2.4 Financial Markets

The Financial Markets

Overview

In this section, we will delve into the distinguishing features and operations of various types of financial markets. Earlier, we discussed the characteristics of capital, its sources, and its users, along with a brief introduction to different financial instruments. Now, we will focus on the financial markets where individuals and institutions engage in financial transactions.

A financial market provides a forum where buyers and sellers come together to complete their financial transactions. In modern financial markets, intermediaries such as investment advisors and bond dealers act on behalf of their clients, facilitating transactions without the need for face-to-face meetings.

Key Elements of Financial Markets

Financial instruments and securities are essential for the efficient transfer of capital from suppliers (investors) to users (borrowers). This efficient transfer benefits both sides through:

• Speedy transactions: Ensuring swift buying and selling of securities.
• Low transaction costs: Keeping costs minimal for both buyers and sellers.
• High liquidity: Allowing assets to be easily converted to cash without significant loss of value.
• Effective regulation: Maintaining market integrity and investor protection.

Electronic Platforms

In many cases, financial markets do not have a physical location. For example, in Canada, securities such as stocks, bonds, and derivatives are traded via electronic platforms, providing greater accessibility and convenience for market participants.

Types of Financial Markets

The capital market comprises several individual financial markets, such as the stock market, bond market, and money market. While each of these has specific functions, this section will cover the most significant aspects:

• Stock Markets: Where equity securities (stocks) are bought and sold.
• Bond Markets: Where debt instruments (bonds) are traded.
• Money Markets: Focused on short-term fixed-income securities with a term of one year or less.

Market Classifications

Financial markets can be further categorized based on the nature of the transactions and the mechanisms of buying and selling securities:

Primary Markets and Secondary Markets

• Primary Markets: Where new securities are issued and sold for the first time, typically through initial public offerings (IPOs).
• Secondary Markets: Where existing securities are bought and sold among investors, without the involvement of the issuing companies.

Auction Markets and Dealer Markets

• Auction Markets: Buyers and sellers transact directly against each other with the help of an auctioneer, as seen in stock exchanges.
• Dealer Markets: Dealers act as market makers, holding an inventory of securities and quoting prices at which they will buy (bid) or sell (ask).

Glossary

• Capital Market: A market where financial securities are bought and sold, including both stock and bond markets.
• Primary Market: Market for new issues of securities, where companies initially sell securities to investors through IPOs or other means.
• Secondary Market: A market for buying and selling existing securities among investors, without the direct involvement of the issuing companies.
• Auction Market: A type of financial market where trades are made by auction at a designated price, typical in stock exchanges.
• Dealer Market: A market where buy and sell orders are filled by participants acting as dealers or market makers, quoting buy and sell prices.

Key Takeaways

• Financial markets play a critical role in the efficient transfer of capital between suppliers and users through well-organized mechanisms.
• Various types of markets, including stock, bond, and money markets, serve specific functions in the capital market ecosystem.
• Markets are distinguished by their transactions (primary vs. secondary) and mechanics (auction vs. dealer).
• Effective market operations depend on speed, low costs, high liquidity, and stringent regulation.
• The increasing prevalence of electronic trading platforms enhances market accessibility and efficiency.

Frequently Asked Questions (FAQs)

Q: What is the difference between a primary market and a secondary market?

A: The primary market is where new securities are issued and sold for the first time (e.g., IPOs), whereas the secondary market involves the buying and selling of existing securities among investors.

Q: How do auction markets and dealer markets differ?

A: In auction markets, transactions are made directly between buyers and sellers with the help of an auctioneer. In dealer markets, dealers act as market makers, holding securities inventories and quoting bid and ask prices for trading.

Q: What is the role of electronic trading platforms in financial markets?

A: Electronic trading platforms facilitate faster, more efficient transactions and increase market accessibility by allowing participants to trade securities online without needing a physical location.

In this section

• 2.4.1 Primary And Secondary Markets
  Learn the intricacies of the primary and secondary markets, how they function, and their roles in the financial ecosystem. Dive into the specifics of initial public offerings (IPOs), trading mechanisms, and much more.
• 2.4.2 Auction Markets
  Understand the workings of auction markets, including key concepts like bid-ask spreads, trades, and types of stock exchanges in Canada. This section covers the fundamental aspects of how securities are bought and sold and includes detailed examples and key definitions.
• 2.4.3 Dealer Markets
  Exploring the workings of dealer markets, including the over-the-counter trading of bonds, debentures, and unlisted equities. The guide illuminates the methods and advantages of trading in dealer markets and synthesizes regulatory nuances in Canada.
• 2.4.4 Alternative Trading Systems
  Learn about Alternative Trading Systems (ATS) in the Canadian financial markets, covering electronic marketplaces for equity and fixed-income markets.