Financial market

A financial market is an economic marketplace in which individuals, companies, and institutions trade financial securities and derivatives at relatively low transaction costs. These markets facilitate the exchange of instruments such as stocks, bonds, commodities, and foreign currencies, either through organised exchanges or through decentralised bilateral arrangements. Financial markets play a fundamental role in modern economies by allocating capital, transferring risk, and enabling investment across domestic and international settings.

Types of financial markets

The term “financial markets” can denote a wide spectrum of activities. Within the financial sector it often refers specifically to markets used for raising finance, but more broadly it encompasses all venues where financial instruments are issued, traded, or exchanged.
Key market categories include:

• Capital markets, which provide long-term financing through the issuance and trading of shares and bonds.
• Money markets, which deal in short-term debt instruments with maturities of one year or less.
• Commodity markets, which support the trading of raw materials and natural resources.
  • Soft commodities are grown (e.g. wheat, soybeans, coffee, sugar).
  • Hard commodities are mined or extracted (e.g. gold, metals, crude oil, natural gas).
• Derivative markets, which offer instruments such as futures, forwards, options, and swaps for managing or taking on financial risk.
• Foreign exchange markets (forex), which allow the exchange of national currencies.
• Digital asset and fintech markets, which include cryptocurrencies, blockchain-based securities, and emerging financial technologies.

A financial market may be a physical location, such as the New York Stock Exchange or the Bombay Stock Exchange, or an electronic system, such as NASDAQ. While stock exchanges serve as organised venues for equity trading, many transactions—particularly in bonds and foreign exchange—occur bilaterally or through electronic platforms outside traditional exchanges.

Capital markets and market structure

Capital markets are divided into:

• Primary markets, where new securities are issued.Initial public offerings (IPOs) and the issuance of government bonds are key examples. In these transactions the proceeds flow directly from investors to the issuer.
• Secondary markets, where existing securities are bought and sold among investors.Secondary trading provides liquidity, allowing investors to convert holdings into cash with minimal loss of value. Liquid markets feature many active buyers and sellers, reducing transaction costs and price volatility.

Liquidity is vital to market efficiency. Illiquid securities may require sellers to accept steep discounts due to limited demand, whereas highly liquid instruments support flexible and rapid trading.

Raising capital

Financial markets channel savings from investors to companies, governments, and other borrowers, allowing them to finance operations and pursue growth. This process, known as maturity transformation, is central to economic development.

• Money markets provide firms with short-term funding to manage cash-flow needs.
• Capital markets supply long-term financing for investment and expansion.

Intermediaries such as banks and investment banks facilitate these flows. Banks accept deposits and lend funds in the form of loans and mortgages. Investment banks assist corporations in raising capital by underwriting new issues of shares or bonds.
Financial markets also allow existing commitments to be traded. For example, a company may issue shares on a stock exchange, enabling investors to buy, sell, or transfer ownership without the issuer being directly involved.

Lenders

Lenders temporarily provide funds to borrowers in exchange for repayment and interest. Individuals often act as lenders without realising it by:

• Depositing money in savings accounts.
• Contributing to pension funds.
• Paying insurance premiums.
• Purchasing government bonds.

Corporations may also lend surplus cash through short-term money market instruments or choose to return excess funds to shareholders via dividends or share buybacks. Banks, which accept deposits and create money through lending, are major institutional lenders.

Borrowers

Borrowers include:

• Individuals, who take out personal loans and mortgages.
• Companies, which borrow for working capital, investment, and expansion. Large or complex projects may require mixed funding packages from multiple sources.
• Governments, which issue bonds to finance spending beyond tax revenues. In the UK this need is referred to as the Public Sector Net Cash Requirement (PSNCR). Governments also borrow on behalf of nationalised industries and public bodies and may offer retail savings products such as premium bonds.
• Local authorities and municipalities, which borrow for public infrastructure and local services.
• Government-owned corporations, such as postal, utility, or transport providers.

Borrowers may also raise funds internationally with assistance from foreign exchange markets. Groups of borrowers with similar financing needs may consolidate through financial vehicles such as mutual funds or mortgage-based arrangements to lower borrowing costs.

Derivative products

Derivatives constitute a major sector of modern financial markets, expanding rapidly in the 1980s and 1990s. Their value derives from an underlying asset such as a stock, bond, commodity, currency, or index. Price fluctuations in these underlying variables create risk, which derivatives can be used to hedge or to exploit for speculative gain.
The four principal types of derivative contracts include:

• Futures contracts
• Forward contracts
• Options
• Swaps

Derivatives allow market participants to manage interest rate risk, foreign exchange risk, commodity price volatility, and credit risk. They also support the transfer of risk to parties willing to assume it.

Regulation of financial markets

Growing complexity and interconnectedness within derivatives markets became apparent during the global financial crisis of 2008, prompting major regulatory reforms. Significant frameworks include:

• The Dodd–Frank Act (United States), which enhances transparency, mandates central clearing for many over-the-counter derivatives, and strengthens oversight of systemic risk.
• The Markets in Financial Instruments Directive II (MiFID II) (European Union), which aims to improve transparency, efficiency, and investor protection throughout EU financial markets.