A Deep Dive into the Basics of Financial Markets

Table of Content

• What is a Financial Market?
• Understanding the Financial Markets
• Classifications of Financial Markets
• Examples of Financial Markets
• Advantages and Disadvantages of Financial Markets 
• Conclusion
• FAQs

The world as we know it is changing, developing and evolving. With a steady rise in the startup culture, to businesses growing, expanding and exploring to accommodate the changing economy, requires finances, these finances are raised through the financial markets. As a country develops, we see the financial markets also developing and supporting the country in its economic growth.

In a growing economy the financial market of the country has a significant and substantial contribution. 

Let’s understand the meaning of a financial market, what are the types of financial market and the functions of a financial market. 

A financial market is a place for creating and trading of financial assets. It’s a place where a business will go to raise capital (money for their business) or an investor will look to invest.  It an intermediary between savers and investors mobilizing the funds between them. The assets traded here include debt, securities, shares and bonds.

What is a Financial Market?

Functions of a financial markets is to serve as platforms where buyers and sellers trade financial assets such as stocks, bonds, currencies, and commodities. Functions of a financial market or basics of financial market is to facilitate the exchange of capital and liquidity, which are crucial components of any economy. In this article, we will explore the functions of a financial market, their classifications, and examples of various financial markets. Learn about What is Financial Risk – Meaning, Types & Tools and Financial & Risk Management course.

Understanding the Financial Markets

Functions of a financial market include bringing buyers and sellers together to trade financial assets. These assets may include stocks, bonds, commodities, and currencies. The primary functions of a financial market are to facilitate the exchange of capital and liquidity. For better understanding, read about 8 Key Scope of Financial Management to know in 2023.

Classifications of Financial Markets

Financial markets (basics of financial market) can be classified into two types: primary markets and secondary markets. The primary market is where companies issue new securities, while the secondary market is where existing securities are bought and sold. Learn about Financial Accounting vs Management Accounting along with Finance Manager Salary In India In 2023 and All You Need to Know About MBA In Finance.

Functions of a financial market 

Optimally utilizing time and money

Financial markets help in bringing the sellers and buyers to a common platform. Time and resources are not wasted in searching for buyers and sellers. Additionally, also provides information related to securities traded in the financial markets.

• Transparency 

  The financial markets are public and subject to rule and regulation by the government. This provides an added layer of transparency in terms of trading, information exchange and prices of the assets traded.

• Offset of risk 

  As these markets are transparent and are subject to regulation they follow strict compliance rules, it provides companies to raise capital in a systematic manner. They also allow companies to offset risk by allowing them to use commodities, foreign exchange futures contracts, and other derivatives as a tool to minimize their risk factor.

• Liquidity 

  Due to the sheer size of financial markets, it makes it easy to liquidate the assets as and when needed to raise cash. The size allows for reduction in the cost of doing business and companies do not have to spend extra resources to raise capital.

• Long-term and short-term investment

  Financial markets cater to various categories of people and this in turn leads them to have investments that have both short- and long-term options. This allows investors to choose their investments based on their requirements.

• Financial intermediaries

  For the smooth functioning of financial markets, intermediaries such as banks, non-banking financial companies, stock exchanges, mutual fund companies and insurance companies need to be cohesive in their policies and practices.

• Capital formation rate 

  One main function of a financial market is the capital formation rate. Based on the demand and supply of securities with proper regulation establishes the capital formation rate. This in turn will encourage investors to enter the market. 

• Economic growth and development

  Financial markets are one of the pillars that support economic growth and development of a country. When savings generate revenue, by way of investing and expansion of businesses, it parallelly ensures the growth and development of an economy.

• Accessibility 

  Today investors look for various avenues of investing funds and businesses look for funds to develop, grow and expand their businesses. Financial markets provide a platform, that is regulated and governed by governments to ensure safe and secure practices.

• Reduction in cost of transaction

  Information is a vital part of all business and this requires money and time. But financial markets provide information to all interested parties, and this accessibility to financial market information and news reduces the cost of transactions to all entities involved. 

• Creation of assets and liabilities 

  A financial market is responsible for the allowing the creation of new asset classes and liabilities via investments and borrowings respectively. 

Types of financial markets 

Financial markets include the following:

1. Money market 
2. Capital market 
3. Forex market

When it comes to financial markets, stock market is the first thing that is at the forefront for everyone.

What we neglect to understand is that there are different kinds of markets, that are targeted to different audiences, and they all gave varying goals they accomplish. 

Markets have variety of tools and products to meet their goals. Even though they are separated by their goals they are interconnected with each other to help build investor confidence. This link between, markets mean any financial market news pertaining to one sector will be bound to effect other sectors as well.

• Money market

  
  Investors looking for high liquidity and short maturity period, will look for tools and instruments for trading in the money market. A short maturity signifies a period of less than 1 year. Some of the instruments traded in this market include certificates of deposit, commercial paper, call money, trade and treasury bills etc.
  
  This market is usually characterized with instruments that are tradeable, negotiable and are issued at discount. These instruments are highly secure, though the return on them is comparatively lower compared to other avenues of investment. Businesses and companies looking to raise working capital are who seek out the money market investments.

• Capital markets

  
  Companies and businesses looking to raise capital through debt and equity such as shares and government rated securities trade in this market. In the capital market financial instruments having medium- and long-term maturity period are traded. (More than 1 year and 5 years respectively).
  Capital markets are further classified into:

  1. Debt market: 

     This market primarily deals with loans or debt being arranged where the lender provides loan to borrowers and borrowers agree to repay the amount with interest. It also includes instruments with fixed rates such as debentures, bonds and fixed deposits.

  2. Equity/Stock market:

      In this segment of the financial markets, stocks and shares of a company are purchased and sold between investors. Based on financial news of a company or government policies affecting certain segments in the business world, the price of these stocks and shares can fluctuate. Some of the examples of a stock exchange are BSE (Bombay Stock Exchange), NSE (National Stock Exchange), NYSE (New York Stock Exchange).
     Again, equity markets are further divided into:

  1. Primary market:

      A primary market is a segment that deals with IPO’s and FPO’s (follow on public offer). Its also commonly known as New Issue market, where the shares of a company are sold to the public for the first time. A business raises funds through this by diluting their ownership with the help of investment banks or merchant banks.

  2. Secondary market:

      Secondary Market is a platform where shares of existing companies are traded. A stock exchange platform is where this exchange happens and the value of the share varies depending on the demand and supply and financial news relating to the company or the segment the company operates in. Also known as old issues market.
     This is further classified into:

     1. Spot market:

         In the spot market all transactions and delivery happen immediately. An asset or financial instrument that is bought or sold the exchange of money and the asset handover is immediate.

     2. Derivative market:

         In a derivative market, the delivery of the assets happens at future date via contract between the seller and buyer where the price is decided today but delivery happens at future date. Forwards, futures, options and swap are examples of some of the instruments traded on the derivative market. These are popularly known as risk management instruments of the stock market.

• Forex market

  It is a segment that allows you deal in foreign exchange where currencies of other countries can be purchased and sold.

Other segments include bond markets (only bonds are issued and traded), commodities market (commodities such as gold, silver, crude oils etc. are traded) and over the counter markets (it is an unregulated market, where transactions take place between two entities without the involvement of intermediaries).

Other segments include bond markets (only bonds are issued and traded), commodities market (commodities such as gold, silver, crude oils etc. are traded) and over the counter markets (it is an unregulated market, where transactions take place between two entities without the involvement of intermediaries). 

A brief look into the global financial markets 

With geographical boundaries diminishing and with accessibility to all kinds of information combined with easy accessibility, the sky has become the limit. Today the world global markets involve the quick flow of capital not only from sector to sector but nation to nation.  

With the world being more integrated, economic development of nation influences commodity prices throughout the world. Businesses and investors can also trade in the markets across the globe.

Final thoughts

Businesses today face a wide range of challenges and trials. In order to overcome these and at the right time it becomes highly valuable to have an in-depth knowledge about the financial markets. As businesses operate globally, having a strong foundation of financial markets work, what tools are available and how to identify the best for your business becomes a highly required skill set.

Financial markets at the end of the day are essential and vital to the growth of the country and its economy. And it strategically and cleverly used will be beneficial to all parties and entities involved.

Financial markets are the backbone of any country and understanding the nuances of this becomes vital. Being aware of the financial market news along with information about global markets will lead to capitalizing opportunities at the right time. 

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Examples of Financial Markets

1. Stock Market: Its marketplace where publicly traded companies’ stocks are bought and sold by investors.
2. Foreign Exchange Market: This is a decentralized market where currencies are traded. The forex market is the largest and most liquid market in the world.
3. Bond Market: It’s a marketplace where bonds are issued and traded.
4. 4. Commodities Market: This is where commodities such as gold, silver, oil, and other natural resources are traded.

Advantages and Disadvantages of Financial Markets

• Functions of a financial market or the basics of financial market is to provide services such as liquidity, transparency, and access to capital. 
• Investing and trading in financial markets come with some disadvantages, including market volatility, uncertainty, and risk. These risks and challenges associated with investing and trading in financial markets include market volatility, economic downturns, fraud, and other unpredictable factors that can impact the value of financial assets.

Risks and challenges of Financial Markets

Investing and trading in financial markets come with some risks and challenges. 

• The market volatility can lead to unpredictable price fluctuations, which can impact the value of financial assets. 
• Economic downturns can result in decreased consumer spending, reduced corporate earnings, and increased unemployment. 
• Fraudulent activities such as insider trading, Ponzi schemes, and accounting fraud can also pose a risk to investors. Other factors such as political instability, natural disasters, and global events can also impact financial markets. 

Therefore, it is crucial to stay informed, conduct research, and seek professional advice before investing in financial markets.

Conclusion

Functions of a financial market include facilitating the exchange of capital and liquidity between investors and businesses. Understanding the functions of a financial market, basics of financial market and their classifications, and examples of various financial markets can help investors make informed decisions when investing in financial assets. However, it is crucial to recognize the risks and challenges associated with investing and trading in financial markets to minimize losses and maximize profits. As with any investment, it is essential to conduct thorough research, analyze the market trends and seek professional advice before making any investment decisions in financial markets. To start with, explore Top 10 Real-Time Finance Projects for Beginners.