Types of Financial Markets
A market in which shares of stock are bought and sold is called stock market. The word ‘stock’, in American usage, means equity or ownership in a corporation. A share is the basic unit of a company’s capital, which it tries to raise from the stock market. When you own a stock, you are referred to as a share or stockholder. A stock shows that you own a small fraction of a corporation; hence if you buy stock in the Pepsi Corporation and they come out with a ‘cool’ new drink that becomes a hit, then you get to share the profits. A stock also gives you the right to make decisions that may influence the company. Therefore, the more stocks you own, the more decision-making power you have.
Foreign Exchange is the simultaneous buying of one currency and selling of another. The foreign exchange market is the largest financial market in the world. The world’s currencies are on a floating exchange rate and are always traded in pairs. Here, settlement is made for international purchases and sales, i.e., for exports and imports, as also for payments international purchases and sales of assets. Operating virtually round the clock, the forex market trades enormous amounts of money, estimated at several trillion dollars daily.
The forex market is not centrally located. It is an over-the-counter market where business is conducted through telephones, computers, fax machines etc. Among its members are large corporations, commercial banks, money centers, pension funds and investment banking firms. As individuals or companies from one country trade across borders, the need for foreign currency arises. The resultant trading differential generates profits and keeps the forex market in animation.
Debt is the liability or obligation in the form of bonds, loan notes, or mortgages, owed to another person or persons and required to be paid by a specified date (maturity).
It is one in which mainly debt is transacted which could be in the form of debt instruments or cash. In the first place, there is the money market a huge market trading in debt instruments with an original maturity of one year or less. Typical instruments here include Treasury Bills, bank certificates of deposits etc. Secondly, there is the bond market in which long-term debt obligations are traded. As such, the bond market is the long-term complement to the money market.
I. The Money Market:
In this, the short-term surpluses of financial and other institutions and individuals are bid by borrowers, comprising institutions and individuals and also by the Government. In other words, a money market is one in which short-term funds are borrowed and lent. The borrowers are traders, speculators, brokers and producers of various commodities as well as government and institutional borrowers. The lenders include commercial banks, insurance companies and other institutional borrowers.
II. The Bond Market:
Bond market is the market for all types of bonds, whether on an exchange or over-the-counter. A bond is a debt instrument. An example of a bond can be a debenture. The following are the terms mostly used in the bond market.
Bond Term: The term of the bond is the number of years between the date it was initially issued and the date it matures.
Current Yield: A current yield is simply the yearly amount you receive in coupon income, divided by the market value of your bond. The current yield does not take into account the timing of coupon interest or the interest you might earn when you invest your coupon income.
Equilibrium in Financial Markets
Financial markets are said to be perfect when the following conditions are met:
1. A large number of savers and investors operate in markets.
2. The savers and investors are rational.
3. All operators in the market are well-informed and information is freely available.
4. There are no transaction costs.
5. The financial assets are infinitely divisible.
6. The participants in the market have homogeneous expectations.
7. There are no taxes.
On the whole it can be stated that equilibrium is established in the financial markets when the expected demand for funds for short-term and long-term investments matches with the planned supply of funds generated out of savings and credit creation.