What is the Financial Market?
Financial Market refers to the marketplace where the activities related to the creation and trading of the different financial assets such as bonds, shares, commodities, currencies, derivatives etc takes place and it provides the platform to sellers and buyers of the financial assets to meet and trade with each other at a price as determined by market forces.
It’s a broad term and includes various types of markets where money can be borrowed at a low cost by companies requiring investment. Investors often trade in securities to earn profit be it in the long term or short term. Depending upon the economy, millions of dollars of money are traded daily in the financial market. For example, the New York Stock Exchange (NYSE), National Stock Exchange (NSE), etc.
These financial markets are regulated by independent regulatory bodies with strict rules and regulations. They have stringent and mandatory reporting and compliance standards. Any violation by companies, investors, brokers, banks, financial institutions or any other authorized bodies, can lead to heavy penalties and in extreme cases cancellation of license.
Types of Financial Markets
Below is the list of 6 types of Financial markets.
#1 – Money Market
Money Market is a type of financial market for lending or borrowing short term loans with a maturity of less than 1 year. The players are usually corporates, banks and financial institutions as a huge amount of money is involved. The instruments dealt in the money market are Treasury Bills, Commercial Papers, Certificate of Deposit, Bills of exchange, etc.
#2 – Capital Market
Capital Market is a type of financial market for the trading of stocks (shares) and bonds. This market is used for lending or borrowing money for the long term. Capital markets are further split into the primary and secondary markets. The companies issue shares in the form of equity or preference shares or fixed interest-bearing bonds in the primary market. Once the shares are issued, the investors subscribe to them at a lower price and later sell them to another investor at a higher price to earn profit in the secondary market.
#3 – Derivatives Market
Derivatives Market is a type of financial market which deals with trading of Futures, Options, Forward contracts and swaps. They can be dealt with either over the counter or in exchange-traded derivatives. Derivatives derive their value from the underlying asset and are used to manage financial risk due to a change in price.
#4 – Commodity Market
Commodity Market facilitates the trading of commodities like gold, oil, wheat, rice, etc. There are around 50 major commodity markets all over the world.
#5 – Foreign Exchange Market
Foreign Exchange Market facilitates the trading of currencies. These markets are operated through financial institutions and determine foreign exchange prices for every currency.
#6 – Spot Market
Spot Market is a market where transactions are done on spot and in cash only.
The following are the advantages of the financial market.
- It provides a platform for companies to raise money for the long term and short term both.
- Companies can raise capital at a lower cost as compared to taking a loan from commercial banks at a higher interest rate. Also, commercial banks don’t lend a huge amount of loans.
- Companies have the flexibility to raise capital from the market as required from time to time until it exhausts its authorized share capital.
- The intermediaries in financial markets like banks, financial institutions provide financial and strategic consultancy to companies and investors both. They provide information, guidance and expert services that may not be available otherwise.
- It provides a platform to trade and deal with multiple shares, securities, bonds, derivatives, etc. all the one time.
- Stringent rules and regulations in the financial market gain confidence of both investors and companies and help boost the economy.
- Provide a platform for international, inter-currency money lending and borrowing.
We can see here some disadvantages of the financial market.
- Too many formalities by regulatory bodies can make the whole process time-consuming.
- Sometimes, companies cannot afford to enter the financial market due to stringent rules and regulations. They are unable to set-up resources that need continuous monitoring and compliance check procedure.
- The investors can lose their money due to the non-availability of information or due to unawareness.
- The companies can become more profit-driven rather than investor driven company. It’s very important that the Board of Directors take decisions taking into consideration all its stakeholders and avoid exploiting the use of investors’ money for their own profit.
Even after independent regulatory bodies and various banks and financial institutions regulating the financial market, there is instability in terms of price and rate fluctuations and certain cases of fraud have come up which calls for more speculation and strong policies by these bodies.
The transparency provided by financial markets helps us decide how and where to invest our money. It can accommodate the risk and investment for small or big investors, long term or short term investors, big companies or small companies. A strong market boosts the economy by helping the government circulate money in the country as and when required and also opens up opportunities for various sectors to grow.
This has been a guide to what is the financial market. Here we discuss types of the financial market which include the money market, capital market, spot market, etc along with its advantages and disadvantages. You can learn more about financing from the following articles –