A financial market is a market where people trade financial securities and derivatives at low transaction costs. A financial market is a word that describes a market where bonds, stocks, securities and currencies are traded. It includes stock markets, index futures, commodities and financial futures. Financial markets exist to bring people together so that money flows where it is needed most. Learn what we mean by financial markets and why we need them? Understand the main advantages offered by these markets and see some examples of different 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 exchange 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 commodities. Markets work by placing many interested buyers and sellers, including households, businesses and government agencies, in one “place”, making it easier for them to find each other. Traditionally, dealers who met in person at physical markets traded stocks and bonds. Today, most securities transactions take place electronically between brokers linked by computers and are referred to as “over-the-counter” transactions.
Why do we need financial markets?
If you want to start a new business, you can usually depend on personal savings or contributions from friends and relatives as sources of funds to start the business. This model will not be feasible for anyone who wants to start a big project. Therefore, the availability of capital can be a major constraint in starting or expanding a large-scale business. Capital markets facilitate fundraising from the public by selling (issuing) shares of the proposed company. Once the issue has been launched on the financial market, interested shareholders can invest and become shareholders of the company. Through aggregation, even small amounts available from a very large number of individuals translate into usable capital for businesses.
Benefits of financial markets:
Financial markets facilitate:
• Raising capital (on the capital markets)
• Risk transfer (on derivatives markets)
• Price discovery
• Global transactions with the integration of financial markets
• Liquidity transfer (in money markets)
• International trade (on foreign exchange markets)
Examples of financial markets:
Some examples of major financial markets are New York Stock Exchange, located on Wall Street in New York, London Stock Exchange, located on Paternoster Square in London, Bombay Stock Exchange located on Dalal Street, Mumbai, Maharashtra, India. On these exchanges, stocks and bonds were traded by brokers who met face to face.
Today, most securities transactions take place electronically between brokers linked by computers and are referred to as “over-the-counter” transactions. NASDAQ, which originally stood for National Association of Securities Dealers Automated Quotation System, is an over-the-counter market where the shares of many high-tech companies are traded. Now, even the Bombay Stock Exchange offers OTC trading options. The largest over-the-counter market in India is the National Stock Exchange.
1. Primary markets:
Economists make a distinction between primary and secondary markets. We explained the mechanism by which companies raise funds from the public in the previous paragraph and this mechanism is called primary markets. A primary market is a financial market in which stocks, bonds and other securities are sold for the first time. When a company sells shares 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 purchased shares of a company, you as a shareholder may need your money in the future. You can sell these shares to other investors or to new investors. These transactions do not reduce or change the capital of the company. Exchanges bring these sellers and buyers together and facilitate trade. Therefore, companies that raise funds from the public are required to list their shares on the stock exchange. This mechanism of buying and selling stocks through the stock exchange is known as secondary markets. A secondary market is a financial market in which investors buy and sell existing securities.
Primary and secondary markets can be in the same physical or virtual location.
How prices increase?
As a shareholder, you are a co-owner of the company and are entitled to all the benefits of ownership, including the dividend (profit of the company distributed to the owners). Over the years, if the company performs well, other investors would like to become owners of this successful company by buying back its shares. This increase in demand for the stock leads to an increase in its price. You then have the option of selling your shares at a higher price than the price at which you bought them. The reverse is also true!
3. Capital markets:
Apart from stocks, there are many other financial instruments (securities) used to raise capital. Debentures or bonds are debt securities that earn interest over their life and are used by companies to raise medium to long-term debt capital. The institutions, actors and mechanism that bring together the providers and users of capital is known as the capital market. It allows people to do more with their savings by offering a variety of assets thus increasing the wealth of investors who make the right choice. Simultaneously, this allows entrepreneurs to do more with their ideas and talents, thereby facilitating capital formation.
There is a wide variety of financial intermediaries that bring providers and users of funds together to facilitate transactions.
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