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. While it remains unused by the depositor, the bank can use their money and the money of other depositors to loan to other individuals and organizations and charge an interest fee.
By doing so, 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, every country is home at least one, though 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 out of the stocks when they perform well in the market. As 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 much higher price, the investor also 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 fee.
3. Commodities market
From the name itself, 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 such a thing as 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 Financial 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 it such as for 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
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: