A marketplace that provides an avenue for the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives
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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:
FAQs
Financial Markets include any place or system that provides buyers and sellers the means to trade financial instruments, including bonds, equities, the various international currencies, and derivatives. Financial markets facilitate the interaction between those who need capital with those who have capital to invest.
What are the 5 roles of financial markets? ›
The 5 roles of financial markets are ensuring a low cost of transactions and information, ensuring liquidity by providing a mechanism for an investor to sell the financial assets, providing security to dealings in financial assets, and providing facilities for interaction between the investors and the borrowers.
What are the 2 most common types of financial markets? ›
The two main types of financial markets are Capital Markets and Money Market. The capital market is the market for medium and long term funds. You can read about the Financial Market – Functions, Features, Difference between Money and Capital Market in the given link.
What are the four key markets in the financial markets? ›
The 4 types of financial markets are currency markets, money markets, derivative markets, and capital markets.
What is the importance of the financial market? ›
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.
What are the three main roles of financial markets? ›
Here are four important functions of financial markets:
- 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. ...
- Determines the price of securities. ...
- Makes financial assets liquid. ...
- Lowers the cost of transactions.
The financial market has a primary function of bringing savers and borrowers together. This means that the fund that is saved in savings accounts is issued out as loans to spenders or borrowers.
What is the most popular financial market? ›
New York Stock Exchange
But it has remained the largest stock exchange in the world by market capitalisation ever since the end of World War I, when it overtook the London Stock Exchange.
What are examples 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.
What are the 3 kinds most common securities traded in the financial markets? ›
In the United States, the term broadly covers all traded financial assets and breaks such assets down into three primary categories:
- Equity securities – which includes stocks.
- Debt securities – which includes bonds and banknotes.
- Derivatives – which includes options and futures.
What is the structure of the financial market? The structure of the financial market broadly divides into the Money Market and Capital Market. The money market caters to short-term fund requirements, while the capital market takes care of long-term funding needs.
What are 3 financial institutions? ›
There are three major types of depository institutions in the United States. They are commercial banks, thrifts (which include savings and loan associations and savings banks) and credit unions.
What are the 4 types of markets and explain each? ›
The four popular types of market structures include perfect competition, oligopoly market, monopoly market, and monopolistic competition. Market structures show the relations between sellers and other sellers, sellers to buyers, or more.
What are the disadvantages of the financial market? ›
While financial markets provide numerous benefits, such as liquidity and investment opportunities, they also come with certain disadvantages, including: Volatility and market fluctuations: Financial markets are subject to volatility and fluctuations in asset prices, which can lead to potential losses for investors.
How do financial markets work? ›
A financial market is a place where firms and individuals enter into contracts to sell or buy a specific product, such as a stock, bond, or futures contract. Buyers seek to buy at the lowest available price and sellers seek to sell at the highest available price.
What are the two segments of the financial market? ›
Capital markets and money markets are the two primary segments of the financial market.
What are the role and functions of financial markets? ›
Functions of Financial Market
Financial Markets helps in mobilizing savings, determining and settling the prices of various securities, providing liquidity to assets, and easing access to all types of traders. While studying the functions of Financial Markets, students must take note of these aspects discussed below.
What are the roles of markets? ›
Markets are an important part of the economy. They allow a space where governments, businesses, and individuals can buy and sell their goods and services. But that's not all. They help determine the pricing of goods and services and inject much-needed liquidity into the economy.
What are the roles of the financial sector? ›
In order for an economy to remain stable, it needs to have a healthy financial sector. This sector advances loans for businesses so they can expand, grants mortgages to homeowners, and issues insurance policies to protect people, companies, and their assets.
What is the role of the financial system and markets? ›
The financial system refers to the network of institutions, such as banks, insurance companies, markets, and stock exchanges. The primary function of the financial system is to distribute savings from individuals and businesses to productive investments, allocate capital efficiently, and manage risks.
