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Investing has a higher potential for higher returns than saving which allows us the scope to grow our wealth over time with a higher return of interest to meet our long-term financial goals. But investing needs learning and the ability to take risks. Therefore, the first step in investing is to know the Financial Market and Different types of Financial Markets.
There are a variety of financial markets, each with its specific function. This article will provide you with an overview of financial markets and the different types of financial markets.
Financial Market
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A financial market is a place where buying and selling of financial products and securities occur. These products include stocks, currencies, commodities, cryptocurrencies etc. These financial markets sometimes do business for trillions of dollars daily. Such markets act as a platform for sellers and buyers to connect and deal with their financial assets at a price decided by market forces. Such markets act as a medium between the people or institutions requiring capital and those who want to invest. In simple terms, those having extra funds offer them to those who need financial support to grow their businesses. These markets are vital for the smooth functioning of capitalist economies. Whenever a financial market fails, it can result in economic disruption including recession and unemployment.
How do financial markets work?
A financial market is a platform where businesses and investors look forward to raising their funds and retrieving good returns on investment. This marketplace includes a seller and a potential buyer where the seller cracks a deal by having an appropriate buyer for their financial products.
These markets are classified into different types of financial markets. Major classifications are based on the nature of the claim, maturity, delivery time, and organizational structure.
Now let us discuss what are the different types of financial markets.
Financial market and its types
In long-term finance, they are called “capital markets” and in the short term they are called “money markets”. Short-term loans are dealt in money markets generally for a year or less.
Let’s now study in detail what are the types of financial markets.
1. Stock Market
One of the most prevalent types of financial markets is the stock market. These are the venues where the companies list their shares and buy and sell them to investors and traders. Also known as the equities market, is used by companies to raise capital via an “initial public offering” (IPO), with shares traded amongst various buyers and sellers in what is known as the secondary market.
The stock exchange is an exchange where the stockbrokers/traders can buy and sell shares, equities, bonds and other securities. Many large companies list their stocks on the stock exchange which makes it more liquid thus attracting many investors. The exchange may act as a guarantor of settlement. These and other stocks may also be traded “over the counter”(OTC) which is through a dealer. Participants in the stock market range from small individual stock investors to large investors from all over the world including banks, insurance companies, pension funds and hedge funds.
A potential buyer bids a specific price for a stock, and a potential seller asks for a specific price for the same stock. Buying or selling at the market means you will accept any ask price or bid price for the stock. When the bid and ask prices match, a sale takes place, on a first-come, first-served basis if there are multiple bidders at a given price.
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2. Over-The-Counter (OTC)
OTC trading involves the trading of commodities, financial instruments and derivatives between two parties without the help of an exchange. Products must be standardized to ensure transparency in stock exchange-based equities trading.
3. Bonds Markets
The bond market is a type of financial market wherein participants can issue new debt or buy and sell debt securities. A bond is a security in which an investor loans money for a limited period at re-established rates. A bond is an agreement between the lender and the borrower that contain details of the loan and payments. Trading usually takes place in the form of bonds but also in the form of notes and bills for public and private expenditures.
4. Money market
The money market is a type of financial market which provides short-term funds for less than one year for comparatively low-interest rates. Trading in the money market is done over the country and is wholesale. Trading usually happens of highly liquid and short-term assets. Investing is typically done in government securities, certificates of deposit, commercial papers of companies, and other highly liquid, low-risk securities.
5. Derivatives Markets
Derivatives are contracts that derive their value from the performance of an underlying entity such as an asset, index or interest rate. They are secondary securities that are linked to primary security and must be well-standardized for transparency in stock exchange-based equities trading.
6. Forex Markets
The forex market is a global financial market for trading currencies at current or determined prices. It is the most liquid in the world, handling more than $7.5 trillion in daily transactions. Large international banks are the main participants in the forex market. Products traded on traditional stock market exchanges must be well-standardized for transparency.
7. Commodities Market
The commodities market is a platform where producers and consumers meet to exchange physical commodities such as agricultural products (e.g., livestock, soybeans, corn etc.), energy products( oil, gas, carbon etc.), metals( gold, platinum, silver etc.), or soft commodities (cotton, coffee, sugar etc.). These are known as spot commodities markets where physical products are exchanged for money. Trading in this type of market usually takes place on a derivatives market that utilizes spot commodities as the underlying asset.
Conclusion
In summary, learning about the financial market and its types is essential for a business to raise capital and for investors to trade money. Financial markets play a vital role in our economy by providing price discovery and liquidity.
FAQs
A financial market is a marketplace where securities and other financial instruments are traded between investors. The purpose of a financial market is to provide liquidity and opportunity for investments
There are mainly four types of financial markets: stock markets, bond markets, foreign exchange markets and derivative markets.
Financial instruments can be divided into four categories: Debt (bonds and loans), Equity ( stocks and mutual funds), Derivatives ( options and future contracts) and Foreign Exchange (currency pairs and forward contracts).
Financial markets are efficient and are given strict rules and regulations framed by authorities for traders and investors to follow. Hence, if an individual or a company is found violating the laws. They are likely to face heavy penalties which can lead to cancellation of licenses.
Financial markets act as a platform to let institutions and individuals use their savings in the best way possible to build finances. It keeps assets liquid and keeps the capitalist economy active.
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