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Do you ever wonder, How you get that specific amount of interest on the money you deposit in your savings bank account? How the banks can give interest to all depositors even if the given loan rates are very low? Guess what, banks also invest in the financial market.
What is the Financial Market?
It is a marketplace where buying and selling of financial products occur like stocks, bonds, commodities, derivatives, currencies, and cryptocurrencies. And in the finance world, these financial products are known as Financial instruments.
So you can also say that the marketplace where financial instruments are getting traded is known as the financial market.
Types of Financial Market
There are so many types of financial markets. Some are known to the masses while others sound like new words to many. Here we are going to cover all the types or maybe the major ones.
1. Capital Market
A capital market is a place where buyers and sellers trade financial securities like bonds, stocks, etc. The trading is undertaken by participants such as individuals and institutions. The capital market trades mostly in long-term securities.
You can understand the importance of the capital market by the fact that the magnitude of a nation’s capital market is directly interconnected to the size of its economy.
The capital market consists of:
1.1 Stock Market
It is a market where you can trade equity securities or shares of publicly listed companies on the stock exchanges.
As the terms stock, share and equity are somewhere similar to each other, so Stock Market is also known as Share Market and Equity Market.
Share Market consisted of two levels.
One is Primary Market where new fresh shares are issued by the companies through public issues to the general public and other investors.
And another is the Secondary Market where the issued shares are being traded by the investors. Here, on both sides, we’ve investors while in the Primary market one party is the issuing company and the other is the investors.
1.2 Bond Market
This is the marketplace where investors trade debt securities that are brought to the market by either governmental entities or corporations.
If the government is issuing the bond then we will call it a government bond and if it is issued by any corporation then we use the term corporate bonds.
Here you give your money to the hands of the government and the repetitive corporation via investing in their bonds. So the bond market is very safe and contains low risk.
Your investment is a debt to these bond issuers – which they will return you after a specific period with an interest – and that’s why the bond market is also known as Debt Market. And this pre-defined interest is fixed income for you so we also know the bond market by the name of Fixed Income Market.
The bond market also has two levels same as the stock market wherein the Primary Market newly bonds are issued and in the Secondary Market the issued bonds are traded between the investors.
2. Money Market
It refers to a section of the financial market where financial instruments with high liquidity and short-term maturities are traded.
It involves large-volume trades between the central bank, commercial banks, corporates, and the government.
So, you can’t directly invest in the money market.
As an investor you can only invest indirectly through MMMFs (Money Market Mutual Funds) where your money goes into financial instruments like Treasury bills, Certificates of Deposit, Commercial Papers, etc., and these investment ensures guaranteed returns as they’re highly liquid as well as they do not have any risk.
3. Derivative Market
The basic principle behind entering into the derivative market is to earn profits by speculating on the value of the underlying asset in the future.
Derivatives are contracts between two or more individual parties whose value depends upon the underlying financial assets which are generally stocks, bonds, currencies, commodities, market indices, etc.
Derivatives types are forwards, futures, options, and swaps.
4. Currency Market
It is a market in which participants like banks, corporations, central banks, investment management firms, hedge funds, retail forex brokers, and investors from around the world buy and sell different currencies.
It is also known as Forex Market (abbreviation for Foreign Exchange Market).
Currencies are always traded in pairs. For instance, USD/INR (US Dollars: Indian Rupee). Here, USD is the Term currency and INR is the Base currency.
5. Commodity Market
It involves trading raw products such as oil, gold, or grain.
Commodities are broadly categorized into two types:
- Hard Commodity:
These kinds of commodities generally include natural resources that must be mined or extracted. e.g. gold, rubber, and oil
- Soft Commodity:
Livestock or agricultural goods are considered soft commodities. e.g. corn, wheat, coffee, sugar, soybeans, and pork.
6. Cryptocurrency Market
Cryptocurrency is the digital currency that emerged in the past few years and is based on Blockchain technology.
Nowadays there are a lot of cryptocurrencies out there that are traded by crypto traders or investors, but the major ones are Bitcoin, Ethereum, etc.
Cryptocurrency markets are decentralized, as they are not backed by a central authority such as a government. Instead, they run across a network of computers via a P2P (Peer to Peer) network.
Functions or Importance of Financial Market
We can’t underestimate the role of financial markets in the success and strength of the economy of any country.
Here are some of the functions of the financial market:
- Price determination
Investors and traders come into the market to make profits but unintentionally they help the market to determine the price of the securities, same as the company decides the rate of any product by analyzing the supply and demand.
- Allocation of capital and assets
Markets are the biggest solution for the flow of capital and money of investors who can participate in capital gains over time and this is how the global economy or the national economy functions smoothly.
- Makes assets liquid
Investors can decide to trade their securities anytime. They can use financial markets to sell or buy the securities that they have or make investments as they desire.
Conclusion
Financial Market is an aggregate term for all the places where an investor is supposed to invest his/her money to earn profits mainly through capital gains.
It is up to you which market type fascinates you and how much risk you can bear and this will decide whether you would be a stock investor, a forex trader or a crypto investor.
Probably your question “what is the financial market?” would be get solved and I hope now you would have a pretty good understanding of the financial market and its types.
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