By John Alexander Adam
When we talk about ‘financial markets’, we most commonly think of the stock market. However, there are a vast array of different financial markets, some huge and some relatively small. In essence, a financial market is any regulated marketplace where assets are traded and prices set by the forces of supply and demand. Some financial markets are open to anyone while others have requirements around who can participate. There are, however, a handful of primary financial markets that the lion’s share of the global economy’s financial transactions take place through that we’ll explain in brief here:
Capital markets are where private corporations and governments raise capital for long term investments through the sale of securities. These securities can be roughly broken down into two main groups: equities and bonds. Equities are an ownership stake in the company itself whereas a bond is a debt investment where the buyer essentially loans money to a company or government, repayable with interest. Primary capital markets are where these securities are sold initially and secondary capital markets are where they are subsequently traded.
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’.
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 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.
If you would like to improve your understanding of business and finance, why not take a qualification such as the CFA® Program. Morgan International offers a number of different professional finance, investment and accounting qualification programs at locations across the Middle East.