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 marketsTypes Of Financial MarketsThe financial market is a marketplace where trading financial assets like shares, bonds, debentures, and commodities are traded. .
#1 – Money Market
Money MarketMoney MarketThe money market is a market where institutions and traders trade short-term and open-ended funds. It enables borrowers to readily meet finance requirements through any financial asset that can be readily converted into money, providing an organization with a high level of liquidity and transferability. 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 DepositCertificate Of DepositCertificate of deposit (CD) is a money market instrument issued by a bank to raise funds from the secondary money market. It is issued for a specific period for a fixed amount of money with a fixed rate of interest. It is an arrangement between the depositor of money and the bank., Bills of exchange, etc.
#2 – Capital Market
Capital MarketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets. 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 marketThe Companies Issue Shares In The Form Of Equity Or Preference Shares Or Fixed Interest-bearing Bonds In The Primary MarketThe primary market is where debt-based, equity-based or any other asset-based securities are created, underwritten and sold off to investors. It is a part of the capital market where new securities are created and directly purchased by the issuer.. 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 MarketDerivatives MarketThe derivatives market is that financial market which facilitates hedgers, margin traders, arbitrageurs and speculators in trading the futures and options that track the performance of their underlying assets. 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 counterCounterOver the counter (OTC) is the process of stock trading for the companies that don't hold a place on formal exchange listings. The broker-dealer network facilitates such decentralized trading of derivatives, equity and debt instruments. or in exchange-traded derivatives. Derivatives derive their value from the underlying asset and are used to manage financial riskFinancial RiskFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy. due to a change in price.
#4 – Commodity Market
Commodity MarketCommodity MarketThe commodity market is a place where people buy and sell positions in commodities such as oil, gold, copper, silver, barley, wheat, and so on. Started with agricultural commodities, there are now fifty main commodity markets throughout the world, dealing with over a hundred commodities. 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 banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits. 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 capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side..
- The intermediaries in financial markets like banks, financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. 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 –