Financial markets encompass the part of a free market economic system in which people and entities can trade financial products like shares, debt securities, ‘derivatives,’ and currencies. The trade of these products is essential to the workings of a market economy, allowing for the allocation of resources according to levels of supply and demand determined by buyers and sellers. Perhaps the best-known type of financial market is share markets, where portions of the ownership of companies are bought and sold by investors. The largest share markets in the world are located in the United States, followed by East Asia and Europe. Share markets play a vital role in global financial markets as they allow companies to raise money from investors to grow the company while allowing investors to increase their wealth by connecting them to companies needing investment.
Types of financial markets
While important, share markets are far from the only – or even the largest – type of financial market. Another key component of financial markets is debt markets. Debt markets are usually divided into money markets, which deal with short-term debt of one year or less, and capital markets, which trade longer-term debt. While banks, companies and governments all raise funds on debt markets, government bonds are perhaps the most associated product. Currency markets are another important market, facilitating the exchange of one national currency for another. However, the largest financial market is, in fact, the derivatives market, which accounts for financial products ‘derived’ from underlying financial assets (for example, ‘options’ and ‘futures’ contracts, which lock in a future price for the buying or selling of financial investment). While derivatives are often sold off-exchange (‘over the counter), stock index futures are the most common equity exchange-traded derivative (ETD).
Global vs domestic financial markets
Many financial markets operate on a national level, governed by national regulations. For example, most stock exchanges primarily service locally based companies. However, most countries will still allow foreign investment into their country, increasing the value of funds circulating in the domestic economy. In addition, many intranational agreements coordinate financial markets across a group of countries. The European Union is perhaps the best known for this, with the Euronext stock exchange being a common set of regulations and infrastructure that brings together some of Europe’s largest national stock exchanges into a single entity. Finally, there are international agreements that coordinate certain international financial markets – although these are generally agreements between specific countries to align their domestic regulations (thus facilitating trade between these countries), not the creation of external bodies that independently govern international financial markets.
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