What Are Financial Markets

What Are Financial Markets and Instruments

Financial markets have existed for centuries, but their definitions and functions changed over time. Today, financial markets allow everyone to trade a variety of assets. They are a vital component of a functioning capitalist economy. Businesses and investors meet at a financial market to raise funds, make money, trade, and set prices. In the primary market, securities are created, like in the case of an IPO. Then, in the secondary market, they are sold, such as various stocks. First, we will look at a financial market’s functions. Then, we will discover the ones present around us.

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First, let’s define a financial market. Financial markets are a regulated place for business to be conducted for everyone.

They facilitate various transactions for different types of securities. Transparency of information is essential to give everyone the same opportunity to succeed.

Below are four important functions for a flawless financial market.

1. Savings Are More Productive

Keeping our money in a regular savings account often yields less than a 1% yearly return.

With at least 2% inflation, money left in a savings account loses value over time.

Savings invested in a financial market can often produce much better results.

2. Efficient Pricing of Securities

With the information at our disposal, we can efficiently determine the price of a security. This isn’t only about price and demand. We aren’t just trading apples and oranges. Pricing security is much more complex and depends on several factors. 

3. Liquidity and Transaction Costs

Buyers and sellers can instantly convert their money into a security and vice versa. 

First, the cost to obtain the information regarding securities is either free or comes at a small cost. Next, buying and selling securities is also cheap. This allows almost everybody to take advantage of the system and make money.

What Are the Types of Financial Markets?

In this section, we will look at various forms of financial markets. It isn’t only about stocks. There is a multitude of other securities available. Brokers will facilitate trades between parties. We will also find out where to purchase them.

2. Stock Market

Stocks are the most common and well-known securities available. In the US, the major stock exchanges are the NYSE and NASDAQ. Trillions of dollars switch hands daily. There are different regulations and fees for every exchange. Companies need to meet certain requirements to list their stocks on each exchange. Stocks are highly scrutinized to prevent any harm to shareholders. Many foreign companies also choose to list their stocks. This allows them to have access to more liquidity and reach more investors. 

The NYSE and NASDAQ are the biggest exchanges in the world. Buying stocks, mutual funds, ETFs, and options is possible. We offer various trading courses on our platform; check them out here. Unlike the stocks in the next section, major multinational companies are listed there.

2. Over-the-Counter Markets (OTC)

OTC is the home for pink sheets and much more volatile and riskier securities. It is much less regulated, and the requirements to list there are looser. Companies that do not wish to disclose their financial and internal information choose to list there. There are three tiers of OTC markets.

The OTCQX requires a qualitative annual review to remain listed.

The OTCQB is priced at a minimum of 1 percent per stock. They also do an annual certification that their information is up-to-date.

Pink Sheets are lawless. 

The OTC market is very volatile and often illiquid, and the information may not always be up-to-date. Investors have to be very careful here. Beginners aren’t recommended here. Specialized brokers are often required to trade here. 

3. Bond Market

What are financial markets? Next, bonds are loan-type securities. Investors loan money to public companies, municipalities, states, countries, etc., for a specific time and a defined interest rate. The funds may be used to finance projects, pay a debt, or for any other reason. 

What are the different types of bonds? Below are three popular ones.

US Treasury bills, notes, and bonds: Safest government bonds that dictate long-term fixed rates bonds. 

Municipal bonds: Issued by cities with lower interest rates are tax-free and riskier than treasury bonds.

Corporate bonds: Company-issued, riskier than government-backed bonds, higher returns

  1. Junk bonds: High-yield, high chance of default bonds
  2. Preferred stocks: Pays dividends, safer in case of bankruptcy
  3. Certificates of Deposit: For banks

Bonds are very liquid and are a good measure of the state of the economy. They determine the interest rates and the ease of borrowing, among other things. Sometimes, governments will purchase bonds to inject money into the economy. Remember quantitative easing?

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How to Buy Bonds

The easiest way is via an ETFVanguard and iShares offer a wide range of funds that follow different categories of bonds. They also offer dividends, but their performance is nowhere near the S&P or similar indices. For those who want to buy individual bonds, finding a broker with that feature becomes necessary. It can be not easy unless you’re an accredited investor. It is better to buy them on the primary market. On the secondary market, pricing information and other bond features are less transparent. Stick with ETFs unless you’re experienced.

4. Money Market

The money market is comprised of highly liquid, safe short-term securities. They offer a higher return than a savings account but well below long-term investments. The easiest way to purchase them is with an ETF. I don’t recommend looking into these unless you’re looking for extra diversification. Short-term bonds are part of the money market.

What Are Commodity Financial Markets?

5. Commodities Market

This market includes all the natural resources imaginable. Commodities include metals, gold, oil, cotton, coffee, sugar, livestock, carbon credits, and many more.

Investors trade futures contracts. They try to bet on the future value of the underlying asset.

Very few people want to purchase actual cows. The commodities market is for more experienced investors seeking to add extra risk and diversification to their portfolios.

How to Trade Commodities

Once again, the easiest way is with ETFs. Many track either one single or groups of commodities. They trade on the Chicago Mercantile Exchange, the Chicago Board of Trade, and the New York Mercantile Exchange. All are owned by the CME Group.

Certain brokers will allow investors to trade commodities on their platform. However, it is recommended to become an accredited investor. For everyday investors, it is possible to buy commodity stocks. Many natural resources, oil, and metal companies partake in a mix of different commodities.

Selling commodities contracts is a big part of the economy. It assures the seller that they can sell their products for a determined price and date.

Supply and demand affect the prices as well as the state of the economy. Investors invest in gold when the economy is performing poorly. There exist many ways to hedge current investments with commodities. 

6. Forex Market

This is the most liquid market in the world as it deals exclusively with pairs of currencies.

One currency is always exchanged for another. More than 5 trillion dollars exchange hands daily. The most liquid pairs are EUR/USD, USD/JPY, and GBP/USD.

The forex market is open 24 hours daily and has few rules and fees. A Forex account is necessary. TD Ameritrade FX, IG, Interactive Brokers, and FOREX.com offer this option. 

Bitcoin Financial Markets

7. Other Markets

Finally, other financial markets include derivatives, which hedge funds mainly use. Derivatives are contracts between two parties based on an underlying financial asset. They are much more advanced investments.

In the last years, new markets have received a lot of attention. They are based on blockchain technology and include crypto and NFTs.

They aren’t regulated and are very hard to control. Some platforms are attempting to limit anyone from creating their digital nonsense. However, many new investors are oblivious to scams. Investors can make a fortune and lose it within a night. 

Final Thoughts: What Are Financial Markets?

There you have it: new information on new ways to invest your money. Many of the mentioned can be reached with your average broker. However, for others, special accounts must be open. Lastly, accredited investors can reach these new markets with much more ease. The majority of investors solely trade in the stock market. I can’t blame them. It can be a headache to contact your broker, open a new account, learn how to use it, and figure out how everything is taxed. The door is always open, but trade carefully and gather tons of experience.

If you want to learn more about how to profit from the stock market, head over to our free library of educational courses. We have something for everyone, including trading options for those with small accounts.

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