A financial market refers to a platform facilitating the trade of financial assets such as stocks, bonds, securities, derivatives, and foreign exchange. Financial marketplaces allow customers to make money and raise money for the growth of their businesses. These markets are essential for the smooth operations of a capitalist economy because they help in allocating resources and also create liquidity for entrepreneurs and businesses. Financial markets ease the process of exchanging financial holdings between buyers and sellers. They pave the way for bringing funds from surplus units (investors, buyers) towards deficit units (borrowers, sellers).
Financial transparency is a vital element of trading in financial markets. It helps in setting appropriate and efficient prices in the market. The prices of securities determined by the market are may not indicate their intrinsic value due to various economic factors. Every country owns at least one financial market irrespective of its volume of trade. The following are the top six types of financial markets.
The stock markets deal with the trading of shares of publicly owned companies. Every share is worth a value in the form of its price. Investors can buy and sell these shares to earn a profit. The performance of a trader in the market determines his success and growth.
The process of buying shares is quite simple and easy. However, the real challenge comes at the time of making the decision about which shares to buy that will perform well in the future and earn profit for you. Companies can raise capital for their operations through an Initial Public Offering (IPO) in the market to offer their share for sale to many buyers and investors.
Stocks or shares can be traded either via list exchange or Over-the-Counter (OTC) market. The traders or investors are the primary participants of the stock market along with specialists and Market Makers (MMs) who deal with the maintenance of liquidity in the market. There are also different best online stock broker who plays the role of facilitating trade between sellers and buyers through their services.
The performance of the stock market can be evaluated through various factors. The simplest way of making a profit in the stock market is buying stocks at a lower price and selling them at a higher rate.
The bond markets provide facilities for businesses to finance money for their projects. Here people invest by buying bonds from different countries for an agreed period of time after which the company pays the investor his principal amount along with the agreed amount of interest. A bond is a financial instrument in the form of security through which a company or government can borrow a loan from investors at a pre-defined interest rate for a specific period of time. It can also be defined as an agreement between the lender (investor) and the borrower. This agreement includes complete information regarding the loan, its payment, and interest. Bonds can be issued by the government, municipalities, states, and corporations for the purpose of financing operations and projects. The bond market is known as the fix-income, credit, or debt market.
A derivative can be defined as a contract between two or more parties. The value of this contract is derived from a set of assets or a financial asset such as security. Derivatives are regarded as secondary securities as their value is based on the respective primary securities that are linked to them. Apart from that primary security, the derivative has no value.
Unlike the stock market where stocks are traded directly, a derivative market deals in future markets and options contracts. It also trades in advanced financial products whose value is derived from financial instruments such as currencies, commodities, bonds, stocks, market indexes, and interest rates. Future markets refer to markets that list and trade future trades.
Future markets are well-regulated and confirm and settle trades using clearinghouse services. They also use standardized contract specifications. Options markets trade-in options contracts. The asset classes on which contracts can be listed in options and futures markets may include commodities, securities, fixed-income securities, etc.
Commodities markets provide buyers (consumers) and sellers (producers) with a platform to trade physical commodities like soft commodities (sugar, coffee, and cotton), precious metals (silver, gold, and platinum), energy products (carbon credits, oil, and gas) and agricultural products (soybeans, livestock, corn, etc.). They are also known as spot commodity markets. Here physical goods and commodities are traded against money. Derivative markets also utilize these spot commodities in place of underlying assets to derive value for their derivatives. This results in bulk trading in this market also. Commodities are exchanged for options, futures, and forwards in list exchanges as well as over-the-counter (OTC) markets.
Over-the-counter (OTC) Markets:
OTC or over-the-counter markets are actually decentralized markets. A decentralized market is one without a physical location. In these markets, electronic trading is conducted without involving any third party or broker between the buyer and seller. This means that direct trading takes place between the buyer and the seller. Although most of the stocks are traded through listed exchanges, an OTC market deals with the trading of riskier or smaller companies especially those who do not qualify the criteria for listing in exchanges. There are also some derivatives markets that are entirely OTC. All this sums up to result in a significant part of financial markets. OTC markets lack proper regulations and liquidity. Moreover, they are also more opaque than other financial markets.
A forex market is one that deals in trading foreign exchange. It allows traders to buy, sell speculate, or hedge on currency pairs’ exchange rates. It is the most liquid financial market in the world because it trades in cash which is the most liquid asset among all assets. The volume of daily transactions in forex markets accounts for trillions of dollars. This volume exceeds the combined volume of the equity and futures markets. Like the over-the-counter (OTC) market, the forex market is also decentralized. It involves a wide network of computers spread on a global level. It also consists of intermediaries or brokers. This market is made up of different institutions such as investment management firms, banks, hedge funds, central banks, commercial companies, investors, and retail forex brokers.