You must have heard about stocks, wall street, dalal street and simply Mr. Market. But, what are financial markets and how they function?
In this article we will let you know different types of financial markets and why they exist.
What are financial markets?
Financial markets include stock, bond, forex, derivative and commodities markets. It’s a place where traders buy and sell financial assets.
Which means, financial markets refers broadly to any marketplace where the trading of financial assets such as stocks, bonds, derivatives, currencies and commodities etc. takes place.
For example, in stock market buyers and sellers trade stocks in exchange of money. It’s a common platform where buyers and sellers come to trade.
In other words, the financial markets provide a platform where buyers and sellers can trade financial assets such as shares, bonds, commodities and currencies at a transparent price determined by the demand and supply forces.
These financial markets are regulated by independent bodies established by respective countries’ rules and regulations.
Why financial markets?
Financial markets has been created for so many reasons. Here are few most important reasons;
- As the business grows, their need for capital expands dramatically. Financial markets help businesses to acquire large amounts of capital based on their requirements
- It helps to offset risks
- To provide a transparent way to set prices of the financial assets traded
- To make it easy for buyers and sellers to trade their financial holdings
- For providing liquidity
- To have a smooth operation of capitalist economies
Types of Financial Markets
Now you know, what are the financial markets? Lets understand 5 different types of financial markets that are very popular to know.
The Stock Market
Stock market is a marketplace where successful companies come to raise large amounts of capital in order to expand their business. Probably it’s the most popular and biggest centralized financial market.
In exchange of money, they issue shares of their company. After raising capital, they get listed themselves in stock exchanges to allow trading of shares.
Number of shares issued by the company represent ownership in that company. Owners of these shares or stock have different rights based on their ownership percentage such as right to get dividend if company declares, voting rights etc.
These owners of stocks can sell their shares or buy a few more from the stock exchange where the company’s stocks are listed.
For easy trading of their stocks, companies get listed in stock exchanges where people across the country can buy and sell stocks. Here are the most popular stock exchanges where investors buy and sell stocks;
- New York Stock Exchange (NYSE)
- BSE – Bombay Stock Exchange
- NSE – National Stock Exchange
Lots of investors instead of directly jumping to the stock market, prefer to invest through mutual funds. It’s very helpful for those investors who are new to the stock market or do now know how and when to select a stock to buy and sell.
Professionally managed mutual funds have the ability to give you good return in comparison to other available traditional investment options. You can take help of a financial expert to choose 4 to 5 mutual funds according to your risk factors for investment.
The bond market
Businesses often require large loans for expansion. To get the fund they can approach banks, financial institutions or issue stocks.
If the management wants to payback the fund raised instead of going for increase in share capital, they take the root of the bond market. Bonds issued in this case are referred to as corporate bonds.
Similarly, we have government bonds, municipality bonds, issued by government agencies to raise funds.
A bond is a security in which the buyer loans money for a defined period of time at a predefined interest rate.
It’s also referred to as the credit, debt or fixed income market.
In the bond market, investors buy bonds from companies and government agencies to get periodical interest. Investors looking for periodical income, buy bonds. Depending on the terms and conditions, investors get back their money with interest after a period of time.
The commodities market
Commodities market is a place where people offset their future risk by buying and selling natural resources, agricultural goods. A specific market has been created as their prices are very volatile.
Most important commodities traded are;
- Crude oil
Forex market is a place where currencies can be bought, exchanged and sold. Forex market influences the exchange rates of different countries.
It’s a decentralised technology based global market where banks, corporations, government, institutional investors and brokers around the world are connected to trade currencies.
Major participants are banks, commercial companies, hedge funds, forex brokers, investors and financial institutions.
A derivative is a contract between the two parties, whose price is derived from the underlying assets. These assets can be company’s stock, currencies and commodities.
A derivative market mostly trades in futures, options and forward contracts. It allows an investor to transfer the risk attached to the underlying asset to another investor who is willing to take it.