What Are Financial Markets?
Financial markets refer broadly to any marketplace where the trading of securities occurs, including
the stock market, bond market, forex market, and derivatives market, among others. Financial
markets are vital to the smooth operation of capitalist economies.
Types of Financial Markets
Perhaps the most ubiquitous of financial markets are stock markets. These are venues where
companies list their shares and they are bought and sold by traders and investors. Stock markets, or
equities markets, are used by companies to raise capital via an initial public offering (IPO), with
shares subsequently traded among various buyers and sellers in what is known as a secondary
Stocks may be traded on listed exchanges, such as the New York Stock Exchange (NYSE) or
Nasdaq, or else over-the-counter (OTC). Most trading in stocks is done via regulated exchanges,
and these play an important role in the economy as both a gauge of the overall health in the
economy as well as providing capital gains and dividend income to investors, including those with
retirement accounts such as IRAs and 401(k) plans.
Typical participants in a stock market include (both retail and institutional) investors and traders, as
well as market makers (MMs) and specialists who maintain liquidity and provide two-sided markets.
Brokers are third parties that facilitate trades between buyers and sellers but who do not take an
actual position in a stock.
An over-the-counter (OTC) market is a decentralized market—meaning it does not have physical
locations, and trading is conducted electronically—in which market participants trade securities
directly between two parties without a broker. While OTC markets may handle trading in certain
stocks (e.g., smaller or riskier companies that do not meet the listing criteria of exchanges), most
stock trading is done via exchanges. Certain derivatives markets, however, are exclusively OTC, and
so make up an important segment of the financial markets. Broadly speaking, OTC markets and the
transactions that occur on them are far less regulated, less liquid, and more opaque.
A bond is a security in which an investor loans money for a defined period at a pre-established
interest rate. You may think of a bond as an agreement between the lender and borrower that
contains the details of the loan and its payments. Bonds are issued by corporations as well as by
municipalities, states, and sovereign governments to finance projects and operations. The bond
market sells securities such as notes and bills issued by the United States Treasury, for example.
The bond market also is called the debt, credit, or fixed-income market.
Typically the money markets trade in products with highly liquid short-term maturities (of less than
one year) and are characterized by a high degree of safety and a relatively low return in interest. At
the wholesale level, the money markets involve large-volume trades between institutions and
traders. At the retail level, they include money market mutual funds bought by individual investors
and money market accounts opened by bank customers. Individuals may also invest in the money
markets by buying short-term certificates of deposit (CDs), municipal notes, or U.S. Treasury bills,
among other examples.
A derivative is a contract between two or more parties whose value is based on an agreed-upon
underlying financial asset (like a security) or set of assets (like an index). Derivatives are secondary
securities whose value is solely derived from the value of the primary security that they are linked to.
In and of itself a derivative is worthless. Rather than trading stocks directly, a derivatives market
trades in futures and options contracts, and other advanced financial products, that derive their value
from underlying instruments like bonds, commodities, currencies, interest rates, market indexes, and
Futures markets are where futures contracts are listed and traded. Unlike forwards, which trade
OTC, futures markets utilize standardized contract specifications, are well-regulated, and utilize
clearinghouses to settle and confirm trades. Options markets, such as the Chicago Board Options
Exchange (CBOE), similarly list and regulate options contracts. Both futures and options exchanges
may list contracts on various asset classes, such as equities, fixed-income securities, commodities,
and so on.
The forex (foreign exchange) market is the market in which participants can buy, sell, hedge, and
speculate on the exchange rates between currency pairs. The forex market is the most liquid market
in the world, as cash is the most liquid of assets. The currency market handles more than $6.6 trillion
in daily transactions, which is more than the futures and equity markets combined.1 As with the OTC
markets, the forex market is also decentralized and consists of a global network of computers and
brokers from around the world. The forex market is made up of banks, commercial companies,
central banks, investment management firms, hedge funds, and retail forex brokers and investors.
Commodities markets are venues where producers and consumers meet to exchange physical
commodities such as agricultural products (e.g., corn, livestock, soybeans), energy products (oil,
gas, carbon credits), precious metals (gold, silver, platinum), or “soft” commodities (such as cotton,
coffee, and sugar). These are known as spot commodity markets, where physical goods are
exchanged for money.
The bulk of trading in these commodities, however, takes place on derivatives markets that utilize
spot commodities as the underlying assets. Forwards, futures, and options on commodities are
exchanged both OTC and on listed exchanges around the world such as the Chicago Mercantile
Exchange (CME) and the Intercontinental Exchange (ICE).
The past several years have seen the introduction and rise of cryptocurrencies such as Bitcoin and
Ethereum, decentralized digital assets that are based on blockchain technology. Today, thousands of
cryptocurrency tokens are available and trade globally across a patchwork of independent online
crypto exchanges. These exchanges host digital wallets for traders to swap one cryptocurrency for
another, or for fiat monies such as dollars or euros.
Because the majority of crypto exchanges are centralized platforms, users are susceptible to hacks
or fraud. Decentralized exchanges are also available that operate without any central authority.
These exchanges allow direct peer-to-peer (P2P) trading of digital currencies without the need for an
actual exchange authority to facilitate the transactions. Futures and options trading are also
available on major cryptocurrencies.