Financial markets have been around for centuries, but their definition 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 take a look at the functions of a financial market. Then, we will discover the ones present around us.
Table of Contents
- Functions of a Financial Market
- Types of Financial Markets
Functions of a Financial Market
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 4 important functions for a flawless financial market.
Savings Are More Productive
Keeping our money in a regular savings account will often yield less than a 1% return per year.
With inflation being at least 2%, money left in a savings account loses value over time.
Savings invested in a financial market can often produce much better results.
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 a security is much more complex and depends on a handful of factors.
Liquidity and Transaction Costs
Buyers and sellers can convert their money into a security and vice-versa almost instantaneously.
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 some money.
Types of Financial Markets
In this section, we will take a 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.
What Are Financial Markets: Stock Market
Stocks are the most common and well-known securities available. In the US, major stock exchanges are the NYSE and NASDAQ. Trillions of dollars switch hands daily. There is 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 they can reach more investors.
The NYSE and NASDAQ are the biggest exchanges in the world. It is possible to buy stocks, mutual funds, ETFs and options. We offer various trading courses on our platform, check them out here. Major multinational companies are listed there, unlike the stocks in the next section.
What Are Financial Markets: 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 3 tiers of OTC markets.
The OTCQX requires a qualitative annual review to remain listed.
The OTCQB is priced at a minimum of 1cent 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, 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.
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 to finance projects, pay a debt, or for any other reason.
What are the different types of bonds? Below are 3 popular ones.
US Treasury bills, notes, and bonds: Safest government bonds that dictate long-term fixed rates bonds.
Municipal bonds: Issued by cities, lower interest rate, tax-free, and riskier than treasury bonds.
Corporate bonds: Company issued, riskier than government-backed bonds, higher returns
- Junk bonds: High-yield high chance of default bonds
- Preferred stocks: Pays dividends, safer in case of bankruptcy
- 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?
How to Buy Bonds?
The easiest way is via an ETF. Vanguard 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, it becomes necessary to find a broker with that feature. It can be difficult 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.
The money market is comprised of highly liquid safe short-term securities. They offer a higher return than a savings account, but well below any 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 some extra diversification. Short-term bonds are part of the money 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.
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 24h and has very few rules and fees. A Forex is account is necessary. Brokers such as TD Ameritrade FX, IG, Interactive Brokers, and FOREX.com offer this option.
Finally, other financial markets include derivatives, which are mainly used by hedge funds. 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.
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 have the opportunity to 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 along the way.
If you want to learn more about how you can profit from the stock market, head on over to our free library of educational courses. We have something for everyone, including trading options for those with small accounts.