOs
At the point when a company lays down a good foundation for itself, it will require access to capital from investors. As the company develops it frequently ends up needing access to a lot bigger amounts of capital than it can get from progressing operations or a traditional bank loan. Firms can raise this size of capital by selling shares to the public through an initial public offering (IPO). This changes the situation with the company from a "private" firm whose shares are held by a couple of shareholders to a publicly-traded company whose shares will be subsequently held by various individuals from the overall population.
The IPO additionally offers early investors in the company an opportunity to cash out part of their stake, frequently receiving exceptionally attractive benefits all the while. Initially, the price of the IPO is generally set by the underwriters through their pre-marketing process.
When the company's shares are listed on a stock exchange and trading in it starts, the price of these shares will change as investors and traders survey and rethink their intrinsic value and the supply and demand for those shares at any moment in time.
OTC Derivatives and the 2008 Financial Crisis: MBS and CDOs
While the 2008-09 financial crisis was caused and exacerbated by several factors, one factor that has been widely recognized is the market for mortgage-backed securities (MBS). These are a type of OTC derivatives where cash flows from individual mortgages are packaged, sliced up, and sold to investors. The crisis was the consequence of a sequence of occasions, each with its own trigger and finishing in the close breakdown of the banking system. It has been contended that the seeds of the crisis were planted as far back as the 1970s with the Community Development Act, which required banks to loosen their credit requirements for lower-income consumers, making a market for subprime mortgages.
The amount of subprime mortgage debt, which was guaranteed by Freddie Mac and Fannie Mae, kept on venturing into the mid 2000s, when the Federal Reserve Board started to cut interest rates definitely to keep away from a recession. The combination of loose credit requirements and cheap money prodded a housing boom, which drove speculation, pushing up housing prices and making a real estate bubble. Meanwhile, the investment banks, searching for simple profits in the wake of the dotcom bust and the 2001 recession, made a type of MBS called collateralized debt obligations (CDOs) from the mortgages purchased on the secondary market.
Since subprime mortgages were packaged with prime mortgages, there was not a chance for investors to comprehend the risks associated with the product. At the point when the market for CDOs started to warm up, the housing bubble that had been building for quite some time had at long last burst. As housing prices fell, subprime borrowers started to default on loans that were worth more than their homes, speeding up the decline in prices.
At the point when investors realized the MBS and CDOs were worthless due to the toxic debt they addressed, they endeavored to empty the obligations. In any case, there was no market for the CDOs. The subsequent cascade of subprime lender failures made liquidity contagion that arrived at the upper tiers of the banking system. Two major investment banks, Lehman Brothers and Bear Stearns, imploded under the weight of their exposure to subprime debt, and in excess of 450 banks failed over the next five years. Several of the major banks were near the precarious edge of failure and were safeguarded by a citizen financed bailout.
Financial Markets FAQs
Highlights
- There are numerous sorts of financial markets, including (yet not limited to) forex, money, stock, and bond markets.
- These markets might incorporate assets or securities that are either listed on regulated exchanges or, more than likely trade over-the-counter (OTC).
- At the point when financial markets fail, economic disruption including recession and unemployment can result.
- Financial markets allude broadly to any marketplace where the trading of securities happens.
- Financial markets trade in a wide range of securities and are critical to the smooth operation of a capitalist society.
FAQ
Why Are Financial Markets Important?
Without financial markets, capital couldn't be allocated efficiently, and economic activity like commerce and trade, investments, and growth opportunities would be enormously lessened.
Who Are the Main Participants in Financial Markets?
Firms utilize stock and bond markets to raise capital from investors. Speculators shift focus over to different asset classes to make directional wagers on future prices, while hedgers use derivatives markets to relieve different risks, and arbitrageurs try to exploit mispricings or abnormalities saw across different markets. Brokers frequently act as mediators that unite buyers and sellers, earning a commission or fee for their services.
What Are the Different Types of Financial Markets?
A few instances of financial markets and their jobs incorporate the stock market, the bond market, forex, commodities, and the real estate market, among several others. Financial markets can likewise be broken down into capital markets, money markets, primary versus secondary markets, and listed versus OTC markets.
What Are the Main Functions of Financial Markets?
Financial markets exist in light of multiple factors, yet 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 all the more easily while likewise allowing investors to participate in capital gains over time.
How Do Financial Markets Work?
Regardless of covering a wide range of asset classes and having different designs and regulations, all financial markets work basically by uniting buyers and sellers in some asset or contract and allowing them to trade with each other. This is much of the time done through an auction or price-discovery mechanism.
