What is Financial Market?

Financial market is a market where buyers and sellers trade commodities, financial securities, foreign
exchange, and other freely exchangeable items (fungible items) and derivatives of value at low
transaction costs and at prices that are determined by market forces.

The money markets, where large-scale, short-term debts are arranged, and capital markets, where
longer-term debts are traded, make up the financial market.

Securities include bonds and shares, while commodities might be gold, silver and other metals, or
agricultural products such as coffee, cocoa, wheat, corn, etc.

Alternatively put, financial markets are places where the savings from several sources are mobilized
towards those who need funds. They are intermediaries which direct money from savers or lenders to
sellers or borrowers.

Types of Financial Markets

The different types of financial markets include capital market, money market, stock markets, spot
market, futures market, physical asset market, financial asset market, derivative markets, primary
markets, secondary market, privatemarkets and public markets. The financial institutions
includeinvestment banks, commercial banks, life insurance companies, mutual fund corporations, credit
unions, and private equitycompanies etc. These organisations enhance the capital allocationby directly
transferring or through intermediary, the money andsecurities from the one who has the excess capital
and transfer tothe ones who require the capital.

Functions of Financial Market

 It facilitates mobilisation of savings and puts it to the most productive uses.
 It helps in determining the price of the securities. The frequent interaction between investors
helps in fixing the price of securities, on the basis of their demand and supply in the market.
 It provides liquidity to tradable assets, by facilitating the exchange, as the investors can readily
sell their securities and convert assets into cash.
 It saves the time, money and efforts of the parties, as they don’t have to waste resources to find
probable buyers or sellers of securities. Further, it reduces cost by providing valuable
information, regarding the securities traded in the financial market.
 The financial market may or may not have a physical location, i.e. the exchange of asset
between the parties can also take place over the internet or phone also.

Capital Markets

A capital market is one in which individuals and institutions trade financial securities. Organizations and
institutions in the public and private sectors also often sell securities on the capital markets in order to
raise funds. Thus, this type of market is composed of both the primary and secondary markets.
Any government or corporation requires capital (funds) to finance its operations and to engage in its
own long-term investments. To do this, a company raises money through the sale of securities - stocks
and bonds in the company's name. These are bought and sold in the capital markets.

Stock Markets

Stock markets allow investors to buy and sell shares in publicly traded companies. They are one of the
most vital areas of a market economy as they provide companies with access to capital and investors
with a slice of ownership in the company and the potential of gains based on the company's future
performance. This market can be split into two main sections: the primary market and the secondary
market. The primary market is where new issues are first offered, with any subsequent trading going on
in the secondary market.

Money Markets

The money market, sometimes referred to the cash market due to its high levels of liquidity and short
term nature, is where securities with extremely short term maturity dates are traded. They are used for
short terms borrowing and lending, normally up to a year at most and for as little as a week at the other
end of the spectrum. Money markets are primarily used by large corporations and governments for
short term liquidity and the main securities sold and traded there are U.S. Treasury Bills, Certificates of
Deposit, Eurodollars, repurchase agreements, municipal notes, federal funds and commercial paper.

The money market is considered as about as safe as any investment can be due to its short term nature,
high liquidity, and the financial solidity of the organizations selling the short term debt. Subsequently,
returns are also small and money markets are generally viewed as a safe place to park cash in the short
term, rather than as an ‘investment’.

Physical Asset Market and Financial Asset Market

Physical Asset Market are tangible assets and can be seen and touched and can be liquidated in the
event of default in order to pay off debts, in an accounting point of view. Examples of physical assets are
vehicles, real estate, machinery, gold and other form of tangible resources. Physical asset are subject to
depreciation, in other words, they usually experience a reduction in value due to wear and tear of the
asset through continuous use. Some are also perishable such as food and plants.

Financial Asset Market are intangible, they cannot be seen or felt, except for the documents
representing ownership of an asset. A financial asset represents a claim on ownership of a company or
legal right to future payments. Some examples of financial assets are stocks, bonds, savings,
investments, accounts receivable, options and much more. Financial assets do not depreciate or loss
value due to wear and tear like physical assets, it mainly loss value depending on the market conditions.

Lastly, Physical assets also require maintenance, upgrades and repairs, whereas financial assets do not
incur such expenses.
Derivatives Markets

Derivatives are contracts whose value is based on an underlying asset. Common derivatives include CFDs
(Contract for Difference), futures, options and swaps. When you buy a derivative you do not buy any
actual physical asset, such as oil or equity in a company. Rather, what you buy is a contract which
promises to pay the difference in price between the underlying asset at the point of the contract’s
purchase and the price at the expiry of that contract. This means that you can buy a derivative that can
allow you to profit from the decrease in the underlying asset’s price if you believe that is what will
happen.

Derivatives, as you may have gathered, are complex financial instruments and are essentially used by
traders to speculate on price movements of the underlying assets. They also often involve leverage,
which means that profits, or losses, can be magnified by many times the initial sum invested.

The Spot Market

The spot market or cash market is a public financial market in which financial instruments or
commodities are traded for immediate delivery. It contrasts with a futures market, in which
delivery is due at a later date. In a spot market, settlement normally happens in T+2 working
days, i.e., delivery of cash and commodity must be done after two working days of the trade
date. A spot market can be through an exchange or over-the-counter (OTC). Spot markets can
operate wherever the infrastructure exists to conduct the transaction.

Primary Markets vs. Secondary Markets

A primary market issues new securities on an exchange. Companies, governments and other groups
obtain financing through debt or equity based securities. Primary markets, also known as "new issue
markets," are facilitated by underwriting groups, which consist of investment banks that will set a
beginning price range for a given security and then oversee its sale directly to investors.

The primary markets are where investors have their first chance to participate in a new security
issuance. The issuing company or group receives cash proceeds from the sale, which is then used to fund
operations or expand the business. (For more on the primary market, see our IPO Basics Tutorial.)

The secondary market is where investors purchase securities or assets from other investors, rather than
from issuing companies themselves. The Securities and Exchange Commission (SEC) registers securities
prior to their primary issuance, then they start trading in the secondary market on the New York Stock
Exchange, Nasdaq or other venue where the securities have been accepted for listing and trading. (To
learn more about the primary and secondary market, read Markets Demystified.)
The secondary market is where the bulk of exchange trading occurs each day. Primary markets can see
increased volatility over secondary markets because it is difficult to accurately gauge investor demand
for a new security until several days of trading have occurred. In the primary market, prices are often set
beforehand, whereas in the secondary market only basic forces like supply and demand determine the
price of the security.

Secondary markets exist for other securities as well, such as when funds, investment banks or entities
such as Fannie Mae purchase mortgages from issuing lenders. In any secondary market trade, the cash
proceeds go to an investor rather than to the underlying company/entity directly. (To learn more about
primary and secondary markets, read A Look at Primary and Secondary Markets.)

Forex Markets
The forex market is the Granddaddy of financial markets, the largest in the world with average daily
volumes of over $2 trillion traded. The market is open 24 hours a day and runs through different
financial centers in different time zones around the world, meaning that the market never sleeps. When
London and other European centers such as Frankfurt and Zurich finish for the day, New York and other
cities take over with the baton then passing to Asia where Tokyo, Honk Kong, Singapore and Sidney
before Europe wakes up again. Every transaction involving different currencies, from exchanging money
for your holidays to trade between small and large enterprises around the world dealing in different
currencies to debt swaps between governments and their buying and selling of currency reserves, pass
through the forex markets every day. Unlike most other markets, this colossal market has no central
marketplace like a stock exchange or other regulated body. Transactions take place ‘over the counter’
with exchange rates controlled entirely by global supply and demand.

As well as the four mentioned here, there are many other kinds of financial markets of various
complexity and hosting different kinds of participants. They range from hard and soft commodities
markets to spot markets and over-the-counter markets for penny shares.

Future Markets
Futures markets are places (exchanges) to buy and sell futures contracts. There are several futures
exchanges. Common ones include The New York Mercantile Exchange, the Chicago Board of Trade, the
Chicago Mercantile Exchange, the Chicago Board of Options Exchange, the Chicago Climate Futures
Exchange, the Kansas City Board of Trade, and the Minneapolis Grain Exchange.

A futures contract is a financial contract giving the buyer an obligation to purchase an asset (and the
seller an obligation to sell an asset) at a set price at a future point in time.
The assets often underlying futures contracts include commodities, stocks, and bonds. Grain, precious
metals, electricity, oil, beef, orange juice, and natural gas are traditional examples of commodities, but
foreign currencies, emissions credits, bandwidth and certain financial instruments are also part of
today's commodity markets.

There are two kinds of participants in futures markets: hedgers and speculators. Hedgers do not usually
seek a profit by trading commodities futures but rather seek to stabilize the revenues or costs of their
business operations. Speculators are usually not interested in taking possession of the underlying assets.
They essentially place bets on the future prices of certain commodities. Speculators are often blamed for
big price swings in the futures markets, but they also provide a lot of liquidity to the futures markets.

Futures exchanges do not set the prices of futures contracts or their underlying traded commodities.
Rather, supply and demand determines the prices. But two things in particular ensure the stability and
efficiency of futures markets: standardized contracts and the presence of clearing members.
Standardized contracts mean that every futures contract specifies the underlying commodity's quality,
quantity and delivery so that the prices mean the same thing to everyone in the market. A commodity
from one producer is no different from another and the buyer knows exactly what he's getting. Clearing
members manage the payments between buyer and seller. They are usually large banks and financial
services companies. Clearing members guarantee each trade and thus require traders to make good-
faith deposits (called margins) in order to ensure that the trader has sufficient funds to handle potential
losses and will not default on the trade. The risk borne by clearing members lends further support to the
stability of futures markets.

The world of commodities and the futures markets on which they are based are complex, fascinating,
and have a profound effect on economies and average citizens around the world. Changes in commodity
prices can affect entire segments of an economy, and these changes can in turn spur political action (in
the form of subsidies, tax changes, or other policy shifts) and social action (in the form of substitution,
innovation, or other supply-and-demand activity).

Most buyers and sellers trade commodities on the futures markets because many commodity
producers, especially those of traditional commodities like grain, bear the risk of potentially negative
price changes when their products are finally ready for the market. In general, however, the liquidity
and stability of the commodities exchanges helps producers, manufacturers, other companies, and even
entire economies operate more efficiently and more competitively.

Private vs Public Markets

Private Markets

For most commercial transactions, there is an obvious customer and performance is easily measured by
whether the customer is satisfied with the service they received and the price they paid. If they are, they
will continue to purchase the service. If not, they will not buy it again, or will find an alternative
provider.

There are exceptions where switching is difficult – such as energy or telecoms – so these markets often
have specific regulators. Nevertheless, performance and prices are relatively easy to judge and compare.

Public markets

With a public service market the picture is more complicated. To begin with, the “customer” is not
always obvious – there may be a range of parties with conflicting needs. For example, the “customer” of
a probation service is a combination of the ex-prisoner, the victim, the Ministry of Justice, the courts and
society as a whole. This makes assessing needs and measuring performance far more complex.

Finding the right providers to supply the service can also be problematic, particularly where the service
is new. For example, there may be:

 Few (or no) providers with a track record in supplying that service
 No established way of determining a fair price
 No easy way to measure performance

If performance is poor, a lack of alternative suppliers makes it difficult to switch provider.

To illustrate, this table shows the difference between three different types of market: a simple retail
market (coffee), a service involving both public and private sector markets (refuse collection), and a
complex public services market (probation services):

  Simple private Public/private Complex public

market: Buying a service market: service market:
cup of coffee Refuse collection Probation services

Who is the The coffee drinker The business or Multiple

customer? householder; stakeholders:

For residential  Offenders

collection, the  Victims
council who  Courts
purchases the  Governmen
service. t
 Society

Need to balance
needs of society
and the individual.
The purchaser
 (government) is
not the same as the
service user.

Who provides Multiple retailers of Many organisations Few organisations

services? varying sizes, from can provide this have previous
independents to service if they can experience/
large chains. afford the initial capacity to do this
outlay for specialist work.
Barriers to entry are equipment.
low. Barriers to entry are
Private suppliers high.
exist.

Barriers to entry are

medium.

How do you set What the coffee Agree contract and Performance
the price? drinker is prepared performance metrics which may
to pay. standards in be subjective, such
advance. These are as:
relatively simple to
determine.  Reoffendin
g rates
 Inspection
ratings
 Feedback
from users

Very difficult to
separate out the
role of prison
services, health
services, etc when
measuring
outcomes.

How do you Whether coffee- Objective Agree contract and

measure quality of drinker likes the performance performance
the provider? taste of the product metrics such as: standards in
and the service advance. These
provided.  Volume of may be difficult to
waste collected determine, for
 Number of example
missed deliveries reoffending rates
which are
dependent on many
 factors.

What recourse is Ask for money Engage an Contracts and lack

there if back. alternative supplier. of alternative
product/service Choose a different provision may make
does not meet coffee vendor. Contracts may switching difficult.
needs? Switch to tea. make switching
complex but May need a “failure
alternative provision regime” to ensure
relatively easy to continuity of service
find. when a provider
fails /needs to be
changed.

How is market  Company  Company  Company

regulated to and competition law and competition law and competition law
ensure  Consumer  Consumer  Tender
competition is protection protection processes
fair? legislation legislation
Additional
regulations to
reflect the need to
reflect the public
interest.

How is market  Health and  Health and  Health and

regulated to safety law safety law safety law
ensure service is  Employmen  Employmen  Employmen
provided safely t law t law t law
and ethically?  Food safety  Environmen Workforce
regulations tal protection accreditation
 Food waste  Waste  Probation
regulations management regulations
licensing
regulations

Ensuring a public service market meets the needs of service users and society therefore presents very
complex challenges. It is not surprising that the UK - in pioneering the use of different delivery
mechanisms at a rapid pace - has encountered difficulties in making systems work.