Financial Market

Updated July 13, 2023

What is Financial Market?

A financial market refers to a platform where people and entities can trade (i.e., buy or sell) securities, commodities, or other goods, reflecting the demand and supply of financial assets.

The financial market is an intermediary which helps facilitate the exchange of funds and securities, thereby mobilizing the capital between the entities. It connects the person with excess money or free funds (i.e., investor) and the entities who need money for the business (i.e., investee).

Characteristics of Financial Market

• The essential function of a financial market is to connect investors and borrowers. Thus, it links the two, and the market earns some commission for providing the bridge. They ensure transactions are smooth.
• The trust of the investors drives the financial markets. Hence, the regulation of financial markets ensures that the investors are always protected. The financial markets are governed by rules & regulations that differ for each market.
• The financial intermediaries are banks, NBFCs, stock exchanges, mutual funds, insurance companies, brokers to these companies, etc. These facilitate the trade between the parties.
• The financial markets are readily available for both parties. However, the timing of each financial market differs as per the type of market.
• The financial market includes securities that are marketable as well as which are non-marketable. Investors trade non-marketable securities, such as fixed deposits in banks, post office investments, or private loans, over the counter (OTC) rather than on an exchange. On the other hand, marketable securities such as stocks and bonds are traded over an exchange.
• Investors may have short-term, medium-term, or long-term perceptions. Therefore, if a financial market can meet the needs of every type of investor, it is considered effective.
• Also, the financial market should be effective enough to reward the investor based on the risk the investor assumes.

Example of Financial Market

Financial markets are widespread in everything where money & securities are involved. The financial market can be best explained through the stock market:

• The primary and secondary markets divide corporate entities’ stock markets. Whenever a new company lists its securities for the first time, it does so through the primary markets, also known as Initial Public Offers (IPOs). The company decides the IPO price based on various parameters such as demand for its product, history of promoters, company prospects, and investor expectation of returns. This releases the capital from investors to the company.
• Once listed, the company’s stocks become available for trading in the secondary market. Thus, the secondary market gives liquidity and value to the company’s shares.
• The rising stock price of the company’s shares reflects the increased value as the company demonstrates consistent yearly improvement. The demand and supply forces decide the price of the shares.

Types of Financial Market

Below are the types of Financial Market

Types	Explanation
Bond Market	Companies primarily use the bond market to fund projects or new ventures. Therefore, the rating agencies rate the bonds per the company’s nature and other risks associated with the issuer & the issue. The investments here are generally of long-term nature. Therefore, the issuer must serve the coupon amount as per due dates and honor the principal repayment on the maturity date. A lower bond rating implies a higher risk. Higher risk implies higher expectations of the investors, and thus coupon rate is higher. Conversely, when a bond rating is higher, it implies lower risk, and as a result, lower coupons are offered.
Stock market	The primary stock market is where a stock is listed for the first time at a predetermined price. After that, the interest investors invest as per their risk appetite. Therefore, the stock price will not change until it is listed. The stock market only trades the shares of publicly listed companies. The market where the stocks are available for trading is called a secondary market for the stocks. The basic rule of earning profits is to buy at a lower price and sell at a higher price. However, it is easier said than done. It requires business and economic understanding to evaluate whether any stock is undervalued or overvalued. Moreover, this requires knowledge about the market and experience.
Commodities Market	Natural resources & commodities such as oil, gold, coffee, and agricultural goods are included in the commodities market. The demand and supply forces decide the price of commodities. The commodities futures market helps trade for the commodities later on at the current prices. It increases the volatility in the market. ICE Futures, US, and CME group are the major US commodity exchanges in the US.
Derivatives Market	Derivative means a financial contract whose value is determined by the underlying assets. Futures, options, and swaps are examples of the derivatives market. Derivatives help to allow investor exposure at lower investment levels as well. For example, if a company’s stock price is $ 450, but a derivative is available at $ 25, it would help investors trade in the derivatives market. However, derivatives are highly volatile and carry many risks. Thus, investors with a higher risk appetite can trade in such a market.
Forex Market	This market helps in the exchange of foreign currencies. It allows banking institutions, individuals, and authorized entities to buy, sell or exchange in foreign currencies. Due to high volatility and liquidity, trillions of dollars exchange hands daily. The market can be categorized into two main types: interbank and over-the-counter (OTC). The Interbank market is available only for currency exchange amongst banks, while the OTC market is available for businesses, individuals, and corporates.

Functions of Financial Market

• It functions as an intermediary between the investor and the borrower. It ensures that trades occur smoothly.
• It mobilizes the personal savings of individuals into the productive means of the financial market. For example, an individual may earn 2% to 3% in a bank account. The individual may earn a rise in share price if they invest the funds in the financial market in the right stock.
• It aids in providing liquidity to stocks & other financial assets.
• Due to availability during non-business hours, the trades can be made anytime.
• Since the financial market links both parties to the contract, it saves them time and costs.
• The index for each financial market becomes a benchmark for the growth of the sectors in the economy.
• It allows the demand and supply forces to decide the price of financial securities.

Analysis of the Financial Market

• The primary job of financial markets is to ensure the smooth flow of funds between various hands. An investor should quickly get the borrower and vice-versa. It increases the transparency of the information and forms a basis for efficient market prices.
• The investments from corporates and savings from households flow in a stream to help the economy to rise. This helps increase the production of goods & supply of services.
• Finance is the basis of an efficient economy. A financial market is the backbone of a country’s GDP increase.
• An increase in the financial market size implies an increase in the potential of corporates and households. Consequently, the country’s future economic expansion is reflected in its GDP, demonstrating growth.

Benefits of Financial Market

• It acts as an intermediary between the interested parties.
• The parties can exchange the funds, securities & commodities smoothly.
• It increases the employment rate of the country.
• It becomes a benchmark for economic growth.
• It increases access to capital.

Key Takeaways

• The financial market refers to a platform where entities can trade financial securities.
• The various types of financial markets include money, derivatives, stock, bond, and forex.
• The primary job of financial markets is to ensure the smooth flow of funds between various hands.
• An increase in the financial market size implies an increase in the potential of corporates and households.
• It becomes a benchmark for economic growth. Thus, if the financial market fails, the economy collapses, and the impact can be seen through an increase in the unemployment rate and recession.

Conclusion

Financial markets form the basis of increased growth, investment, commerce, trade, and opportunities. It helps allocate the capital resources efficiently and effectively. It spreads the capital in appropriate streams, preventing the blockage of all money in one sector or industry.

Recommended Articles

This is a guide to Financial Market. Here we discuss the definition, example, types, functions, and analysis of the financial market along with benefits. You may also have a look at the following articles to learn more –

1. Functions of Financial Market
2. Stock Market
3. Financial Assets
4. Financial Markets