Financial markets are a marketplace where financial instruments, such as bonds, stocks, foreign exchange, and derivatives, are bought and sold. They are the economy's central nervous system. Financial markets play a critical role in the U.S. and global economy. They facilitate the smooth operation of capitalist economies by promoting economic efficiencies; financial markets allocate resources and create liquidity for firms and enterprises. There are four different types of financial markets: the stock, bond, commodities, and derivatives market. Each of these financial markets specializes in different financial instruments and influence the U.S. and global economy.
The stock market is where stocks or shares are bought and sold. A share represents ownership in a publicly-traded company (Amadeo, 2020). Each share comes with a price and investors profit when the value of a stock increases. This keeps the U.S. and the global economy growing. Many investors use different indices to track the performance of stocks in the market. The most commonly used indices are the DJIA ("Dow Jones Industrial Average") and the S&P 500 ( Darškuvienė, 2010) . The stocks are traded on listed exchanges, such as the NYSE ("New York Stock Exchange") and Nasdaq. Stock exchanges are regulated, and this plays a vital role in the U.S. and global economy. This is because they gauge the economy's overall health and provide capital gains and dividend income to investors. Stock markets put savings into more productive use and make financial assets liquid.
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The bond market specializes in the issuance of securities. They are issued by corporations and governments to finance projects and operations (Amadeo, 2020). Companies, municipalities, and governments issue various types of bonds, such as corporate, municipal bonds, and treasury. Coupons are usually attached to these bonds. The coupons dictate the interest rate and periodic payments (Amadeo, 2020). The revenue is principally limited to the interest rate. The bond market plays a vital role in the U.S. and the global economy. Bonds provide some of the liquidity that keeps the U.S. and the global economy functioning smoothly (Amadeo, 2020). Besides, the bond market determines the price of securities, makes financial assets liquid, and lowers the cost of transactions.
The commodities market is where natural resources or commodities are bought and sold. The price of commodities or natural resources is volatile or unpredictable. The commodity market was established to help enterprises and businesses to offset their future risks when buying these commodities (Amadeo, 2020). The price of the commodities in the future is principally determined and sealed today. The commodities market plays a vital role in the U.S. and global economy. For example, oil is the most important commodity in the U.S. and global economy. This commodity a widely used in various sectors, including the transportation, industrial, electricity, and manufacturing sectors. A change in price in oil impacts other commodities, such as food and transport. Thus, the commodities market increases a trader's leverage by allowing the trader to borrow the money to purchase the commodity.
The derivates market specializes in derivatives. A derivative is a contract or an agreement between entities or parties (Vo et al., 2019). The value of the derivative is often based on the market value of the financial or set asset being traded. The value of a derivative is solely derived from securities or indices like the DJIA and the S&P 500, as well as from stocks, bonds, commodities, and interest rates (Amadeo, 2020). As such, derivatives are secondary securities. Unlike the other financial markets, the derivates market is highly risky, and losses in this market can be infinite. However, derivates can be used to magnify potential gains. Sophisticated investors and hedge funds use it due to the higher return associated with it. Derivates may decrease the volatility of the stock market, which in turn may decrease the volatility of the U.S. and global economy. The 2008 global financial crisis is a stark example of the negative effects of derivatives. Several factors led to this financial crisis, including the hedge fund investments in subprime mortgages and other derivatives.
References
Amadeo, K. (2020). An introduction to the financial market. [Online]. Retrieved April 26, 2021, from https://www.thebalance.com/an-introduction-to-the-financial-markets-3306233
Darškuvienė, V. (2010). Financial Markets. Vytautas Magnus University. Kaunas .
Vo, D. H., Huynh, S. V., & Ha, D. T. T. (2019). The importance of the financial derivatives markets to economic development in the world’s four major economies. Journal of Risk and Financial Management , 12 (1), 35.
