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.
Financial markets have evolved significantly over several hundred years and are undergoing constant innovation to improve liquidity.
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.
In finance, financial markets facilitate:
a. The raising of capital (in the capital markets)
b. The transfer of risk (in the derivatives markets)
c. International trade (in the currency markets)
– and are used to match those who want capital to those who have it.
Typically a borrower issues a receipt to the lender promising to pay back the capital. These receipts are securities which may be freely bought or sold. In return for lending money to the borrower, the lender will expect some compensation in the form of interest or dividends.
In mathematical finance, the concept of a financial market is defined in terms of a continuous-time Brownian motion stochastic process.
In economics, typically, the term market means the aggregate of possible buyers and sellers of a thing and the transactions between them.
The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This may be a physical location (like the NYSE) or an electronic system (like NASDAQ). Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell stock from the one to the other without using an exchange.
Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, similar to stock exchanges.
Financial markets can be domestic or they can be international.
Types of financial markets
The financial markets can be divided into different subtypes:
a. Capital markets which consist of:
o Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.
o Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.
b. Commodity markets, which facilitate the trading of commodities.
c. Money markets, which provide short term debt financing and investment.
d. Derivatives markets, which provide instruments for the management of financial risk.
o Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.
* Insurance markets, which facilitate the redistribution of various risks.
* Foreign exchange markets, which facilitate the trading of foreign exchange.
The capital markets consist of primary markets and secondary markets. 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.
Lenders
Individuals
Many individuals are not aware that they are lenders, but almost everybody does lend money in many ways. A person lends money when he or she:
1 puts money in a savings account at a bank;
2 contributes to a pension plan;
3 pays premiums to an insurance company;
4 invests in government bonds; or
5 invests in company shares.
Companies
Companies tend to be borrowers of capital. 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.
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.) Alternatively, they may seek to make more money on their cash by lending it (e.g. investing in bonds and stocks.)
source : dow jones, wikipedia.org
