Importance Of Financial Markets: When you read the term – Financial Markets, instantly, your mind registers the image of a stock exchange. However, these aren’t the only types of financial markets in the world.
In fact, there are over six types of markets excluding the stock market. We’re going to cover all of them in this article, while also highlighting the importance of financial markets.
What Are Financial Markets?
Markets are commercial spaces where products and services are traded for cash. A financial market works the same way, with the difference being the products and services are completely financial/finance based.
This means that financial securities are traded (bought & sold) on a regular basis. This includes the stock market, the bond markets, forex, commodities, and so on.
Such markets are necessary for a capital-intensive economy to keep the country’s businesses and industries running smoothly.
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The Role Of Financial Markets In An Economy
Based on the type of market you’re looking at, financial markets have a huge role to play in the economy of the country and thereby the world. It impacts everyone, including those who don’t actively participate in the markets themselves.
- Financial markets allow businesses to raise funds for their company.
- It creates transparency between investors and companies and thereby the government.
- Improves investor confidence, which helps regulate the economy.
- Allows retail investors an opportunity to generate extra income and diversify their wealth.
Types Of Financial Markets
Here are some of the major types of financial markets in the world, starting off with the capital markets or stock markets.
1. Stock Market
The stock market or capital market is where securities, mainly stocks of listed companies are bought and sold in a regulated market.
Here, companies list themselves to raise capital through an initial public offering (IPO), and investors can buy said shares to own a fraction of the company.
In India, the stocks are traded on the two listed exchanges – the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). For any security to trade on the regulated market, it has to list itself on the stock exchanges.
The participants of the market, which includes retail as well as institutional investors, traders, and market makers maintain the liquidity and volatility of the market.
2. Bond Market
Bonds are securities that allow investors to loan money to businesses for a fixed period of time, in exchange for a fixed interest rate. Bonds are not just issued by businesses.
They can be issued by large corporations and governments as well. Usually, bonds are issued to raise capital for an upcoming project or investment. It is also known as the debt market or the fixed-income market.
3. Commodities Market
Commodities refer to physical products such as agricultural products and energy products. A commodity market allows traders to sell their products to consumers.
It ranges from corn and livestock to gold, silver, and oil. The markets where such products are exchanged for money are also known as spot commodity markets.
There is also a futures market in commodities, where products are exchanged for a fixed price at a future date that is pre-decided between the involved parties.
4. Derivatives Market
To understand the derivatives market, you first to know the meaning of derivatives. They are financial instruments, whose value is based on their underlying assets, such as stocks, commodities, indices, and currencies.
This makes derivatives secondary securities as their value is derived from the primary security. A futures contract is an example of a derivative.
5. Money Market
The money markets deal in short-term debt instruments (with maturity equal to or less than a year). That includes T-bills, commercial paper, and certificates of deposit.
This type of market has lower interest and higher safety. The money markets are used mostly by institutional investors and traders.
6. Forex Market
Forex refers to foreign exchange markets. Here, market participants can buy, sell, and hedge currency pairs in international markets. The forex markets are the most liquid markets in the world.
Currency pairs are traded on a daily basis, and it handles over $6 trillion dollars in daily transactions. Traders and investors take advantage of the slight price difference between exchange rates to make profits.
7. Cryptocurrency Market
Of all the financial markets mentioned here, the crypto market is fairly new and controversial. This market is completely based on the price movement and volatility of cryptocurrencies, which are decentralized digital tokens built on blockchain technology.
There are tens of thousands of cryptocurrencies in circulation, and the most dominant ones in the market are Bitcoin and Ethereum.
Most cryptocurrency exchanges operate similarly to a stock exchange, with trading features like coin pairs, futures and options, and day trading.
This market is largely unregulated as new discoveries are still being made in this space and its volatility makes it a high-risk high reward platform for investors and traders alike.
Importance Of Financial Markets
The significance of Financial Markets is outlined in the following points.
1. Liquidity Of Financial Assets
The financial markets create liquidity for financial instruments in the market, so they can easily be bought and sold for cash in markets.
2. Productive Use of Idle Cash
One of the main uses of the financial markets is to take idle cash accumulated by institutions and individuals and put better use in developing a business. This includes savings and excess cash in hand.
3. Access To Capital For Businesses
Through financial markets, businesses, and corporations have easier access to capital for expansion and funding, usually at a lower interest rate than loans issued by creditors.
This opens up new opportunities for companies to raise capital, besides the conservative option of taking loans.
4. Price Discovery Of Securities
In traditional markets, prices are decided by the supply and demand of the products. But for financial instruments, the price is determined by the financial markets.
We have reached the end of our article on the importance of financial markets. As you have read above, the markets are much more complex than investing and trading alone.
They serve a bigger purpose in the economy and are absolutely essential for the growth of industries and the economy as well. Thank you for reading and Happy Investing!
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