Financial market

A financial market is a market in which people trade financial securities and derivatives at low
transaction costs. Some of the securities include stocks and bonds, raw materials and precious
metals, which are known in the financial markets as commodities.

The term "market" is sometimes used for what are more strictly exchanges, that is, organizations
that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This
may be a physical location (such as the New York Stock Exchange (NYSE), London Stock Exchange
(LSE), Bombay Stock Exchange (BSE) or Johannesburg Stock Exchange JSE Limited) or an
electronic system such as NASDAQ. Much trading of stocks takes place on an exchange; still,
corporate actions (mergers, spinoffs) are outside an exchange, while any two companies or people,
for whatever reason, may agree to sell the stock from the one to the other without using an
exchange.

Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a
stock exchange, and people are building electronic systems for these as well.

Types of financial markets

Within the financial sector, the term "financial markets" is often used to refer just to the markets that
are used to raise finances. For long term finance, they are usually called the capital markets; for
short term finance, they are usually called money markets. The money market deals in short-term
loans, generally for a period of a year or less. Another common use of the term is as a catchall for
all the markets in the financial sector, as per examples in the breakdown below.

Capital markets, which consist of:

Stock markets, which provide financing through the issuance of shares or common stock,
and enable the subsequent trading thereof.

Bond markets, which provide financing through the issuance of bonds, and enable the
subsequent trading thereof.

Commodity markets, which facilitate trading in the primary economic sector rather than
manufactured products. Soft commodities is a term generally referring to commodities that are
grown rather than mined, such as crops (corn, wheat, soybean, fruit and vegetable), livestock,
cocoa, coffee and sugar. Hard commodities is a term generally referring to commodities that are
mined such as gold, gemstones and other metals and generally drilled such as oil and gas.
 Money markets, which provide short term debt financing and investment.

Derivatives markets, which provide instruments for the management of financial risk.[1]

Futures markets, which provide standardized forward contracts for trading products at some
future date; see also forward market.

Foreign exchange markets, which facilitate the trading of foreign exchange.

Cryptocurrency markets, which facilitate the trading of digital assets and financial technologies.

Spot market

Interbank lending market

The capital markets may also be divided into primary markets and secondary markets. Newly
formed (issued) securities are bought or sold in primary markets, such as during initial public
offerings. Secondary markets allow investors to buy and sell existing securities. The transactions in
primary markets exist between issuers and investors, while secondary market transactions exist
among investors.

Liquidity is a crucial aspect of securities that are traded in secondary markets. Liquidity refers to the
ease with which a security can be sold without a loss of value. Securities with an active secondary
market mean that there are many buyers and sellers at a given point in time. Investors benefit from
liquid securities because they can sell their assets whenever they want; an illiquid security may
force the seller to get rid of their asset at a large discount.

Raising capital

Financial markets attract funds from investors and channels them to corporations—they thus allow
corporations to finance their operations and achieve growth. Money markets allow firms to borrow
funds on a short-term basis, while capital markets allow corporations to gain long-term funding to
support expansion (known as maturity transformation).

Without financial markets, borrowers would have difficulty finding lenders themselves.
Intermediaries such as banks, Investment Banks, and Boutique Investment Banks can help in this
process. Banks take deposits from those who have money to save on the form of savings a/c. They
can then lend money from this pool of deposited money to those who seek to borrow. Banks
popularly lend money in the form of loans and mortgages.

More complex transactions than a simple bank deposit require markets where lenders and their
agents can meet borrowers and their agents, and where existing borrowing or lending commitments
can be sold on to other parties. A good example of a financial market is a stock exchange. A
company can raise money by selling shares to investors and its existing shares can be bought or
sold.

The following table illustrates where financial markets fit in the relationship between lenders and
borrowers:

Relationship between lenders and borrowers

Lenders Financial Intermediaries Financial Markets Borrowers

Interbank Individuals
Banks
Individuals Stock Exchange Companies
Insurance Companies
Companies Money Market Central Government
Pension Funds
Banks Bond Market Municipalities
Mutual Funds
Foreign Exchange Public Corporations

Lenders

The lender temporarily gives money to somebody else, on the condition of getting back the principal
amount together with some interest or profit or charge.

Individuals and doubles

Many individuals are not aware that they are lenders, but almost everybody does lend money in
many ways. A person lends money when he or she:

Puts money in a savings account at a bank

Contributes to a pension plan

Pays premiums to an insurance company

Invests in government bonds

Companies

Companies tend to be lenders of capital. When companies have surplus cash that is not needed for
a short period of time, they may seek to make money from their cash surplus by lending it via short
term markets called money markets. Alternatively, such companies may decide to return the cash
surplus to their shareholders (e.g. via a share repurchase or dividend payment).
Banks

Banks can be lenders themselves as they are able to create new debt money in the form of
deposits.

Borrowers

Individuals borrow money via bankers' loans for short term needs or longer term mortgages to
help finance a house purchase.

Companies borrow money to aid short term or long term cash flows. They also borrow to fund
modernization or future business expansion. It is common for companies to use mixed packages
of different types of funding for different purposes – especially where large complex projects
such as company management buyouts are concerned.[2]

Governments often find their spending requirements exceed their tax revenues. To make up this
difference, they need to borrow. Governments also borrow on behalf of nationalized industries,
municipalities, local authorities and other public sector bodies. In the UK, the total borrowing
requirement is often referred to as the Public sector net cash requirement (PSNCR).

Governments borrow by issuing bonds. In the UK, the government also borrows from individuals by
offering bank accounts and Premium Bonds. Government debt seems to be permanent. Indeed, the
debt seemingly expands rather than being paid off. One strategy used by governments to reduce the
value of the debt is to influence inflation.

Municipalities and local authorities may borrow in their own name as well as receiving funding from
national governments. In the UK, this would cover an authority like Hampshire County Council.

Public Corporations typically include nationalized industries. These may include the postal services,
railway companies and utility companies.

Many borrowers have difficulty raising money locally. They need to borrow internationally with the
aid of Foreign exchange markets.

Borrowers having similar needs can form into a group of borrowers. They can also take an
organizational form like Mutual Funds. They can provide mortgage on weight basis. The main
advantage is that this lowers the cost of their borrowings.
Derivative products

During the 1980s and 1990s, a major growth sector in financial markets was the trade in so called
derivatives.

In the financial markets, stock prices, share prices, bond prices, currency rates, interest rates and
dividends go up and down, creating risk. Derivative products are financial products that are used to
control risk or paradoxically exploit risk.[3] It is also called financial economics.

Derivative products or instruments help the issuers to gain an unusual profit from issuing the
instruments. For using the help of these products a contract has to be made. Derivative contracts
are mainly four types:[4]

1. Future

2. Forward

3. Option

4. Swap

Over the past few decades, the derivatives market has increased and become essential to the
financial industry. As the market expands, establishing and improving the regulatory framework
becomes particularly critical. In response to the systemic risks exposed by the global economic
crisis in 2008, essential regulations such as the Dodd-Frank Act (US)[5] and the EU Market
Fundamentals Regulation (MiFID II)[6] were enacted.

The Dodd-Frank Act focuses on increasing transparency and regulating the derivatives market,
particularly over-the-counter derivatives transactions, requiring clearing through central
counterparties.[5]

MiFID II enhances the market's efficiency, transparency, and fairness, improving transaction
transparency and strengthening investor protection.[6]

These regulations have significantly changed the market structure and strengthened supervision
and risk management of the derivatives market. Although regulatory measures have enhanced
market stability, they have also had a broad impact on market participants' operating models and
strategies.

Seemingly, the most obvious buyers and sellers of currency are importers and exporters of goods.
While this may have been true in the distant past, when international trade created the demand for
currency markets, importers and exporters now represent only 1/32 of foreign exchange dealing,
according to the Bank for International Settlements.[7]

The picture of foreign currency transactions today shows:

Banks/Institutions

Speculators

Government spending (for example, military bases abroad)

Importers/Exporters

Tourists

Analysis of financial markets

See Statistical analysis of financial markets, statistical finance

Much effort has gone into the study of financial markets and how prices vary with time. Charles
Dow, one of the founders of Dow Jones & Company and The Wall Street Journal, enunciated a set of
ideas on the subject which are now called Dow theory. This is the basis of the so-called technical
analysis method of attempting to predict future changes. One of the tenets of "technical analysis" is
that market trends give an indication of the future, at least in the short term. The claims of the
technical analysts are disputed by many academics, who claim that the evidence points rather to
the random walk hypothesis, which states that the next change is not correlated to the last change.
The role of human psychology in price variations also plays a significant factor. Large amounts of
volatility often indicate the presence of strong emotional factors playing into the price. Fear can
cause excessive drops in price and greed can create bubbles. In recent years the rise of algorithmic
and high-frequency program trading has seen the adoption of momentum, ultra-short term moving
average and other similar strategies which are based on technical as opposed to fundamental or
theoretical concepts of market behaviour. For instance, according to a study published by the
European Central Bank,[8] high frequency trading has a substantial correlation with news
announcements and other relevant public information that are able to create wide price movements
(e.g., interest rates decisions, trade of balances etc.)

The scale of changes in price over some unit of time is called the volatility. It was discovered by
Benoit Mandelbrot that changes in prices do not follow a normal distribution, but are rather modeled
better by Lévy stable distributions. The scale of change, or volatility, depends on the length of the
time unit to a power a bit more than 1/2. Large changes up or down are more likely than what one
would calculate using a normal distribution with an estimated standard deviation.
Financial market slang

Poison pill, when a company issues more shares to prevent being bought out by another
company, thereby increasing the number of outstanding shares to be bought by the hostile
company making the bid to establish majority.

Bips, meaning "bps" or basis points. A basis point is a financial unit of measurement used to
describe the magnitude of percent change in a variable. One basis point is the equivalent of one
hundredth of a percent. For example, if a stock price were to rise 100bit/s, it means it would
increase 1%.

Quant, a quantitative analyst with advanced training in mathematics and statistical methods.

Rocket scientist, a financial consultant at the zenith of mathematical and computer programming
skill. They are able to invent derivatives of high complexity and construct sophisticated pricing
models. They generally handle the most advanced computing techniques adopted by the financial
markets since the early 1980s. Typically, they are physicists and engineers by training.

IPO, stands for initial public offering, which is the process a new private company goes through to
"go public" or become a publicly traded company on some index.

White Knight, a friendly party in a takeover bid. Used to describe a party that buys the shares of
one organization to help prevent against a hostile takeover of that organization by another party.

Round-tripping

Smurfing, a deliberate structuring of payments or transactions to conceal it from regulators or

other parties, a type of money laundering that is often illegal.

Bid–ask spread, the difference between the highest bid and the lowest offer.

Pip, smallest price move that a given exchange rate makes based on market convention.[9]

Pegging, when a country wants to obtain price stability, it can use pegging to fix their exchange
rate relative to another currency.[10]

Bearish, this phrase is used to refer to the fact that the market has a downward trend.

Bullish, this term is used to refer to the fact that the market has an upward trend.

Functions of financial markets

Intermediary functions: The intermediary functions of financial markets include the following:
 Transfer of resources: Financial markets facilitate the transfer of real economic resources
from lenders to ultimate borrowers.

Enhancing income: Financial markets allow lenders to earn interest or dividend on their
surplus invisible funds, thus contributing to the enhancement of the individual and the
national income.

Productive usage: Financial markets allow for the productive use of the funds borrowed. The
enhancing the income and the gross national production.

Capital formation: Financial markets provide a channel through which new savings flow to
aid capital formation of a country.

Price determination: Financial markets allow for the determination of price of the traded
financial assets through the interaction of buyers and sellers. They provide a sign for the
allocation of funds in the economy based on the demand and to the supply through the
mechanism called price discovery process.

Sale mechanism: Financial markets provide a mechanism for selling of a financial asset by
an investor so as to offer the benefit of marketability and liquidity of such assets.

Information: The activities of the participants in the financial market result in the generation
and the consequent dissemination of information to the various segments of the market. So
as to reduce the cost of transaction of financial assets.

Financial Functions
Providing the borrower with funds so as to enable them to carry out their investment plans.

Providing the lenders with earning assets so as to enable them to earn wealth by deploying
the assets in production debentures.

Providing liquidity in the market so as to facilitate trading of funds.

Providing liquidity to commercial bank

Facilitating credit creation

Promoting savings

Promoting investment

Facilitating balanced economic growth

Improving trading floors

Components of financial market

Based on market levels

Primary market: A primary market is a market for new issues or new financial claims. Therefore, it
is also called new issue market. The primary market deals with those securities which are issued
to the public for the first time.

Secondary market: A market for secondary sale of securities. In other words, securities which
have already passed through the new issue market are traded in this market. Generally, such
securities are quoted in the stock exchange and it provides a continuous and regular market for
buying and selling of securities.

Simply put, primary market is the market where the newly started company issued shares to the
public for the first time through IPO (initial public offering). Secondary market is the market where
the second hand securities are sold (security Commodity Markets).

Based on security types

Money market: Money market is a market for dealing with the financial assets and securities
which have a maturity period of up to one year. In other words, it is a market for purely short-term
funds.

Capital market: A capital market is a market for financial assets that have a long or indefinite
maturity. Generally, it deals with long-term securities that have a maturity period of above one
year. The capital market may be further divided into (a) industrial securities market (b) Govt.
securities market and (c) long-term loans market.
Equity markets: A market where ownership of securities are issued and subscribed is known
as equity market. An example of a secondary equity market for shares is the New York
(NYSE) stock exchange.

Debt market: The market where funds are borrowed and lent is known as debt market.
Arrangements are made in such a way that the borrowers agree to pay the lender the original
amount of the loan plus some specified amount of interest.

Derivative markets: A market where financial instruments are derived and traded based on an
underlying asset such as commodities or stocks.

Financial service market: A market that comprises participants such as commercial banks that
provide various financial services like ATM. Credit cards. Credit rating, stock broking etc. is known
 as financial service market. Individuals and firms use financial services markets, to purchase
services that enhance the workings of debt and equity markets.

Depository markets: A depository market consists of depository institutions (such as banks) that
accept deposits from individuals and firms and uses these funds to participate in the debt market,
by giving loans or purchasing other debt instruments such as treasury bills.

Non-depository market: Non-depository market carry out various functions in financial markets
ranging from financial intermediary to selling, insurance etc. The various constituencies in non-
depositary markets are mutual funds, insurance companies, pension funds, brokerage firms etc.

Relation between Bonds and Commodity Prices: With the increase in commodity prices, the cost
of goods for companies increases. This increase in commodity prices level causes a rise in
inflation.

Relation between Commodities and Equities: Due to the production cost remaining same, and
revenues rising (due to high commodity prices), the operating profit (revenue minus cost)
increases, which in turn drives up equity prices.

See also

Asset allocation

Diversification (finance)

Common ordinary equity

Cooperative banking

Financial economics § Financial markets

Financial risk management

Finance capitalism

Financial instrument

Financial market efficiency

Financial market theory of development

Financial services

Investment theory

Market liquidity

Market design
 Market profile

Mathematical finance

Quantitative behavioral finance

Stock investor

Stock market crash

Stock market bubble

Standard deviation

Risk management

Sources

This article incorporates text from a free content work. Licensed under CC BY 4.0. Text taken from
The State of Food Security and Nutrition in the World 2024​(https://openknowledge.fao.org/handle/2
0.500.14283/cd1254en) , FAO, IFAD, UNICEF, WFP and WHO, FAO.

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External links

Financial Markets with Yale Professor Robert Shiller (http://oyc.yale.edu/economics/financial-mar

kets/) (Archived (https://web.archive.org/web/20101103201130/http://oyc.yale.edu/economic
s/financial-markets/) 2010-11-03 at the Wayback Machine)