A Guide To Financial Markets And Services (With Examples)

Updated 12 October 2022

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Businesses need capital to finance their operations and expand their market share. A financial market is a marketplace that facilitates the movement of money between those who require it and those who want to invest. If you work in finance, you can benefit from having a good understanding of financial markets and how they influence spending, production of goods and services and the economy. In this article, we discuss what financial markets and services are, highlight their importance, list their types and share some financial services that banks provide.

What Are Financial Markets And Services?

Financial markets and services provide a platform for buyers and sellers to trade financial instruments, such as bonds, equities, derivatives, commodities and currencies. They reflect the supply and demand factors in the market, influence economic growth, help secure foreign capital, improve the efficiency of financial transactions and stabilise the prices of various assets. Investors can invest in the following markets:

Equity market: Equity markets facilitate the trade of company stocks through exchanges or over-the-counter markets. It provides a company with the capital to improve business operations and investors with partial ownership of a company and a higher return on investment.
Debt market: The primary function of a debt market is to let companies who do not wish to dilute their ownership borrow money from creditors to fund their operations. Creditors can benefit from the guaranteed return of principal and monthly interest paid on the principal until the maturity date.

Why Are Financial Markets Important?

Financial markets are important for the following reasons:

Creating liquidity: They create liquidity in the market that helps businesses raise capital for their short-term and long-term monetary objectives. Higher liquidity makes it quicker and easier to convert an asset into cash.
Determining the prices of assets: The price of an asset depends on its demand and supply in the market. It also depends on investors trading in these assets, the general sentiment of the market and competition.
Easing access to trading: It facilitates efficient trading by providing a marketplace for buyers and sellers to trade their assets. This reduces the time and resources the two parties would have spent looking to execute the trade.
Influencing economic performance: A market's upward or downward trend influences individual customer spending. An increase in customer spending allows an economy to grow, whereas a decrease in spending may slow down business sales and result in an economic decline.

5 Types Of Financial Markets

Here are five types of financial markets:

1. Stock market

The stock market is a marketplace for buyers and sellers to trade on publicly listed stocks. It allows sellers to find buyers for their assets and buyers to buy them at their desired price. Companies issue shares to raise capital for daily operations, pay off their debt or acquire other companies. They issue both common and preferred shares, available for investors to trade. While common shares allow shareholders to vote on company decisions and policies, holders with preferred shares receive a fixed dividend from a company's profits.

The stock market operates as an auction where buyers bid for the price at which they want to purchase shares and sellers ask for the price at which they want to sell them. When the bid and ask values coincide, a trade is successful. The advantages of stocks include:

The exchanges that facilitate the trading of company shares provide higher liquidity and have large trading volumes.
Investing in stocks allows investors to increase their return on investment because a stock's value usually appreciates over a period depending on factors such as a company's profitability, economic conditions and market sentiments.
Various governing boards regulate the stock market, which helps protect investors' interests.

2. Bond market

The bond market is a marketplace for debt securities. Creditors transfer capital to issuers who require funds for their business operations. Issuers can either be corporate entities that sell these bonds to finance ongoing projects or the government that sells them to supplement its revenue from taxes. The creditors receive a fixed interest rate on their invested amount and the principal amount after the bond maturity.

Investors can refer to the credit rating of a bond issuer, which is an indicator of its creditworthiness and financial health, to assess the risk involved in investing in a bond. The bond prices also depend on the market interest rates, where an increase in interest rate results in an increase in bond yield and a reduction in the bond price and vice versa. The advantages of trading bonds include:

Bonds have lower volatility than other classes, making them a safer form of investment.
Bondholders have legal protection, ensuring they receive some or all of their investment in case a bank goes bankrupt.
Bonds have consistent returns and have an interest rate slightly higher than those provided by banks or money market funds.

3. Derivatives market

The value of a derivative depends on the value of its underlying assets. The underlying assets can include stocks, commodities and currencies. Examples of derivatives include futures, options and swaps. Futures are contracts that specify the date and price at which both parties have an obligation to buy or sell an asset. Options are contracts that specify the date and price at which the buyer has a right but not an obligation to buy or sell an asset.

Swap derivatives allow the two parties to exchange liabilities or cash flows on separate financial instruments. For example, a default swap allows one party to buy protection from another party from losses incurred during defaults. The advantages of the derivatives market include:

Investors can use derivatives to hedge risks associated with price fluctuations of underlying assets.
Investors can use derivatives to predict the prices of underlying assets.
They have lower transaction costs when compared to stocks or other securities.
It allows one party to transfer their risk to another party.

4. Forex market

The forex market facilitates the trading of various currencies worldwide. It also eases the conversion of one currency to another for investments and trade settlements. The market has very high liquidity, operates continuously and has the largest trading volume. The participants in a forex market include investors, banks, hedge funds, companies and retail forex brokers.

It has two levels, which are the interbank market and the over-the-counter (OTC) market. Large banks use inter-bank markets to transact large volumes, perform balance-sheet adjustments, hedging and trading. Individuals use the OTC market to trade currencies outside of centralised exchanges. The advantages of the forex market include:

The forex market is global, so no central bank or agency can manipulate the market or indulge in malpractices.
The market is flexible, allowing traders to trade across multiple time zones without restrictions on the amount.
The transactional costs are minimal when compared to those in other asset classes.
Fluctuations in the market depend on long-term factors such as economic growth, geopolitical scenarios and supply and demand, which provide experienced traders enough time to make an informed decision.

5. Commodities market

The commodities market provides a marketplace for trading raw products such as oil, gold, silver and rubber. Hard and soft commodities are two categories of commodities. Hard commodities include natural resources that require mining or extraction, such as gold, silver or rubber. Soft commodities include livestock or agricultural products, such as sugar, coffee and wheat. Their prices depend on various factors, such as geopolitical scenarios, weather, natural and human-made disasters and supply and demand. Investors can directly buy the commodities, invest in commodity stocks or trade commodity derivatives.

The advantages of trading commodities include:

They can be a hedge against inflation and economic decline due to geopolitical conditions.
Commodity derivatives offer higher leverages, which can result in exponential gains.
Due to their negative or minimal correlation with stocks, investors prefer trading in them to diversify their portfolios.
Large-scale participation ensures a fair price of commodities.

Examples Of Financial Services

Here are some examples of financial services:

Wealth management

Wealth management includes managing a customer's portfolio by investing their capital in various asset classes. These asset classes can include stocks, mutual funds, bonds and commodities. The investment varies based on a client's financial health, risk appetite and long-term financial goals.

Banking

Financial services in banking include:

Individual banking: This includes creating, maintaining and issuing current and savings accounts, debit and credit cards and other banking needs for individuals.
Loans: Individuals can obtain loans from banks for cars, houses, education and personal expenses.
Business banking: This includes creating and maintaining checking and savings accounts and treasury services for businesses.

Insurance

Financial services in this segment include providing life and general insurance to ensure the financial well-being of an individual. Car, home, medical and travel are some examples of general insurance. Some examples of life insurance include term-life, money-back and pension plans. The payments depend on the customer risk assessment, premiums and the period of insurance.