Financial markets exist so that issuers and investors may buy and sell assets to build capital and fund growth. The main economic functions that financial markets enable include creating a regulated system for allocating newly formed capital, trading existing assets, and managing financial risks. Understanding the opportunities of investing in different markets is essential for finance professionals as they work toward building capital and spurring economic development for individuals and organizations.
Capital Markets (Stocks/Bonds)
Capital markets are made up of primary and secondary markets where users buy and sell equity securities, known as stocks, and debt securities, called bonds. Primary markets are where companies and governments sell newly issued securities to buyers, while secondary markets consist of previously issued stocks and bonds, which make up the majority of trading in the capital markets. Companies utilize these markets as a means for raising capital by issuing IPOs, bonds, and other securities. Individual investors seek to earn interest or dividends on their investments by investing in these bonds and stocks via capital markets. In this way, investment in capital markets fosters economic growth as companies are able to hire people, grow their businesses, and put new products and services on the market.
Derivatives Markets (Options/Futures/Forwards)
Derivatives are securities with prices that are based or dependent upon the value of an underlying asset. Derivatives can be traded over-the-counter (OTC) or on an exchange and are used by investors to hedge against fluctuations in exchange rates, interest rates, commodity prices, and credit worth. Derivative transactions transfer risks from entities that are unable or unwilling to manage risks to those that are and investors take advantage of this to protect against detrimental changes in the values of their assets and liabilities. Future contracts are the most common derivatives. They represent an agreement between two parties to buy or sell an asset at a specified quantity, price, and time of delivery in the future. Forward contracts are very similar, with the difference being that they are traded mostly in OTC contracts. Options contracts are agreements between two parties to buy or sell assets at a future date, though they differ from futures in that the buyer or seller is not obligated to make the transaction. Speculators also make use of options and futures to hedge against risk or to assume risk in anticipation of making significant financial gains.
Commodities Markets (Metals/Oil/Physical Assets)
Commodities are raw or primary products categorized as either hard commodities, which consist of natural resources that need to be mined or extracted, such as gold or oil, or soft commodities, which are made up of agricultural or livestock products. Investors take part in the commodity market by either purchasing stock in a company in an industry that relies on the price of commodities or by purchasing exchange-traded funds, mutual funds, or index funds which represent these companies. Investors can also buy futures contracts which ensure the buying or selling of a commodity at a predetermined price at a future date. Major commodity exchanges in the United States include the Chicago Board of Trade (CBOT), New York Board of Trade (NYBOT) and the New York Mercantile Exchange (NYMEX).
Foreign Exchange Markets (Currencies)
The foreign exchange (forex) markets enable investors to buy, sell, and speculate on foreign currencies based on expectations of exchange rate fluctuations. Businesses, banks, hedge funds, investment management firms, and individual investors take part in the forex market, which is the largest asset market in the world. Investors find the forex market attractive because of the massive trading volume, meaning large numbers of investors are trading in currency on a daily basis, which provides buyers and sellers with high liquidity. Due to the differing time zones all over the world, the forex market is open twenty-four hours a day five days a week, giving investors more opportunities to capitalize on their investments.
Money markets provide investors with an opportunity for highly liquid short-term investments that are relatively safe, while giving borrowers access to low-cost funds. Maturities for money market funds range from a day to a year benefiting lenders and borrowers in managing cash and short-term funding needs. There are numerous options for investing in money market funds, many of which focus on government, municipal, corporate, or bank debt securities. They are often tailored to the different types of investors, such as retail investors or institutional investors and differ in how they are traded and regulated based on the type of money market fund. U.S. Treasury bills, commercial paper, short-term Federal agency securities, interbank loans, and repurchase agreements are some of the major money market instruments currently being traded.
These financial markets are the platforms where the majority of the world’s trading takes place. They have the potential to boost the economy by allowing individuals, banks, businesses, and governments to function and expand. It is critical that future finance professionals grasp the basics of these markets as they are the foundations of investing.