What is a financial market?

A financial market is a market where buyers and sellers trade commodities, financial securities, foreign exchange, and other freely exchangeable items (fungible items) and derivatives of value at low transaction costs and at prices that are determined by market forces.

The money markets, where large-scale, short-term debts are arranged, and capital markets, where longer-term debts are traded, make up the financial market.

Securities include bonds and shares, while commodities might be gold, silver and other metals, or agricultural products such as coffee, cocoa, wheat, corn, etc.

Alternatively put, financial markets are places where the savings from several sources are mobilized towards those who need funds. They are intermediaries which direct money from savers or lenders to sellers or borrowers.

Financial marketsBasically, financial markets are all about bringing investors (lenders) and borrowers together.

Prices in financial markets are transparent and regulations are set out regarding trading, costs and fees.

In business and financial English, the term ‘market’ refers to a place where potential buyers and sellers get together to trade goods and services, as well as the transactions between them.

Financial market also refers to stock exchanges and commodity exchanges. They may be physical places, such as the London Stock Exchange and New York Stock Exchange, or an electronic system like Nasdaq.

These markets are where corporations and governments come to raise cash, businesses reduce risks, and investors aim to make money.

Some financial markets are very discerning, like exclusive clubs, and only allow participants with a minimum amount of money, knowledge of markets,, or from certain professions.

Financial markets exist in virtually every country in the world. While some are very small, with just a small number of participants, others are gigantic – like the Forex markets – and trade trillions of dollars each day.

Financial markets affect economic performance

According to the Federal Reserve Bank of San Francisco, well-developed, properly-run financial markets play a crucial role in contributing to the health and efficiency of a country’s economy.

There is a close, positive relationship between financial market development and economic growth.

The Federal Reserve Bank of San Francisco writes on its website:

“Financial markets help to efficiently direct the flow of savings and investment in the economy in ways that facilitate the accumulation of capital and the production of goods and services. The combination of well-developed financial markets and institutions, as well as a diverse array of financial products and instruments, suits the needs of borrowers and lenders and therefore the overall economy.”

The financial market starts with your savings

Your savings account provides a secure and convenient place (a bank) to keep money you do not immediately need, plus you earn interest on it.

However, that savings account money does not just sit in a giant safe in the bank. Banks use that money to help other people and entities purchase homes, buy cars, go to university or borrow money for hundreds of different purposes.

When banks lend money, they are drawing on all the money people have deposited in it. In this way, banks act as financial marketplaces for money.

Bank loans can help promote economic growth, but one day that money will have to be paid back, and with interest and a fee to cover the administration costs.

Lending money and buying part-ownership

People use money to make investments. When we buy bonds, we are giving companies or governments a loan. When we purchase shares, we are buying part-ownership of companies.

Companies may use that money to grow, buy new equipment, increase their advertising expenditure, hire new employees, or research new products.

In financial markets, investors seek to buy at the lowest available price, while sellers aim for the highest available price.

Money can be invested in many different types of financial markets, including stock exchanges, over-the-counter markets, currency exchanges, commodity markets, and futures markets.

Investments today can be purchased twenty-four hours a day. When a New York market opens, the Tokyo market has just closed, while the London market is half-way through its working day.

What happens in one financial market affects prices in all markets across the world.

Video – Introduction to financial markets

In this MoneyWeek video, Tom Bennett explains what financial markets are, what they do, and why we need them.