The Financial Markets
In economics, a financial market is a mechanism that allows traders to exchange financial assets. In general, any commodity market could be considered as a financial market if the buyer purpose is not the immediate consumption of the product but the delay in consumption over time. Financial markets are affected and dominated by the forces of supply and demand. These markets serves to put all sellers in the same place, making easier for them to find potential buyers.
The economy which relies primarily on the interaction between buyers and sellers to allocate resources is called a market economy, in contrast to the planned economy. Financial markets in the financial system provided:
- The increase in capital (capital markets).
- The transfer of risk (in the derivatives markets).
- International trade (in the currency markets).
They are used to bring together those who need financial resources to those who have them.
Functions of financial markets
- Establish the mechanisms that facilitate the contact between the participants in the transactions.
- Fix the prices of financial products based on their supply and demand.
- Reduce the costs of intermediation, allowing greater movement of goods.
- Manage the cash flows of products or markets that are exchanged between the traders involved.
Main Features of financial markets
- Size: Number of securities which are traded on a financial market. The more securities are traded the wider is a financial market.
So as shown above, financial markets are essentially based on market speculation.
- Depth: It is the existence of financial securities to cover various contingencies in a financial market. For example, there are financial securities that protect against the rise or fall in the price of a given commodity. Also, we can talk about the existence of supply and demand curves above and below the equilibrium price that exists at a given time (there are traders who would be able to buy at a price above the equilibrium price. And if there is someone who is willing to sell at a lower price).
- Freedom: There are no barriers to entry or exit from the financial market.
- Flexibility: This feature is expressed in the form of prices of financial assets that are traded on a market which can change due to an event or circunstance in the economy.
- Transparency: It is the possibility to obtain information easily about the price of a financial asset. A financial market is more transparent when it is easier to get the information.
A large number of actors are involved in both the supply side and the demand side. So no trader can influence by himself the formation of financial asset prices. (High extent and depth)
That there are no transaction costs or taxes, or interest rate fluctuations or inflation. (High freedom)
Assets are divisible and indistinguishable. (High flexibility)
That there is perfect information, that everyone knows the same thing. (High transparency)
Random Walk Theory
According to the random walk theory, the movements in financial markets can be predicted. In reality, a market analyst can observe a greater or lesser degree of confirmation of this affirmation (due to market inefficiencies such as inside information, panic or irrational behavior), so it is valid to say that markets can have a weak, semi-strong or strong behaviour.
Types of financial markets
Financial markets can be divided into different subtypes:
For the transferred assets
- Money Market: In these markets, money or financial assets are traded with a short-term maturity and high liquidity. These are assets with a maturity that is usually less than a year.
- Capital Markets: Financial assets are traded with a maturity of medium and long term basis to carry out certain processes of investment.
- Stock Markets: Which provide financing through the issuance of shares and allow the subsequent exchange of these.
- Bonds Markets: Which provide financing through the issuance of bonds and allow the subsequent exchange of these.
Depending on their structure the markets can be divided in:
- Organized Markets.
- Unorganized markets which are called in English “Over The Counter”.
According to the negotiation of financial assets
- Primary markets: financial assets are created. In this market the assets are transferred directly by the issuer
- Secondary market: Only existing exchange financial assets, which were issued at an earlier stage. This market allows holders of financial assets and sell the instruments that were issued in the primary market (or that had already been transmitted on the secondary market) and are in its possession, or purchase other financial assets.
- Commodities markets that allow trading of all kinds of commodities.
- Derivatives market, which provides tools for financial risk management.
- Forwards markets, which provide standardized forward contracts for trading products at some future date, see also Forwards.
- Insurance markets, which allows the redistribution of various risks, see the insurance contract
- Foreign Exchange, which allows the exchange of foreign currencies. It is the most liquid financial market in the world.
It is important that an investor knows the most important characteristics of different market instruments, as some may be more suitable than others for an investor in particular. For that reason, in this website we are going to talk about the main principles of the following markets, instruments and financial derivatives:
- Forex Market.
- Stock Market.
- Futures Contracts.
- Financial Options.
- Contracts For Difference.