Introduction to Financial Markets

• Introduction
• Types
• Participants
• Functions
• Importance

• Imagine a giant marketplace where businesses and investors come together. Instead of selling fruits or clothes, this marketplace deals in financial instruments like stocks, bonds, currencies, and gold. This is the world of financial markets.
  To begin with, let’s start by defining the financial market according to David Durand. He defines the Financial Market as a system by which people and institutions can buy and sell financial securities themselves or for mutual benefits. And then, the first point to be considered is security. Security is the financial instrument that makes the investment of funds profitable, it is also called ‘title’. Now, the question in mind is: can these financial systems act in an organized way between individuals and institutions? This is what distinguishes organised financial markets from unorganised financial markets.
  These platforms that bring together buyers and sellers of securities are sometimes physically placed like in the case of the stock market; others, for example, bond markets, are not. However, all financial markets have macro-scale characteristics and micro-scale features. Financial markets have high integration with the overall economy and with a country, region, or even the world at large. The individuals, firms, or countries that make use of these markets are related to some extent. Financial markets and their characteristics, together with their interactional framework, can explain the effect on the social system and predict why and how the economy of the world is shaped.

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• With the financial market, people trade financial securities, commodities, and other valuables such as currencies, mortgage obligations, real estate, and related activities. These security markets are often divided into two key market subsets: primary and secondary markets. Think of the primary market as the birthplace of new securities. Companies and governments issue new stocks and bonds for the first time to raise capital. This can be done through Initial Public Offerings (IPOs) for stocks or bond issuances. Investment banks typically play a role in facilitating these offerings. For example the initial public offering of the Chinese BEV company ZEEKR INTELLIGENT TECHNOLOGY on the 10th of MAY 2024. The company hired four underwriting firms to determine the financial details of its IPO. The underwriters detail that the issue price be $21. Investors can then buy the stock at $21 directly from the issuing company or the New York Stock Exchange (NYSE). Once the company shares start trading on NTSE, traders in the secondary market now set in.
  With the secondary market, investors trade these securities amongst themselves. So, after the initial issuance in the primary market, subsequent buying and selling of those securities happen here. One active player is important to facilitate the trading. These are investment brokers of banks who provide a suitable trading platform like Meta Traders 4 or 5. With the secondary market, traders don’t buy the actual shares but only speculate on the price and profit from the difference between the entry and exit price. This act of price speculation without buying the actual shares is called a contract for difference (CFD). In the secondary market, traders can profit by trading with securities like foreign exchange, stocks, commodities like gold, indices, exchange-traded funds, cryptocurrencies like Bitcoin, etc.
  The most important stock market in the world by listing a company’s securities is the New York Stock Exchange (NYSE), and the largest stock market by monetary value is the NASDAQ. While it trades mainly in stocks, bonds, and derivatives, a financial market can contain almost everything that can be traded, from commodities such as grains, sheep, and pigs to the copyright on films, the right to sell coffee, and even student dorms or prisons.

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• For a financial market to function efficiently, different types of participants with distinct but complementary roles are necessary. It is not sufficient to generate suitable financial instruments and market infrastructures. Indeed, deriving value from those requires participants such as investors, regulated market operators and investment firms, providing liquidity, among others. It is the interaction of those different types of participants that plays a fundamental role in the information-generating process, a fundamental function of the financial markets.

  Investors: These are the folks looking to grow their money. They can be individuals (retail investors) buying stocks through a brokerage account, or large institutions like pension funds and hedge funds managing millions.

  Issuers: On the other side, we have companies and governments needing capital. They issue securities like stocks and bonds in the primary market to raise funds for growth or operations.

  Intermediaries: These are the middlemen who help things run smoothly. Brokers connect buyers and sellers, while investment banks help companies issue securities. Clearinghouses ensure smooth trade settlement and manage risk.

  Regulators: Financial markets need referees! Regulatory bodies like the Securities and Exchange Commission (SEC) set the rules, ensure fair play, and protect investors.

  Market Makers: These are specialists who provide liquidity by continuously quoting buy and sell prices for specific securities, helping to maintain a smooth flow of trades.

  Other Players: The financial market ecosystem also includes credit rating agencies that assess the creditworthiness of issuers, custodians who hold securities for safekeeping, and even central banks that influence interest rates and overall economic conditions.

  This is just a glimpse into the diverse cast of characters that make the financial market work. Each participant plays a specific role, contributing to the flow of capital that fuels economic activity.

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• Financial markets provide an efficient mechanism by which suppliers of capital can channel their savings to the most suitable investors. The services provided by financial markets fall into five primary categories.

  Covenant-Enforcement Function: Shareholders invest in managed corporations. In the course of managing corporate assets, principals make investment decisions that produce gains or losses. Shareholders play the role of lenders because they finance working capital and investment. As a result, they must extract any gains made on those investments. Financial markets provide that information.

  The Risk-Sharing Function: Financial markets enable individuals to spread the burden of risk. They can diversify their assets by buying a variety of financial products, which effectively merge the assets of other individuals. The funds collected from these investments can be used to support new business investments, thereby channeling funds from savers to business managers who can use them most effectively and productively. On the other hand, funds can also be used for personal or other consumption needs.

  The Informational Function: Financial markets process and disseminate pricing information. Pricing dictates the allocation of resources in the economy. Higher prices generate higher profits, which attract new investment, channeling resources to the new business. Conversely, lower profitability may be a signal to reduce investments or to develop.

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• The financial markets play a pivotal role in the economy. They serve to allocate capital from a vast universe of possible investment opportunities. By channelling funds to particular venues, the markets direct and intertwine the activities of the corporate and government sectors, resulting in the creation and distribution of goods and services. When markets function properly, they help bring about the optimal distribution of capital assets. This process should reflect the efforts and judgment of the public as a whole, through the decentralized decision-making of individual investors and corporate managers.
  For most families, household wealth depends on financial markets. Low-income families rely on Social Security payments, which are affected by market performance. High-income families earn from individual investments and company stock. State pension funds connect all groups and carry risk. Efficient processes for pricing and distributing risk in these markets are crucial.

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