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The Financial Market explained in simple terms.

December 23, 2022

The Financial Market explained in simple terms.

A financial market is any marketplace where trading happens, including the stock market, bond market, forex market, and derivatives market.

The financial markets play a crucial role in the smooth operation of capitalist economies.

People who need capital and those who have it can create mutually beneficial relationships. A financial market enables participants to transfer risk (often through derivatives) and advance trade to raise funds. 

Types of Financial market

Stock Markets:

Stock market

One of the most popular and well-known types of financial markets is the stock market, which offers capital funding through issuing shares.

On stock exchanges, you can trade shares of publicly traded companies.

Despite being offered at extravagant rates, these shares function well, giving investors enormous returns.

Commodity Markets:

As their name suggests, commodity markets enable the exchange of goods and commodities.

As a result, it serves as a market for the purchase and sale of rice, oil, billions of tons of coal, and other raw materials by trading companies or investors.

Bond Markets:

Bond issuance on these financial markets provides funding.

A business can obtain financing through the bond market to finance an investment, an enterprise, or a project. Investors purchase bonds from a company, and the company that issued the bond returns the capital and any applicable interest at the end of the period.

Governments, states, and sovereign governments all issue bonds to finance operations and projects. A few examples of securities sold on the bond market include notes and bills issued by the US Treasury. The term "bond market" can also refer to the debt, credit, or fixed-income markets.

Money Markets:

The money markets deal with short-term securities with maturities of less than a year, which are highly liquid.

There is a high level of safety and a relatively low rate of interest return in the money markets. At the wholesale level, the money markets feature considerable trading between institutions and traders. 

Derivatives markets:

Complex financial products known as derivatives derive their value from the value of the underlying assets.

Sophisticated investors and hedge funds can increase their profits by using derivatives markets. The imitative markets trade on futures contracts, CFDs, and options of financial instruments.

Exchange-traded and over-the-counter (OTC) derivatives are the two distinct segments of the derivatives market. In the OTC market, retail traders access derivatives through their brokers. However, these products differ in their legal status and how they trade.

Forex Markets:

A global decentralized or over-the-counter market for exchanging currencies is known as the foreign exchange (FX) market. The Forex market sets the foreign exchange rates for each currency. All aspects of buying, selling, and exchanging currencies, occur on the forex markets.

Cryptocurrency Markets:

Cryptocurrency Markets

Over the past few years, cryptocurrency, or decentralized digital assets, like Bitcoin and Ethereum, have grown significantly.

Today, many independent online cryptocurrency exchanges offer hundreds of cryptocurrency tokens for trading.

These exchanges provide access to digital wallets where traders can exchange one cryptocurrency for another or fiat money like dollars or euros.

Users are at risk of fraud or hacking because many cryptocurrency exchanges are centralized systems.

There are also decentralized exchanges that function without a central authority. Direct peer-to-peer (P2P) trading of digital currencies is possible on these exchanges without using actual exchange authority to handle the transactions. You can trade Major cryptocurrencies in futures and options.

Advantages and Disadvantages of Financial markets

The following are the advantages of the financial markets:

  1. It helps companies to raise capital for both long- and short-term investments.
  2. Companies can finance themselves for less than they would pay for a high-interest loan from a commercial bank. Furthermore, commercial banks do not offer big loans.
  3. Companies are free to borrow money whenever they need it to the point where their authorized share capital is exhausted.
  4. It provides a trading and dealing platform for various shares, stocks, bonds, derivatives, and other financial instruments.
  5. Stricter financial market laws and regulations foster trust among investors and firms, which helps to grow the economy.
  6. Offer a platform for international borrowing and lending of money in many currencies.

Following are some of the drawbacks of the financial markets:

  1. The process could get drawn out if regulatory agencies impose too many steps.
  2. Some companies can not access the financial sector because of laws and regulations. They cannot set up resources that require ongoing oversight and compliance checks.
  3. Investors may lose money because of ignorance or lack of information about the situation.
  4. A company's focus could change from investors to profits. The Board of Directors must adopt decisions in the best interests of all parties involved in the business and refrain from using investor funds for personal advantage.

Functions of financial markets:

The financial markets carry out several tasks, such as setting prices for different financial instruments by assisting in price discovery, raising capital, giving investors a chance to buy or sell their respective financial instruments at the market price, giving traders access to a variety of types of information, and distributing risk, among others.

The following are the functions of financial markets:

1. Determine the price: The financial market serves as the platform for the price discovery of the various financial instruments between buyers and sellers. The market forces, i.e.., supply and demand, determine the prices at which the financial instruments trade in the financial market.

2. Raising funds: Participants in the financial market set the prices at which financial instruments trade in addition to the required return from the investor's invested cash. Investors' desire for returns determines why they are seeking investment opportunities. The financial market distributes funds available from lenders or investors to those who need them. Therefore, the financial market aids in the mobilization of investors' savings.

3. Cash-Flow: During market hours, investors sell their financial instruments at the current market fair value at any moment, thanks to the liquidity function of the financial market.

4. Sharing risks: Because the people making the investments and the people putting their money in them are two different parties, the financial market serves the purpose of risk sharing. Investing in the financial market shifts the risk from the investor to those who provide the funding.

5. Access easily: Investors need to invest their money for companies to make a profit, and industries need to raise funds from investors. Thus, the financial market platform makes it simple for buyers and sellers to discover each other, saving time and money.

6. Reduce the cost of Transaction: When buying and selling stocks, the trader needs different types of information. It takes time and money to accomplish the same. However, the financial market enables traders to receive all details without investing money. The financial market lowers the cost of the transactions in this way.

7. Forming Capital: The financial market facilitates Capital formation in the nation, which acts as a conduit for new investors' savings.

Financial markets

Summary

To conclude, open and regulated financial markets offer a means for businesses to raise sizable amounts of capital.

The stock and bond markets play a vital role in this process.

Through access to commodities, foreign exchange futures, and other derivative markets, markets also enable firms to mitigate risk.

Exchanges determine prices on everything transacted because financial markets are open, transparent, and accessible to the general public.

Financial markets reflect all information currently accessible regarding the assets and securities bought and sold.

The scale of financial markets provides liquidity. When they need to raise money, sellers can sell their assets. Because buyers and sellers are easier to identify, businesses and investors should experience lower operating costs.

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