Financial markets, as the name suggests, is a broad term that refers to marketplaces where buyers and sellers engage in trading financial securities.
These securities could include stocks, derivatives, bonds, and other types of assets. The presence of a healthy financial market is almost imperative for the smooth operation of capitalist economies.
Financial markets also provide liquidity to the markets as it allows the investors to buy/sell securities at prices determined by the supply and demand of these financial instruments.
There are different types of financial markets that we’ll explore in this post.
Understanding Financial Markets
Financial markets are like virtual marketplaces where people trade assets like stocks. These entities represent your ownership in a company.
In the same way, there are bonds issued by governments or companies that you can also own a part of.
These assets combined have prices that fluctuate based on what people are willing to pay for them. The reason people participate in financial markets is to invest their savings and potentially make a profit over time. This is a great way of building your wealth.
In every financial market and instrument, there’s a certain risk associated with it – which makes financial markets subject to gains and losses too. Before you participate in any type of financial market, it’s important to assess your risk tolerance so as to prevent uncertainties with time.
Types of Financial Markets
Based on its nature, there are different types of financial markets that you can participate in. Here’s a list.
1. Stock Markets
Stock markets are the buzz in the world of investments.
The popularity of stock markets comes from the fact that they are open to everybody.
Stock markets are financial markets that allow individuals and businesses to come together to buy and sell shares of publicly traded companies. These markets allow companies to raise capital by issuing shares to the public.
These shares are bought by investors that participate in the potential growth and profitability of these companies.
- These participants include individual investors, companies and institutions, and traders that take part in these markets through exchanges or online trading platforms.
- Stocks and their prices are determined by the supply and demand.
- This supply and demand is influenced by factors like the performance of the company, market sentiment, and other economic indicators.
Stock markets have gained a lot of importance and popularity in India too because of availability and the ease to enter these markets with your investment.
2. Commodities Markets
The commodities markets are another kind of financial market where producers and consumers exchange different physical commodities. These may include tangible goods like oil, gold, or other forms of material.
- In such markets, the participants trade different contracts that will represent the future delivery of these physical goods.
- The contract includes the quantity and quality of the commodity.
- The contracts also include the agreed-upon price and the date of delivery.
The main purposes of commodities markets are:
Hedging – Involves using commodity contracts in order to manage price risk. For example, a farmer sells a futures contract to lock in a specific price for his crops.
Speculation – Speculation in the commodities market involves trading contracts with the aim to profit from price movements. The speculators analyze the supply and demand factors which helps them make informed trading decisions.
3. Bond Markets
Bonds are loans made by investors to governments or corporations. These bonds represent a promise between a borrower to repay the principal amount that’s borrowed with interest payments over a period of time.
The bond market includes an entity that wants to borrow money, which is why they issue bonds to investors. These bonds have features that include:
- The interest rate
- Maturity date
- And the repayment terms
The bond market firstly provides a means for governments and corporations to raise capital for different purposes that include financing infrastructure projects and expanding businesses.
The investors in return seek to earn income by lending their money and receiving periodic interest payments.
4. Over-the-counter markets
Over-the-counter (or OTC) markets are decentralized financial markets where there’s no involvement of a third party in a transaction. The trading happens without the involvement of a centralized exchange.
OTC markets allow participants to trade financial products such as stocks, commodities, bonds, and derivatives.
OTC markets are different from traditional markets – because, unlike traditional exchanges, OTC markets operate through a network of dealers or market makers who facilitate transactions by matching buyers and sellers. These types of transactions are typically conducted via phone, email, or online trading platforms.
Some of the major advantages of OTC markets include:
- Increased flexibility
- Customization of contracts
- Lower transaction costs
OTC markets and the transactions that happen in them are usually far less regulated and less liquid too.
5. Derivatives Markets
Derivates markets are another important type of financial market where participants involve in trading financial instruments derived from underlying assets.
These instruments (or derivatives) get their value from the performance of stocks, bonds, or commodities.
Derivatives act as contracts between two or more parties – where the value of the contract depends on the price movement or other factors of the underlying asset.
Most times, the purpose of these contracts is:
- Hedging against risks
- Speculating on price movements
- Managing investment portfolios
The different types of derivatives include:
- Futures contracts – Agreements to buy/sell an asset at a specific date and price in the future. These types of contracts allow investors to hedge against price fluctuations or even speculate on future price movements.
- Options contracts – These types of contracts give the right (and not an obligation) to buy or sell an asset at a particular price within a specific time period. These types of contracts are usually used for hedging or speculative trading strategies.
- Forward contracts – These are agreements between two parties to buy/sell an asset at a predetermined price and future data. The difference between forward contracts and futures contracts is that forward contracts are usually customized and traded over the counter. This means that they allow both parties to lock in the prices for future transactions and reduce uncertainty.
Financial markets make all sorts of transactions and asset transfers possible.
Most importantly, these markets provide a place for investors and debtors to equally participate in trading assets and building their wealth.
Having a great knowledge of financial markets will help you understand how most transactions work and how you can start using them to your advantage.
In fact, a better understanding of financial markets will also introduce you to new career opportunities that can set you up for life. Visit our blog page to learn more about finance and the fields associated with it.