Financial markets

What do markets do?

Financial markets take many different forms and operate in diverse ways

Price setting. The value of an ounce of gold or a share of stock is no more, and no less, than what someone is willing to pay to own it. Markets provide price discovery, a way to determine the relative values of different items, based upon the prices at which individuals are willing to buy and sell them.

Asset valuation. Market prices offer the best way to determine the value of a firm or of the firm’s assets, or property. This is important not only to those buying and selling businesses, but also to regulators. An insurer, for example, may appear strong if it values the securities it owns at the prices it paid for them years ago, but the relevant question for judging its solvency is what prices those securities could be sold for if it needed cash to pay claims today

Arbitrage. In countries with poorly developed financial markets, commodities and currencies may trade at very different prices in different locations. As traders in financial markets attempt to profit from these divergences, prices move towards a uniform level, making the entire economy more efficient.

Raising capital. Firms often require funds to build new facilities, replace machinery or expand their business in other ways. Shares, bonds and other types of financial instruments make this possible. Increasingly, the financial markets are also the source of capital for individuals who wish to buy homes or cars, or even to make credit-card purchases.

Commercial transactions. As well as long-term capital, the financial markets provide the grease that makes many commercial transactions possible. This includes such things as arranging payment for the sale of a product abroad, and providing working capital so that a firm can pay employees if payments from customers run late.

Investing. The stock, bond and money markets provide an opportunity to earn a return on funds that are not needed immediately, and to accumulate assets that will provide an income in future

Risk management. Futures, options and other derivatives contracts can provide protection against many types of risk, such as the possibility that a foreign currency will lose value against the domestic currency before an export payment is received. They also enable the markets to attach a price to risk, allowing firms and individuals to trade risks until they hold only those that they wish to retain.

Yield is the income the investor receives while owning an investment

Capital gains are increases in the value of the investment itself, and are often not available to the owner until the investment is sold.

Mutual funds and unit trusts are investment companies that typically accept an unlimited number of individual investments.

A third type of investment company, a hedge fund, can accept investments from only a small number of wealthy individuals or big institutions. investment strategies, such as using borrowed money to increase the amount invested and focusing Hedge funds are able to employ extremely aggressive investment on one or another type of asset rather than diversifying. If successful, such strategies can lead to very large returns; if unsuccessful, they can result in sizeable losses and the closure of the fund.

Liquidity, the ease with trading can be conducted. In an illiquid market an investor may have difficulty finding another party ready to make the desired trade, and the difference, or “spread”, between the price at which a security can be bought and the price for which it can be sold, may be high. Trading is easier and spreads are narrower in more liquid markets. Because liquidity benefits almost everyone, trading usually concentrates in markets that are already busy

Transparency, the availability of prompt and complete information about trades and prices. Generally, the less transparent the market, the less willing people are to trade there

Reliability, particularly when it comes to ensuring that trades are completed quickly according to the terms agreed.

Legal procedures adequate to settle disputes and enforce contracts.

Suitable investor protection and regulation. Excessive regulation can stifle a market. However, trading will also be deterred if investors lack confidence in the available information about the securities they may wish to trade, the procedures for trading, the ability of trading partners and intermediaries to meet their commitments, and the treatment they will receive as owners of a security or commodity once a trade has been completed.

Low transaction costs. Many financial-market transactions are not tied to a specific geographic location, and the participants will strive to complete them in places where trading costs, regulatory costs and taxes are reasonable.

Pegs. Another form of fixed exchange rates is a pegged rate.

The word “bond” means contract, agreement, or guarantee. All these terms are applicable to the securities known as bonds. An investor who purchases a bond is lending money to the issuer, and the bond represents the issuer’s contractual promise to pay interest and repay principal according to specified terms. A short-term bond is often called a note.

Bonds backed by the full faith and credit of national governments are called sovereigns

Equity, quite simply, means ownership. Equities, therefore, are shares that represent part ownership of a business enterprise.

Future contracts – keep in mind for materials atleast

A put option entitles the buyer to sell the underlying at an agreed price, known as the strike price, for a specific period of time. A call option gives the buyer the right to purchase the underlying at the strike price. In other words, the buyer of a put, who is said to be long the put, expects the price of the underlying to fall by a given amount, and the writer, who is short the put, thinks that the price of the underlying will fall less or not at all. Conversely, the buyer of a call anticipates that the price of the underlying will rise above the strike price and the writer thinks it will not.

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