What is a financial market?
The term “financial market” refers to any market where buyers and sellers trade financial items, i.e. money (short-term funds), capital (long-term funds) or currencies.
The purpose of the financial market is to facilitate transactions between economic agents seeking to raise capital and those seeking to invest capital. Capital providers (lenders), such as holders of savings or investors, supply funds that they wish to invest. Demand for this capital comes from companies, governments and households (borrowers) who wish to use the capital to finance their own investment.
Lenders and borrowers may interact directly in the market (direct exchange) or financial intermediaries, such as banks, insurance companies or investment companies, may facilitate the transfer of funds by pooling the capital supplied and lending it to borrowers (indirect exchange). Financial intermediaries generate their profit from interest, commissions and premiums.
Efficient financial markets are crucially important for the economy: They quickly and securely provide market participants (banks, companies, households and the public sector) with sufficient funds. As financial markets and financial products are highly complex, it is imperative that they are transparent and that the risks they involve are made visible. Transparency builds confidence and thereby enhances the stability of financial markets.
The financial market may be broken down into different segments:
The money market is the market in which funds with short maturities (up to 12 months) are traded. It facilitates the transfer of funds between holders and borrowers of cash assets and thus accommodates liquidity differences. Most transactions in the money market consist of interbank lending, but central banks also conduct operations in the money market with commercial banks with the dual aim of steering the short-term money market rate and securing the supply of liquidity to banks.
The supply of and demand for short-term liquidity fluctuates much more strongly, or is much more volatile, than the long-term supply of and demand for capital. These fluctuations are equalized in the money market.
The capital market is the market in which financial instruments with maturities of more than 12 months are traded. These instruments include debt- or equity-backed securities and other securitized investments, e.g. mutual funds. Banks, insurance companies, companies, the public sector and households may all participate in the capital market.
Capital market transactions may take place on an exchange or may be handled directly by the issuer, who seeks to raise capital, and the investor, who provides capital.
Foreign exchange market
The foreign exchange (forex, FX, or currency) market is a market in which currencies are traded, with such transactions establishing an exchange rate as the price at which one currency is traded for another.
Foreign exchange supply (demand) is created through the export (import) of goods and services or through financial transactions.
In the medium and long term, exchange rate movements are, as a rule, oriented on the economic fundamentals of an economy, such as growth, external debt, government debt, inflation and unemployment.