Put simply, financial markets are places where you can buy and sell financial instruments. These instruments include stocks, bonds, fiat currencies, derivatives, cryptocurrencies, etc. Each of these assets has its own market where it’s traded, and in this blog, we will learn about all the different types of financial markets.
What Are the Different Types of Financial Markets?
There are seven types of financial markets.
1. Capital markets
The capital market is a financial market where you can buy and sell debt and equity securities. Investors can buy bonds, which are essentially loans that are issued by governments, corporations, and other organizations, or stocks, which represent ownership in a company. The capital market plays a crucial role in the economy by providing companies and governments with a source of long-term financing and by allowing investors to diversify their portfolios and earn a return on their investments. The capital market includes both primary markets, where new securities are issued and sold to investors, and secondary markets, where existing securities are bought and sold among investors.
An example of a primary market transaction could be when a company sells new shares of stock in an Initial Public Offering (IPO). A secondary market transaction would be when an investor buys shares of stock from another investor on a stock exchange, such as the New York Stock Exchange (NYSE) or the NASDAQ.
2. Bond market
Governments and companies use the bond market to raise money to fund their projects or investments. Investors in a bond market buy bonds from a company with an agreement that the company will buy back these bonds within a predefined period of time for the amount paid by the investor, plus interest. Investors also know the bond market by other names– credit, debt, or fixed-income market.
3. Derivatives market
Derivatives are products whose value is tied to an underlying asset (stocks, crypto, etc) or group of assets (index). They are like bets on the future price of something, such as a stock, bond, currency, commodity, or real estate.
There are different types of derivatives. One type is a “future.” A future is a contract that says someone will buy or sell something at a certain price on a certain date in the future. Another type of derivative is an “option.” An option gives someone the right, but not the obligation, to buy or sell something at a certain price on or before a certain date.
People use these contracts to protect themselves against the risk of prices going up or down or to try to make money by betting on which way prices will go. Big investors and professional traders are the ones who usually use derivatives, but they are also available to small investors through brokers and online trading platforms.
4. Money market
Money markets are where you can trade assets like treasury bills, foreign exchange, commercial papers, etc. These instruments are typically short-term, highly liquid, and low-risk. Governments, financial institutions, and businesses use them to raise short-term capital.
Broadly, money markets are of three types –
- The wholesale market: High-volume trades between banks and other financial institutions takes place where they lend and borrow money from each other.
- The retail market: It is for individuals and small businesses to invest in assets like certificates of deposit and money market mutual funds.
- Foreign exchange market: Different currencies are bought and sold in this market. We will talk about foreign exchange markets in detail further in the blog.
5. Commodities market
Commodities markets deal in physical commodities. These may include agricultural products (like corn, rice, and livestock), precious metals (like gold and silver), energy products (like oil and fossil fuels), and soft commodities (like coffee, sugar, and cotton).
These commodities have their own market because their prices can be unpredictable because of supply and demand forces. While this market deals in physical commodities where you can buy and sell actual physical products, there also exists a financial commodities market. It is where you trade contracts for the future delivery of a commodity at a predefined price.
These markets are an important source of revenue for countries that are rich in natural resources. For e.g. the export of oil and other natural resources can contribute significantly to the economies of countries like Saudi Arabia, Russia, and Venezuela.
6. Forex market
The forex or foreign exchange market is a global market where the world’s currencies ($, €, ¥, etc) are traded. Different currencies are traded in pairs, with one currency being bought for another. Forex traders buy and sell currencies to profit from the change in the value of one currency against another. The forex market comprises banks, companies, hedge funds, retail forex investors and brokers, etc.
Forex trades are conducted over the counter (OTC). It means that instead of using a central exchange like the stock market, forex traders use a global network of brokers/dealers to execute their trades.
The forex market is open 24 hours a day, five days a week, and the most active trading times for it is usually when the financial markets in London and New York are open.
7. Cryptocurrency market
Compared to other financial markets, the cryptocurrency market is still relatively new, considering Bitcoin only came into existence in 2009. However, it is equally, if not more popular than other markets when it comes to investor activity.
Since its existence, various cryptocurrencies have made their way into the crypto market. Most of these cryptocurrencies are tied to an underlying protocol built on the blockchain and derive their value from the success/failure of those projects, along with demand and supply.
Crypto exchanges enable the trading of crypto assets. These could either be centralized or decentralized. A centralized exchange is like an intermediary between the buyer and the seller. For example, Binance. Decentralized exchanges enable direct trade between the buyer and the seller.
In a very short time frame, the crypto market has piqued the interest of both institutional and retail investors. This has led to the launch of more sophisticated offerings like crypto derivates, ETFs, etc.
Functions of the Financial Markets
Financial markets play a vital role in the functioning of the economy by providing a platform for the exchange of funds between investors and borrowers:
- They allow individuals/businesses to allocate capital where it is most needed and can be used efficiently. Investors can buy securities like stocks, bonds, and cryptos to fund businesses and projects.
- Financial markets make it possible for businesses to trade with each other and with consumers by providing a way to transfer funds.
- Such markets provide liquidity to investors by allowing them to easily buy and sell securities. It helps investors exit their investments if needed and ensures that the value of securities is closely tied to the underlying assets.
- By bringing together a large number of buyers and sellers, financial markets help to determine the fair market value of securities and other assets.
- Financial markets also greatly lower the barrier of entry for retail investors by reducing transaction costs.
The Significance of Financial Markets
Financial markets are responsible for making a lot of things possible.
- They make sure traders and investors are treated fairly, irrespective of the size of their pockets.
- They are gateways to acquiring capital for companies and governments.
- Growth in trade on financial markets obviously opens up new job opportunities, thus reducing unemployment and improving the overall economy.
Conclusion
Now that you know the different types of financial markets, you can explore them and the opportunities they provide. You can always invest in assets that you believe in and suit your risk appetite. If cryptocurrencies are an asset you are interested in and you’re looking for low-risk options, we’d suggest taking a look at Coin Sets. These are crypto baskets based on a variety of themes.
FAQs
1. Why do money markets exist?
Money markets are a place for investors to explore high-liquidity, short-term investment options. Governments, financial institutions, and corporations are the ones who typically use them to fulfill their short-term capital requirements. The instruments in these markets are very low-risk and give relatively low returns.
2. Who are the major financial market participants?
In a typical financial market, you have your big firms, speculators, hedgers, arbitrageurs, and of course, brokers.
The firms raise capital through stock and bond markets. The speculators are the ones who look to make money off betting on future prices. The hedgers use the derivatives market to mitigate investment risks, while the arbitrageurs are opportunists who wait for price inefficiencies to exploit the market. For example, an arbitrageur would buy a crypto that is undervalued on one exchange and sell it for a profit on another exchange where it is overpriced.
And finally, the brokers are the ones who facilitate transactions between buyers and sellers.
3. Are financial markets efficient?
In terms of everyday functions, financial markets are well-oiled machines that run on the rules and regulations framed by authorities. If a trader or investor violates these rules, they will face a penalty.
