In economics, a financial market is a mechanism that allows people to easily buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices that reflect the efficient market hypothesis. The bond market (also known as the debt, credit, or fixed income market) is a Financial market where participants buy and sell Debt Fixed income refers to any type of Investment that yields a regular (or fixed return A Corporate Bond is a bond issued by a Corporation. The term is usually applied to longer-term debt instruments generally with a maturity date falling at least a A government bond is a bond issued by a national government denominated in the country's own Currency. In the United States, a municipal bond (or muni) is a bond issued by a city or other local government or their agencies Bond valuation is the process of determining the Fair price of a bond. In Finance, a high yield bond ( non-investment grade bond, speculative grade bond or junk bond) is a bond that is rated below A stock market, or (equity market is a private or public market for the trading of company Stock and derivatives of company Software for Fixed assets management and Stock control developed in 2004. Preferred stock, also called preferred shares or preference shares, is typically a higher ranking stock than Voting shares, and its terms are negotiated A voting share (also called common stock or ordinary share) is a share of Stock giving the Stockholder the right to vote on matters A Registered share is a Stock that is registered on the name of the exact owner A voting share (also called common stock or ordinary share) is a share of Stock giving the Stockholder the right to vote on matters A stock exchange, share market or bourse is a Corporation or Mutual organization which provides "trading" facilities for Stock The foreign exchange ( currency or forex or FX) market refers to the market for currencies. The derivatives markets are the Financial markets for derivatives The market can be divided into two that for exchange traded derivatives and that for In Finance, a credit derivative is a derivative whose value derives from the Credit risk on an underlying bond loan or other financial asset '"Hybrid securities"' often referred as "hybrids" are a broad group of securities that combine the elements of the two broader groups of securities Debt and Options are financial instruments that convey the right but not the obligation to engage in a future transaction on some Underlying security, or in a Futures In Finance, a futures contract is a standardized Contract, traded on a Futures exchange, to buy or sell a certain Underlying instrument A forward contract is an agreement between two parties to buy or sell an asset at a specified point of time in the future For the Thoroughbred horse racing champion see Swaps (horse. In finance a swap is a derivative in which two counterparties Commodity markets are markets where raw or primary products are exchanged In Finance, the money market is the global Financial market for short-term borrowing and lending Over-the-counter ( OTC) trading is to Trade Financial instruments such as Stocks bonds, commodities or derivatives Real estate is a legal term (in some jurisdictions notably in the USA, United Kingdom The spot market or cash market is a Commodities or Securities market in which goods are sold for Cash and delivered immediately The field of finance refers to the concepts of Time, Money and Risk and how they are interrelated There are two basic financial market participant categories Investor vs Corporate finance is an area of Finance dealing with the financial decisions Corporations make and the tools and analysis used to make these decisions Personal finance is the application of the principles of Finance to the monetary decisions of an individual or family unit Public finance is a field of economics concerned with paying for collective or governmental activities and with the administration and design of those activities A banker or bank is a Financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money Financial regulations are a form of Regulation or supervision which subjects Financial institutions to certain requirements restrictions and guidelines aiming to Economics is the social science that studies the production distribution, and consumption of goods and services. Trade is the willing exchange of goods, services, or both Trade is also called Commerce. A security is a Fungible, Negotiable instrument representing financial value A commodity is anything for which there is demand but which is supplied without qualitative differentiation across a market Fungibility is the property of a good or a Commodity whose individual units are capable of mutual substitution In Economics and related disciplines a transaction cost is a Cost incurred in making an economic exchange
Financial markets have evolved significantly over several hundred years and are undergoing constant innovation to improve liquidity. Market liquidity is a Business, Economics or Investment term that refers to an Asset 's ability to be easily converted through an act of buying
Both general markets (where many commodities are traded) and specialized markets (where only one commodity is traded) exist. Markets work by placing many interested buyers and sellers in one "place", thus making it easier for them to find each other. An economy which relies primarily on interactions between buyers and sellers to allocate resources is known as a market economy in contrast either to a command economy or to a non-market economy such as a gift economy. A market economy is a realized Social system based on the Division of labour in which the prices of Goods and Services are determined in a A planned economy or directed economy is an Economic system in which the Government or Workers' councils manages the Economy. A market economy is a realized Social system based on the Division of labour in which the prices of Goods and Services are determined in a A gift economy is a Social theory in which goods and services are given without any explicit agreement for immediate or future Quid pro quo.
In Finance, Financial markets facilitate--
- The raising of capital (in the capital markets);
- The transfer of risk (in the derivatives markets);
- International trade (in the currency markets)
--and are used to match those who want capital to those who have it. The field of finance refers to the concepts of Time, Money and Risk and how they are interrelated In Economics, capital or capital Goods or real capital refers to items of extensive value The capital market is the Market for securities, where companies and Governments can raise longterm funds Risk is a Concept that denotes the precise probability of specific eventualities The derivatives markets are the Financial markets for derivatives The market can be divided into two that for exchange traded derivatives and that for International trade is exchange of Capital, Goods, and Services across International borders or Territories. The foreign exchange ( currency or forex or FX) market refers to the market for currencies.
Typically a borrower issues a receipt to the lender promising to pay back the capital. A receipt is a written acknowledgement that a specified article or sum of money has been received as an exchange for goods or services These receipts are securities which may be freely bought or sold. A security is a Fungible, Negotiable instrument representing financial value In return for lending money to the borrower, the lender will expect some compensation in the form of interest or dividends. Interest is a fee paid on borrowed capital Assets lent include Money, Shares, Consumer goods through Hire purchase, major assets Dividends are payments made by a Corporation to its Shareholder members
Contents |
Definition
The term Financial markets can be a cause of much confusion.
Financial markets could mean:
1. organizations that facilitate the trade in financial products. i. e. Stock exchanges facilitate the trade in stocks, bonds and warrants.
2. the coming together of buyers and sellers to trade financial products. i. e. stocks and shares are traded between buyers and sellers in a number of ways including: the use of stock exchanges; directly between buyers and sellers etc.
In academia, students of finance will use both meanings but students of economics will only use the second meaning. Economics is the social science that studies the production distribution, and consumption of goods and services.
Financial markets can be domestic or they can be international.
Types of financial markets
The financial markets can be divided into different subtypes:
- Capital markets which consist of:
- Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof. The capital market is the Market for securities, where companies and Governments can raise longterm funds A stock market, or (equity market is a private or public market for the trading of company Stock and derivatives of company Software for Fixed assets management and Stock control developed in 2004.
- Bond markets, which provide financing through the issuance of Bonds, and enable the subsequent trading thereof. The bond market (also known as the debt, credit, or fixed income market) is a Financial market where participants buy and sell Debt In Finance, a bond is a Debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and Interest
- Commodity markets, which facilitate the trading of commodities. Commodity markets are markets where raw or primary products are exchanged
- Money markets, which provide short term debt financing and investment. In Finance, the money market is the global Financial market for short-term borrowing and lending
- Derivatives markets, which provide instruments for the management of financial risk. The derivatives markets are the Financial markets for derivatives The market can be divided into two that for exchange traded derivatives and that for The field of finance refers to the concepts of Time, Money and Risk and how they are interrelated
- Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market. A futures exchange is a central financial exchange where people can trade standardized Futures contracts; that is a contract to buy specific quantities of a Commodity A forward contract is an agreement between two parties to buy or sell an asset at a specified point of time in the future The forward market is the over-the-counter Financial market in contracts for future delivery so called Forward contracts Forward contracts are personalized
- Insurance markets, which facilitate the redistribution of various risks. Insurance, in Law and Economics, is a form of Risk management primarily used to hedge against the Risk of a contingent loss
- Foreign exchange markets, which facilitate the trading of foreign exchange. The foreign exchange ( currency or forex or FX) market refers to the market for currencies. The foreign exchange ( currency or forex or FX) market refers to the market for currencies.
The capital markets consist of primary markets and secondary markets. The capital market is the Market for securities, where companies and Governments can raise longterm funds The primary is that part of the Capital markets that deals with the issuance of new securities. The secondary market is the financial market for trading of securities that have already been issued in an initial private or public offering Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy existing securities.
Raising capital
To understand financial markets, let us look at what they are used for, i. e. what is their purpose?
Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as banks help in this process. A banker or bank is a Financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money Banks take deposits from those who have money to save. Money is anything that is generally accepted as Payment for Goods and services and repayment of Debts. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgages. A loan is a type of Debt. This article focuses exclusively on monetary loans although in practice any material object might be lent A mortgage loan is a Loan secured by Real property through the use of a Mortgage (a legal instrument
More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange. A stock exchange, share market or bourse is a Corporation or Mutual organization which provides "trading" facilities for Stock A company can raise money by selling shares to investors and its existing shares can be bought or sold. In financial markets, a share is a Unit of account for various financial instruments including Stocks Mutual funds Limited partnerships See Investor AB for the Swedish investment company An investor is any party that makes an Investment.
The following table illustrates where financial markets fit in the relationship between lenders and borrowers:
| Relationship between lenders and borrowers | |||
| Lenders | Financial Intermediaries | Financial Markets | Borrowers |
| Individuals Companies |
Banks Insurance Companies Pension Funds Mutual Funds |
Interbank Stock Exchange Money Market Bond Market Foreign Exchange |
Individuals Companies Central Government Municipalities Public Corporations |
Lenders
Many individuals are not aware that they are lenders, but almost everybody does lend money in many ways. A financial intermediary is an Institution, firm or individual who mediates between two or more parties in a financial context A person lends money when he or she:
- puts money in a savings account at a bank;
- contributes to a pension plan;
- pays premiums to an insurance company;
- invests in government bonds; or
- invests in company shares.
Companies tend to be borrowers of capital. Generally a company is a form of Business organization. The precise definition varies When companies have surplus cash that is not needed for a short period of time, they may seek to make money from their cash surplus by lending it via short term markets called money markets. In Finance, the money market is the global Financial market for short-term borrowing and lending
There are a few companies that have very strong cash flows. These companies tend to be lenders rather than borrowers. Such companies may decide to return cash to lenders (e. g. via a share buyback. In some countries including the United States and the United Kingdom, Corporations can buy back their own Stock in a share repurchase also known as ) Alternatively, they may seek to make more money on their cash by lending it (e. g. investing in bonds and stocks. )
Borrowers
Individuals borrow money via bankers' loans for short term needs or longer term mortgages to help finance a house purchase. A loan is a type of Debt. This article focuses exclusively on monetary loans although in practice any material object might be lent
Companies borrow money to aid short term or long term cash flows. Cash flow (also called net cash flow) is the balance of the amounts of Cash being received and paid by a business during a defined period of time sometimes tied They also borrow to fund modernisation or future business expansion.
Governments often find their spending requirements exceed their tax revenues. For the government of parliamentary systems see Executive (government. Tax revenue is the Income that is gained by Governments because of Taxation of the people To make up this difference, they need to borrow. Governments also borrow on behalf of nationalised industries, municipalities, local authorities and other public sector bodies. In the UK, the total borrowing requirement is often referred to as the public sector borrowing requirement (PSBR). Public sector borrowing requirement (PSBR is the old name for the Budget deficit in the United Kingdom.
Governments borrow by issuing bonds. A government bond is a bond issued by a national government denominated in the country's own Currency. In the UK, the government also borrows from individuals by offering bank accounts and Premium Bonds. A Premium Bond is a lottery bond issued by the United Kingdom government's National Savings and Investments scheme Government debt seems to be permanent. Indeed the debt seemingly expands rather than being paid off. One strategy used by governments to reduce the value of the debt is to influence inflation. The economic value of a good or service has puzzled economists since the beginning of the discipline In economics inflation or price inflation is a rise in the general level of prices of goods and services over a period of time
Municipalities and local authorities may borrow in their own name as well as receiving funding from national governments. A municipality is an administrative entity composed of a clearly defined territory and its population and commonly denotes a City, Town, or Village, or Local governments are administrative offices that are smaller than a State. In the UK, this would cover an authority like Hampshire County Council.
Public Corporations typically include nationalised industries. A government-owned corporation, state-owned enterprise or government business enterprise is a legal entity created by a Government to undertake commercial Nationalization, also spelled nationalisation, is the act of taking an industry or assets into the Public ownership of a national government These may include the postal services, railway companies and utility companies.
Many borrowers have difficulty raising money locally. They need to borrow internationally with the aid of Foreign exchange markets. The foreign exchange ( currency or forex or FX) market refers to the market for currencies.
Derivative products
During the 1980s and 1990s, a major growth sector in financial markets is the trade in so called derivative products, or derivatives for short. Derivatives are Financial instruments whose values depend on the value of other underlying financial instruments
In the financial markets, stock prices, bond prices, currency rates, interest rates and dividends go up and down, creating risk. Risk is a Concept that denotes the precise probability of specific eventualities Derivative products are financial products which are used to control risk or paradoxically exploit risk. It is also called financial economics.
Currency markets
Seemingly, the most obvious buyers and sellers of foreign exchange are importers/exporters. The foreign exchange ( currency or forex or FX) market refers to the market for currencies. A currency is a unit of exchange, facilitating the transfer of Goods and/or services It is one form of Money, where money is While this may have been true in the distant past, whereby importers/exporters created the initial demand for currency markets, importers and exporters now represent only 1/32 of foreign exchange dealing, according to BIS. The Bank for International Settlements (or BIS) is an International organization of Central banks which "fosters international monetary and [1]
The picture of foreign currency transactions today shows:
- Banks and Institutions
- Speculators
- Government spending (for example, military bases abroad)
- Importers/Exporters
- Tourists
Analysis of financial markets
Much effort has gone into the study of financial markets and how prices vary with time. Much effort has gone into the study of financial markets and how prices vary with time See also Econophysics, complexity, statistical physics, modeling and analysis of financial markets. Charles Dow, one of the founders of Dow Jones & Company and The Wall Street Journal, enunciated a set of ideas on the subject which are now called Dow Theory. Charles Henry Dow ( November 6, 1851 – December 4, 1902) was an American Journalist who co-founded Dow Jones & Company Dow Jones & Company is an American publishing and financial information firm Dow Theory is a heterodox theory on stock price movements that is used as the basis for Technical analysis. This is the basis of the so-called technical analysis method of attempting to predict future changes. Technical analysis is a Financial markets technique that claims the ability to forecast the future direction of security prices through the study of past market One of the tenets of "technical analysis" is that market trends give an indication of the future, at least in the short term. In Investing, Financial markets are commonly believed to have market trends that can be classified as primary trends secondary trends (short-term and secular trends The claims of the technical analysts are disputed by many academics, who claim that the evidence points rather to the random walk hypothesis, which states that the next change is not correlated to the last change. The random walk hypothesis is a financial theory stating that Stock market prices evolve according to a Random walk and thus the prices of the
The scale of changes in price over some unit of time is called the volatility. Volatility most frequently refers to the Standard deviation of the continuously compounded returns of a Financial instrument with a specific time horizon It was discovered by Benoît Mandelbrot that changes in prices do not follow a Gaussian distribution, but are rather modeled better by Lévy stable distributions. Benoît B Mandelbrot (born 20 November 1924 is a French mathematician, best known as the father of fractal geometry. The normal distribution, also called the Gaussian distribution, is an important family of Continuous probability distributions applicable in many fields In Probability theory, a Lévy skew alpha-stable distribution or just stable distribution, developed by Paul Lévy, is a four parameter family of continuous The scale of change, or volatiliy, depends on the length of the time unit to a power a bit more than 1/2. A power law is any Polynomial relationship that exhibits the property of Scale invariance. Large changes up or down are more likely than what one would calculate using a Gaussian distribution with an estimated standard deviation. In Probability and Statistics, the standard deviation is a measure of the dispersion of a collection of values
In the case of the business finance market, major focuses of concern of analysts are:
“. . . general trends and issues in business financing; factors affecting the relative competitiveness and market shares of banks and other supplying organizations; the main influences on businesses' demands for particular types of finance; and business finance sub-markets, new product developments, and marketing. ”[2]
Financial markets in popular culture
- Gordon Gekko is a famous caricature of a rogue financial markets operator, famous for saying "greed . Gordon Gekko is a Fictional character from the 1987 film Wall Street. A caricature is either a Portrait that exaggerates or distorts the essence of a person or thing to create an easily identifiable visual likeness or in literature a description . . is good".
Only negative stories about financial markets tend to make the news. News is any new information or information on Current events which is presented by print, broadcast, Internet, or Word of mouth The general perception, for those not involved in the world of financial markets is of a place full of crooks and con artists. A confidence trick or confidence game (also known as a bunko, con, flim flam, gaffle, grift, scam, scheme Big stories like the Enron scandal serve to enhance this view. Enron Creditors Recovery Corporation (formerly Enron Corporation, former NYSE ticker symbol ENE was an American Energy company based in
Stories that make the headlines involve the incompetent, the lucky and the downright skillful. The Barings scandal is a classic story of incompetence mixed with greed leading to dire consequences. Barings Bank (1762 to 1995 was the oldest Merchant bank in London until its collapse in 1995 after one of the bank's employees Nick Leeson, lost £827 Another story of note is that of Black Wednesday, when sterling came under attack from hedge fund speculators. In British Politics and Economics, Black Wednesday refers to the events of 16 September 1992 when the Conservative A hedge fund is a private Investment fund open to a limited range of investors which is permitted by regulators to undertake a wider range of activities than other investment Speculation, in a financial context is making an investment that increases the overall risk in a portfolio This led to major problems for the United Kingdom and had a serious impact on its course in Europe. The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom, the UK or Britain,is a Sovereign state located The European Union ( EU) is a political and economic union of twenty-seven member states, located primarily in A commonly recurring event is the stock market bubble, whereby market prices rise to dizzying heights in a so called exaggerated bull market. A stock market bubble is a type of Economic bubble taking place in Stock markets when price of Stocks rise and become overvalued by any measure of Stock In Investing, Financial markets are commonly believed to have market trends that can be classified as primary trends secondary trends (short-term and secular trends This is not a new phenomenon; indeed the story of Tulip mania in the Netherlands in the 17th century illustrates an early recorded example. Tulip mania or tulipomania ( Dutch names include tulpenmanie tulpomanie tulpenwoede tulpengekte and bollengekte) was a period in the
Financial markets are merely tools. Like all tools they have both beneficial and harmful uses. Overall, financial markets are used by honest people. Otherwise, people would turn away from them en masse. As in other walks of life, the financial markets have their fair share of rogue elements.
Financial markets slang
- Big swinging dick, a highly successful financial markets trader. The term was made popular in the book Liar's Poker, by Michael Lewis
- Geek, a Quant
- Grim, an ageless man known for his whistle and tendency to relate current events to financial market
- Nerd, a Quant
- Quant, a quantitative analyst skilled in the black arts of PhD level (and above) mathematics and statistical methods
- Rocket scientist, a financial consultant at the zenith of mathematical and computer programming skill. For the book by Michael Lewis see Liar's Poker. Liar's poker is a bar game that combines statistical reasoning with bluffing and is played Michael Lewis (born October 15, 1960, New Orleans Louisiana) is an American contemporary Non-fiction author A quantitative analyst is a person who works in finance using numerical or quantitative techniques "PhD" redirects here for other uses see PhD (disambiguation. Mathematics is the body of Knowledge and Academic discipline that studies such concepts as Quantity, Structure, Space and Statistics is a mathematical science pertaining to the collection analysis interpretation or explanation and presentation of Data. They are able to invent derivatives of frightening complexity and construct sophisticated pricing models. Derivatives are Financial instruments whose values depend on the value of other underlying financial instruments They generally handle the most advanced computing techniques adopted by the financial markets since the early 1980s. Typically, they are physicists and engineers by training; rocket scientists do not necessarily build rockets for a living.
- White Knight, a friendly party in a takeover bid. In Business, a white knight may be a Corporation, a private company or a person that intends to help another firm In business a takeover is the purchase of one company (the target) by another (the acquirer, or bidder) Used to describe a party that buys the shares of an organization to help prevent the takeover of that organization by another party (that is making a hostile bid).
See also
- Finance capitalism
- Financial instrument
- Investment theory
- Quantitative behavioral finance
- Stock investor
Notes
- ^ Steven Valdez, An Introduction To Global Financial Markets
- ^ The Business Finance Market: A Survey, Industrial Systems Research Publications, Manchester (UK), new edition 2002, page 1. Finance capitalism is a term in Marxian Political economics defined as the subordination of processes of Production to the accumulation of Money Financial instruments are cash evidence of an ownership interest in an entity or a contractual right to receive or deliver cash or another financial instrument Investment theory encompasses the body of knowledge used to support the decision-making process of choosing investments for various purposes Quantitative behavioral finance is a new discipline that uses mathematical and statistical methodology to understand behavioral biases in conjunction with valuation. A stock trader or a stock investor is an Individual or firm who buys and sells Stocks or bonds (and possibly other ISBN 978-0-906321-19-5.
References
- T. E. Copeland, J. F. Weston (1988): Financial Theory and Corporate Policy, Addison-Wesley, West Sussex (ISBN 978-0321223531)
- E. J. Elton, M. J. Gruber, S. J. Brown, W. N. Goetzmann (2003): Modern Portfolio Theory and Investment Analysis, John Wiley & Sons, New York (ISBN 978-0470050828)
- E. F. Fama (1976): Foundations of Finance, Basic Books Inc. , New York (ISBN 978-0465024995)
- M. M. Groz (1999): Forbes Guide to the Markets, John Wiley & Sons, Inc. , New York (ISBN 0-471-24658-1)
- R. C. Merton (1992): Continuous-Time Finance, Blackwell Publishers Inc. (ISBN 978-0631185086)
- Steven Valdez, An Introduction To Global Financial Markets, Macmillan Press Ltd. (ISBN 0-333-76447-1)
- The Business Finance Market: A Survey, Industrial Systems Research Publications, Manchester (UK), new edition 2002 (ISBN 978-0-906321-19-5)
Dictionary
financial market
-noun
- A market where financial securities (such as stocks and bonds) and commodities are bought and sold.
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