Financial markets refer broadly to any marketplace where securities trading occurs
through which funds flow, including the stock market, bond market, forex market, and
derivatives market. Financial markets are vital to the smooth operation of capitalist
economies.
In financial markets, commodities here are usually stocks, treasury bills, bonds, etc.
This type of commodity are with monetary value that can be traded in the financial
market.
These markets may include assets or securities that are either listed on regulated
exchanges or trade over-the-counter (OTC).
Over-the-counter (OTC) is the trading of securities between two counterparties
executed outside of formal exchanges and without the supervision of an exchange
regulator. OTC trading is done in over-the-counter markets (a decentralized place with
no physical location), through dealer networks.
When financial markets fail, economic disruption, including recession and rising
unemployment, can result
Financial markets can be distinguished alongtwo major dimensions: (1) primary versus
secondary markets and (2) money versus capital markets.
Financial markets can be distinguished as to how securities are traded – direct or
indirect, and as to how long is the maturity of a security is. The former will be can be
primary market or secondary market, and the latter can be money market or capital
market.
Primary Market - New issues of securities from companies, usually corporations, are
traded in this market with the help of financial intermediaries
-New issues of financial instruments are sold to the initial suppliers of funds
(e.g., households) in exchange for funds (money) that the issuer or user of
funds needs.
By issuing primary market securities with the help of an investment bank, the funds user
saves the risk and cost of creating a market for its securities on its own
Secondary Market - Securities that were once sold are reissued or resold are sold in
this type of market.
- Secondary markets provide a centraliized marketplace where economic
agents know they can transact quickly and efficiently.
- These markets therefore save economic agents the search and other
costs of seeking buyers or sellers on their own.
- In addition to stocks and bonds, secondary markets also exist for financial
instruments backed by mortgages and other assets (see Chapter 7 ),
foreign exchange (see Chapter 9 ), and futures and options
- Secondary markets offer buyers and sellers liquidity—the ability to turn an
asset into cash quickly
-
For investors, secondary markets provide the opportunity to trade securities at their
market values quickly as well as to purchase securities with varying risk-return
characteristics (see Chapter 2 ). Corporate security issuers are not directly involved in
the transfer of funds or instruments in the secondary market.
Money Markets
Typically, the money markets trade in products with highly liquid short-term maturities
(less than one year) and are characterized by a high degree of safety and a relatively
lower interest return than other markets.
In the money markets, economic agents with short-term excess supplies of funds can
lend funds (i.e., buy money market instruments) to economic agents who have short-
term needs or shortages of funds
The short-term nature of these instruments means that fluctuations in their prices in the
secondary markets in which they trade are usually quite small.
Thus, most U.S. money markets are said to be over-the- counter (OTC) markets.
Capital Markets. Capital markets are markets that trade equity (stocks) and debt
(bonds) instruments with maturities of more than one year (see Figure 1–2 ). The major
suppliers of capital market securities (or users of funds) are corporations and
governments.
these instruments experience wider price fluctuations in the secondary markets in which
they trade than do money market instruments.
Other Types of Financial Markets
There are several different types of markets. Each one focuses on the types and
classes of instruments available on it.
1. Stock Markets
These are venues where companies list their shares, which are bought and sold by
traders and investors. Stock markets, or equities markets, are used by companies to
raise capital and by investors to search for returns.
Stocks may be traded on listed exchanges, such as the New York Stock Exchange
(NYSE), Nasdaq, or the over-the-counter (OTC) market. Most stock trading is done via
regulated exchanges, which plays an important economic role because it is another way
for money to flow through the economy.
Typical participants in a stock market include (both retail and institutional) investors,
traders, market makers (MMs), and specialists who maintain liquidity and provide two-
sided markets. Brokers are third parties that facilitate trades between buyers and sellers
but who do not take an actual position in a stock. They executing buy and sell orders
for securities that are submitted by an investor.
2. Bond Markets
A bond is a security in which an investor loans money for a defined period at a pre-
established interest rate. You may think of a bond as an agreement between
the lender and borrower containing the loan's details and its payments.
Bonds are issued by corporations as well as by municipalities, states, and sovereign
governments to finance projects and operations.
For example, the bond market sells securities such as notes and bills issued by the
United States Treasury. The bond market is also called the debt, credit, or fixed-income
market.
3. Foreign Exchange Markets —markets in which cash flows from the sale of products
or assets denominated in a foreign currency are transacted.
4. Derivative Markets —markets in which derivative securities trade. Derivative
securities, however, are also potentially the riskiest of the financial securities. A financial
security whose payoffs are linked to other, previously issued securities.
Financial institutions (e.g., commercial and savings banks, credit unions,
insurance companies, mutual funds) perform the essential function of channeling
funds from those with surplus funds (suppliers of funds) to those with shortages of
funds (users of funds).
