Financial Markets

A financial market is a market in which people trade financial securities and derivatives at low transaction costs. A financial market is a word that describes a marketplace where bonds, equity, securities, currencies are traded. It includes stock markets, indices futures, commodities, and financial futures. Financial markets exist to bring people together so money flows to where it is needed most. Learn what we mean by financial markets and why we at all need them? Understand the major benefits provided by these markets and see some examples of various types of financial markets. Understand the difference between primary and secondary markets.

What are Financial Markets?

A financial market is a market in which people and entities can trade financial securities, commodities, and other financial assets at prices that reflect supply and demand. Financial markets are places or channels for buying and selling stocks, bonds, and other securities.

Securities include stocks and bonds, and commodities include precious metals or agricultural goods. Markets work by placing many interested buyers and sellers, including households, firms, and government agencies, in one "place", thus making it easier for them to find each other. Traditionally dealers who would meet face-to-face in the physical markets traded stocks and bonds. Today, most securities trading takes place electronically between dealers linked by computers and is referred to as “over-the-counter” trading.

Why we need Financial Markets?

If you want to start a new venture, generally, you may depend on the personal savings or contributions from friends and relatives are the sources of funds to start the business. This model will not be feasible for anyone who wants to start a large project. Hence, the availability of capital can be a major constraint in setting up or expanding business on a large scale. Capital markets facilitate raising money from the public by selling (issuing) shares of the proposed company. Once the issue is floated in the financial market, the interested shareholders can invest and become a shareholder of the company. Through aggregation, even small amounts available with a very large number of individuals translate into usable capital for corporates.

Benefits of Financial Markets:

Financial markets facilitate:

• The raising of capital (in the capital markets)

• The transfer of risk (in the derivatives markets)

• Price discovery

• Global transactions with the integration of financial markets

• The transfer of liquidity (in the money markets)

• International trade (in the currency markets)

Examples of Financial Markets:

Some examples of major financial markets are the New York Stock Exchange, which is located on Wall Street in New York City, The London Stock Exchange, which is located in Paternoster Square in London, The Bombay Stock Exchange located at located on Dalal Street, Mumbai, Maharashtra, India. On these exchanges, stocks and bonds were traded by dealers who would meet face-to-face.

Today, most securities trading takes place electronically between dealers linked by computers and is referred to as “over-the-counter” trading. NASDAQ, which originally stood for the National Association of Securities Dealers Automated Quotation System, is an over-the-counter market on which the stocks of many high-tech firms are traded. Now even the Bombay Stock Exchange provides over-the-counter trading options. The biggest over-the-counter market in India is the National Stock Exchange.

1. Primary Markets:

Economists make a distinction between primary markets and secondary markets. We have explained the mechanism by which corporates raise money from public in the earlier paragraph and this mechanism is called the primary markets. A primary market is a financial market in which stocks, bonds, and other securities are sold for the first time. When an corporate sells the stock for the first time, it is called an initial public offering (IPO), and is offered to the public through the primary market.

2. Secondary Markets:

Once you have subscribed to shares of some company, you, as a shareholder, might need your money back in the future. You can sell these shares to other or new investors. Such trades do not reduce or alter the company’s capital. Stock exchanges bring such sellers and buyers together and facilitate trading. Therefore, companies raising money from the public are required to list their shares on the stock exchange. This mechanism of buying and selling shares through stock exchange is known as the secondary markets. A secondary market is a financial market in which investors buy and sell already existing securities.

Primary and secondary markets can be in the same physical or virtual place.

How Prices Rise?

As a shareholder, you are part-owner of the company and entitled to all the benefits of ownership, including dividend (company’s profit distributed to owners). Over the years if the company performs well, other investors would like to become owners of this performing company by buying its shares. This increase in demand for shares leads to an increase in its price. You then have the option of selling your shares at a higher price than at which you purchased it. The reverse is also true!

3. Capital Markets:

Apart from shares, there are many other financial instruments (securities) used for raising capital. Debentures or bonds are debt instruments, which pay interest over their lifetime and are used by corporates to raise medium or long-term debt capital. The institutions, players, and mechanism that bring suppliers and users of capital together, is known as the capital market. It allows people to do more with their savings by providing a variety of assets thereby enhancing the wealth of investors who make the right choice. Simultaneously, it enables entrepreneurs to do more with their ideas and talent, facilitating capital formation.

There are a large variety of financial intermediaries who bring the providers and users of funds together to facilitate the transactions.