What Are Financial Markets? & How does it work? – RotimiOceans


Financial markets are the largest platforms in the investment space, driving a nation’s economy and providing a robust platform for financial providers and investors. Here’s a detailed guide to what financial business markets are all about!

Financial markets like money and capital are spaces where assets are traded. The stock market, bond market, and foreign exchange market are all examples of markets that trade securities. These markets are not the only ones that do so but are among them. 

Financial markets provide returns to those with surplus funds, such as investors and lenders, and make those funds available to borrowers.

This post explains more about financial markets, their types, and the pros and cons of investing in them!

 

What are Financial Markets?

financial market is where stocks, bonds, assets, or similar securities are traded. There are several types of financial markets, such as foreign exchange, money, stock, and bond markets.

These markets help the functioning of capitalist nations by including assets or securities that can be traded over the counter (OTC) or by listing methods on regulated exchanges. The collapse of financial markets can lead to economic disruptions such as recession and unemployment.

 

Types of Financial Markets

Let us understand the various kinds of financial markets:

 

1. Stock Markets

Stock markets are omnipresent. In almost every developing country, you will find these financial markets, where organizations list the shares that investors then trade. Companies enter the secondary market and build capital using Initial Public Offerings (IPOs) and the stock market.

Stock trading is done via public exchanges such as the Nigerian Stock Exchange and NASDAQ or over the counter. Most stock trading is done through regulated exchanges, indicating the economy’s overall health.

These financial business markets provide investors with capital gains and dividend income. Typical participants in the stock market are:

  • Investors and traders.
  • Market makers (MM).
  • Brokers (who facilitate transactions between buyers and sellers).
  • Professionals who maintain liquidity and provide an interactive market.

Over-the-Counter Financial Markets

These are decentralized markets with no physical locations, and transactions are done digitally or electronically. There’s no broker or middle-person intervention; most trading is done through exchanges.

 

2. Bond Financial Markets

A bond is a contract between a lender and a borrower in which an investor borrows money for a specified period at a predetermined interest rate.

Bonds are issued by organizations and local, state, and sovereign governments to accumulate funds for projects and operations, which are also known as the debt, credit, or bond market.

Take the example of the FGN Savings Bonds, which are considered one of the safest forms of investment as the complete trust and credit of the Federal Government of Nigeria backs them.

There’s no risk of default, ensuring that interest and principal are paid when due. Also, there are no state and local taxes on investments.

You can invest in FGN bonds through the Nigerian Stock Exchange’s brokerage.

 

3. Money Markets

Money markets typically trade short-term securities with a maturity of less than one year. These instruments have high liquidity, a high degree of security, and low interest rates.

The money market involves large-scale transactions between institutions and dealers. It can also be purchased by individual investors who can invest in the money market by purchasing short-term certificates of deposit (CDs), municipal bonds, or treasury bills.

There are two types of money markets:

  • Discount money market

A discount money market is an establishment that deals with non-conditional orders in writing or bills of exchange. Discount vouchers are accommodated by purchasing below face value. There’s always a gap between the maturity value and discount value. Acceptance points (commercial banks) accept bills of exchange against fees.

  • Parallel money market

A parallel money market is a borrowing and lending practice between horizontal sectors tailored between interbank deposits. Banks with surplus funds can offer lending funds to banks with a deficit.

Let’s look at examples of money market investments:

 

4. Treasury Securities

Treasury bills, commonly called T-bills, are short-term government-guaranteed securities issued by CBN. T-Bills sell below par and are generally considered a low-risk and safe investment.

These are issued when the Nigerian government needs to borrow money for some time and have a maximum term of 364 days.

 

5. Certificate of Deposit (CD)

A CD is a savings/term account offering higher interest rates for a specific period than a regular one. You should invest your money in a CD you’re sure you won’t need anytime soon.

The usual maturity period of CDs is 1, 3, and 5 years, so if you want to grow your funds safely within a certain period for a specific purpose, a CD is a good choice. However, premature withdrawal of CDs will only be possible after paying a fee.

 

6. Derivatives Financial Markets

A derivative is a contract between two or more parties that has a value based on an agreed-upon underlying financial asset.

Derivatives are secondary securities whose value is derived from the value of the related primary security – they, by themselves, have no value. Instead of trading stocks directly, the derivatives market trades futures, options contracts, and other sophisticated financial instruments that derive value from underlying assets.

Futures contracts are listed and traded on the futures market using standardized contract specifications. These markets are well-regulated and use clearinghouses to settle and confirm trades.

The Nigerian Stock Exchange lists and regulates contracts similarly, wherein options/futures exchanges can list contracts for different asset classes such as stocks, bonds, and commodities.

 

7. Forex Financial Markets

The foreign exchange (FX) market is one of the most liquid financial markets, where you can purchase, hedge, sell, and speculate on exchange rates between different world currencies.

The forex market deals with instant cash and processes more financial transactions than the futures and stock markets combined.

Forex markets financial include banks, trading houses, hedge funds, and investors. Just like the OTC market, these markets are decentralized and include a large network of participants from across the globe.

 

8. Commodity Financial Markets

Commodity markets are where buyers and sellers choose between agricultural commodities, energy products, precious metals, or consumable commodities as trading items.

Producers and commercial buyers hedge their risks by dealing with them. These may not be suitable for retail investors unless they understand how commodities trading works.

You can also invest in commodities indirectly through stocks, mutual funds, ETFs, and futures contracts.

Let’s look at the Oil and Gas commodity market as an example below 

Nigeria is one of the world’s largest oil producers, offering domestic and foreign investors a huge opportunity to earn millions of Naira annually.

Being a highly regulated sector, it is more complex to invest in than other sectors, requiring proper research, expertise, financial competence, and paperwork.

However, one way to invest in oil is to buy an energy ETF, mutual fund, or shares in oil and gas companies.

 

Functions of Financial Markets

Financial markets are a solid platform where investors and organizations meet to raise large amounts of capital, mainly by exchanging stocks and bonds in financial markets.

Financial markets have the basic function of allowing companies to balance risks on the traded commodities, currency futures, and other derivatives.

These markets are transparent places that reflect appropriate knowledge about everything traded, thus reducing the cost of information gathering. They thrive on liquidity, meaning sellers can offload assets whenever they need to raise cash. Businesses don’t have to go far to find buyers and sellers.

 

Let’s look at the role of financial markets:


These markets help you utilize your savings more productively.

These markets help you utilize your savings more productively.

Is saving your money in bank accounts and saving deposits the only way to keep your money safe and earn interest?

Financial markets like banks are opening their doors to individuals and businesses needing mortgages, student loans, or business loans.

You can invest your savings in markets that generate higher returns and give you the benefit of taking higher risks.

 

Determine the price of a security.

Demand and supply generally calculate the price range when you buy goods and services.

However, financial markets differ as the primary objective is earning profit from securities. Thus, the prices of securities are calculated considering the markets’ financial situation.

 

High liquidity of financial assets

Buyers and sellers can choose to trade securities at any time. They can use financial markets to sell securities or invest as they please.

 

Reduce transaction costs

Financial business markets allow you to get information about securities without spending money.

 

What Are the Advantages and Disadvantages of Financial Markets?

Financial markets provide a venue where participants, such as investors and debtors, are treated fairly and appropriately regardless of size.

These markets provide individuals, businesses, and government agencies access to capital. They help mitigate unemployment by providing many job opportunities.

Plus, financial business markets allow traders to raise funds in long-term and short-term programs to grow their businesses. They do not limit an investor’s choice of security or asset class by offering them a variety of assets to buy, sell, or invest in.

  • The cons are that you must follow the rules and regulations of authorities like the Nigerian Stock Exchange. There are several protocols to follow for interested traders.

Despite having a stringent set of rules to follow, the process is transparent and trustworthy, encouraging more individuals and organizations to participate in the trading process.

 

Conclusion

Financial markets are thriving spaces that boost a nation’s economy. These markets help organisations gather funds and investors make money while helping lower unemployment, providing many new job opportunities.

They also provide a platform where participants such as investors and companies are treated fairly and appropriately regardless of size. Besides, they extend access to capital for government agencies, businesses, and individuals.

Want to grow your wealth and make the most of the financial markets? Start with Pillow. Besides that, you can invest in any of the markets mentioned above and build a strong financial corpus to meet your short-term and long-term objectives.

 

Frequently Asked Questions

 

How do financial markets work?

Financial markets cover several securities and asset classes with different rules, protocols, and structures. They normally work by grouping buyers and sellers into assets or contracts and allowing them to trade against each other through a price discovery mechanism.

 

What are the main functions of financial business markets?

Financial markets enable free markets for capital, financial debt, and money flows. These markets enable the effective allocation of capital and assets in the financial economy.

They can run and boost the global economy and help investors derive fruitful capital gains over time.

 

Why are financial markets important?

Efficient capital allocation is impossible without financial markets, which can severely limit economic activities such as trade, commerce, investment, and growth opportunities.

 

Who are the main participants in financial markets?

The main participants are investors and companies (which can also include government agencies) who use the stock and bond markets to raise money. Brokers often act as intermediaries, matching buyers and sellers and earning commissions or fees for their services.

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