Financial market
Encyclopedia
In economics
, a financial market is a mechanism that allows people and entities to buy and sell (trade
) financial securities (such as stocks and bonds), commodities
(such as precious metals or agricultural goods), and other fungible items of value at low transaction cost
s and at prices that reflect supply and demand
.
Both general markets (where many commodities are traded) and specialized markets (where only one commodity is traded) exist. Markets work by placing many interested buyers and sellers in one "place", thus making it easier for them to find each other. An economy which relies primarily on interactions between buyers and sellers to allocate resources is known as a market economy
in contrast either to a command economy or to a non-market economy such as a gift economy
.
In finance
, financial markets facilitate:
– and are used to match those who want capital to those who have it.
Typically a borrower issues a receipt
to the lender promising to pay back the capital. These receipts are securities
which may be freely bought or sold. In return for lending money to the borrower, the lender will expect some compensation in the form of interest
or dividends.
In mathematical finance
, the concept continuous-time Brownian motion stochastic process
is sometimes used as a model.
, typically, the term market means the aggregate of possible buyers and sellers of a certain good or service and the transactions between them.
The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange
or commodity exchange
. This may be a physical location (like the NYSE
) or an electronic system (like NASDAQ
). Much trading of stocks takes place on an exchange; still, corporate action
s (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell stock from the one to the other without using an exchange.
Trading of currencies
and bonds
is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, similar to stock exchanges.
Financial markets can be domestic or they can be international.
The capital market
s consist of primary market
s and secondary market
s. Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy existing securities. The transaction in primary market exist between investors and public while secondary market its between investors.
where firms make the capital to invest
Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as bank
s help in this process. Banks take deposits from those who have money
to save. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgage
s.
More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange
. A company can raise money by selling shares to investors and its existing shares can be bought or sold.
The following table illustrates where financial markets fit in the relationship between lenders and borrowers:
s.
There are a few companies that have very strong cash flows. These companies tend to be lenders rather than borrowers. Such companies may decide to return cash to lenders (e.g. via a share buyback.) Alternatively, they may seek to make more money on their cash by lending it (e.g. investing in bonds and stocks.)
Companies borrow money to aid short term or long term cash flow
s. They also borrow to fund modernisation or future business expansion.
Government
s often find their spending requirements exceed their tax revenue
s. To make up this difference, they need to borrow. Governments also borrow on behalf of nationalised industries, municipalities, local authorities and other public sector bodies. In the UK, the total borrowing requirement is often referred to as the Public sector net cash requirement (PSNCR).
Governments borrow by issuing bonds
. In the UK, the government also borrows from individuals by offering bank accounts and Premium Bond
s. Government debt seems to be permanent. Indeed the debt seemingly expands rather than being paid off. One strategy used by governments to reduce the value
of the debt is to influence inflation
.
Municipalities
and local authorities
may borrow in their own name as well as receiving funding from national governments. In the UK, this would cover an authority like Hampshire County Council.
Public Corporations
typically include nationalised
industries. These may include the postal services, railway companies and utility companies.
Many borrowers have difficulty raising money locally. They need to borrow internationally with the aid of Foreign exchange market
s.
Borrowers having similar needs can form into a group of borrowers. They can also take an organizational form like Mutual Funds. They can provide mortgage on weight basis. The main advantage is that this lowers the cost of their borrowings.
for short.
In the financial markets, stock prices, bond prices, currency rates, interest rates and dividends go up and down, creating risk. Derivative products are financial products which are used to control risk or paradoxically exploit risk. It is also called financial economics.
Derivative products or instruments help the issuers to gain an unusual profit from issuing the instruments. For using the help of these products a contract has to be made. Derivative contracts are mainly 3 types:
1. Future Contracts
2. Forward Contracts
3. Option Contracts.
are importers and exporters of goods. While this may have been true in the distant past, when international trade created the demand for currency markets, importers and exporters now represent only 1/32 of foreign exchange dealing, according to the Bank for International Settlements
.
The picture of foreign currency transactions today shows:
Much effort has gone into the study of financial markets and how prices vary with time. Charles Dow
, one of the founders of Dow Jones & Company
and The Wall Street Journal
, enunciated a set of ideas on the subject which are now called Dow Theory
. This is the basis of the so-called technical analysis
method of attempting to predict future changes. One of the tenets of "technical analysis" is that market trends
give an indication of the future, at least in the short term. The claims of the technical analysts are disputed by many academics, who claim that the evidence points rather to the random walk hypothesis
, which states that the next change is not correlated to the last change.
The scale of changes in price over some unit of time is called the volatility
.
It was discovered by Benoît Mandelbrot
that changes in prices do not follow a Gaussian distribution, but are rather modeled better by Lévy stable distributions. The scale of change, or volatility, depends on the length of the time unit to a power
a bit more than 1/2. Large changes up or down are more likely than what one would calculate using a Gaussian distribution with an estimated standard deviation
.
A new area of concern is the proper analysis of international market effects. As connected as today's global financial markets are, it is important to realize that there are both benefits and consequences to a global financial network. As new opportunities appear due to integration, so do the possibilities of contagion. This presents unique issues when attempting to analyze markets, as a problem can ripple through the entire connected global network very quickly. For example, a bank failure in one country can spread quickly to others, which makes proper analysis more difficult.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, a financial market is a mechanism that allows people and entities to buy and sell (trade
Trade (financial instrument)
In finance, a trade is an exchange of a security for "cash", typically a short-dated promise to pay in the currency of the country where the 'exchange' is located...
) financial securities (such as stocks and bonds), commodities
Commodity
In economics, a commodity is the generic term for any marketable item produced to satisfy wants or needs. Economic commodities comprise goods and services....
(such as precious metals or agricultural goods), and other fungible items of value at low transaction cost
Transaction cost
In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange . For example, most people, when buying or selling a stock, must pay a commission to their broker; that commission is a transaction cost of doing the stock deal...
s and at prices that reflect supply and demand
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
.
Both general markets (where many commodities are traded) and specialized markets (where only one commodity is traded) exist. Markets work by placing many interested buyers and sellers in one "place", thus making it easier for them to find each other. An economy which relies primarily on interactions between buyers and sellers to allocate resources is known as a market economy
Market economy
A market economy is an economy in which the prices of goods and services are determined in a free price system. This is often contrasted with a state-directed or planned economy. Market economies can range from hypothetically pure laissez-faire variants to an assortment of real-world mixed...
in contrast either to a command economy or to a non-market economy such as a gift economy
Gift economy
In the social sciences, a gift economy is a society where valuable goods and services are regularly given without any explicit agreement for immediate or future rewards . Ideally, simultaneous or recurring giving serves to circulate and redistribute valuables within the community...
.
In finance
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
, financial markets facilitate:
- The raising of capitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
(in the capital marketCapital marketA capital market is a market for securities , where business enterprises and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets...
s) - The transfer of risk (in the derivatives marketDerivatives marketThe derivatives market is the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets....
s) - The transfer of liquidity (in the money marketMoney marketThe money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit,...
s) - International tradeInternational tradeInternational trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...
(in the currency markets)
– and are used to match those who want capital to those who have it.
Typically a borrower issues a receipt
Receipt
A receipt is a written acknowledgment that a specified article or sum of money has been received as an exchange for goods or services. The receipt is evidence of purchase of the property or service obtained in the exchange.-Printed:...
to the lender promising to pay back the capital. These receipts are securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
which may be freely bought or sold. In return for lending money to the borrower, the lender will expect some compensation in the form of interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
or dividends.
In mathematical finance
Mathematical finance
Mathematical finance is a field of applied mathematics, concerned with financial markets. The subject has a close relationship with the discipline of financial economics, which is concerned with much of the underlying theory. Generally, mathematical finance will derive and extend the mathematical...
, the concept continuous-time Brownian motion stochastic process
Brownian Model of Financial Markets
The Brownian motion models for financial markets are based on the work of Robert C. Merton and Paul A. Samuelson, as extensions to the one-period market models of Harold Markowitz and William Sharpe, and are concerned with defining the concepts of financial assets and markets, portfolios, gains and...
is sometimes used as a model.
Definition
In economicsEconomics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, typically, the term market means the aggregate of possible buyers and sellers of a certain good or service and the transactions between them.
The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange
Stock exchange
A stock exchange is an entity that provides services for stock brokers and traders to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and...
or commodity exchange
Commodity exchange
Commodity exchange may refer to:* Commodities exchange, any exchange where various commodities and derivatives products are traded.* Commodity markets, for the markets trading on commodities in general....
. This may be a physical location (like the NYSE
New York Stock Exchange
The New York Stock Exchange is a stock exchange located at 11 Wall Street in Lower Manhattan, New York City, USA. It is by far the world's largest stock exchange by market capitalization of its listed companies at 13.39 trillion as of Dec 2010...
) or an electronic system (like NASDAQ
NASDAQ
The NASDAQ Stock Market, also known as the NASDAQ, is an American stock exchange. "NASDAQ" originally stood for "National Association of Securities Dealers Automated Quotations". It is the second-largest stock exchange by market capitalization in the world, after the New York Stock Exchange. As of...
). Much trading of stocks takes place on an exchange; still, corporate action
Corporate action
A corporate action is an event initiated by a public company that affects the securities issued by the company. Some corporate actions such as a dividend or coupon payment may have a direct financial impact on the shareholders or bondholders; another example is a call of a debt security...
s (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell stock from the one to the other without using an exchange.
Trading of currencies
Foreign exchange market
The foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...
and bonds
Bond market
The bond market is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the Secondary market, usually in the form of bonds. The primary goal of the bond market is to provide a mechanism for long term funding of public and...
is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, similar to stock exchanges.
Financial markets can be domestic or they can be international.
Types of financial markets
The financial markets can be divided into different subtypes:- Capital marketCapital marketA capital market is a market for securities , where business enterprises and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets...
s which consist of:- Stock marketStock marketA stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...
s, which provide financing through the issuance of shares or common stockStockThe capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
, and enable the subsequent trading thereof. - Bond marketBond marketThe bond market is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the Secondary market, usually in the form of bonds. The primary goal of the bond market is to provide a mechanism for long term funding of public and...
s, which provide financing through the issuance of bondBond (finance)In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
s, and enable the subsequent trading thereof.
- Stock market
- Commodity marketsCommodity marketsCommodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts....
, which facilitate the trading of commodities. - Money marketMoney marketThe money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit,...
s, which provide short term debt financing and investment. - Derivatives marketDerivatives marketThe derivatives market is the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets....
s, which provide instruments for the management of financialFinance"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
risk. - Futures marketFutures exchangeA futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. These types of...
s, which provide standardized forward contractForward contractIn finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a...
s for trading products at some future date; see also forward marketForward marketThe forward market is the over-the-counter financial market in contracts for future delivery, so called forward contracts. Forward contracts are personalized between parties The forward market is the over-the-counter financial market in contracts for future delivery, so called forward contracts. ...
. - Insurance marketsInsuranceIn law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
, which facilitate the redistribution of various risks. - Foreign exchange marketForeign exchange marketThe foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...
s, which facilitate the trading of foreign exchangeForeign exchange marketThe foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...
.
The capital market
Capital market
A capital market is a market for securities , where business enterprises and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets...
s consist of primary market
Primary market
The primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers. The process...
s and secondary market
Secondary market
The page applies to the finanical term; For the merchandising concept, see Aftermarket .The secondary market, also called aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold....
s. Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy existing securities. The transaction in primary market exist between investors and public while secondary market its between investors.
Raising the capital
To understand financial markets, let us look at what they are used for, i.e. whatwhere firms make the capital to invest
Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
s help in this process. Banks take deposits from those who have money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
to save. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgage
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
s.
More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange
Stock exchange
A stock exchange is an entity that provides services for stock brokers and traders to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and...
. A company can raise money by selling shares to investors and its existing shares can be bought or sold.
The following table illustrates where financial markets fit in the relationship between lenders and borrowers:
| Relationship between lenders and borrowers | |||
| Lenders | Financial Intermediaries Financial intermediary Financial intermediation consists of “channeling funds between surplus and deficit agents”. A financial intermediary is a financial institution that connects surplus and deficit agents... |
Financial Markets | Borrowers |
| Individuals Companies |
Banks Insurance Companies Pension Funds Mutual Funds |
Interbank Stock Exchange Money Market Bond Market Foreign Exchange |
Individuals Companies Central Government Municipalities Public Corporations |
Lenders
Who have enough money to lend or to give someone money from own pocket at the condition of getting back the principal amount or with some interest or charge, is the Lender.Individuals & Doubles
Many individuals are not aware that they are lenders, but almost everybody does lend money in many ways. A person lends money when he or she:- puts money in a savings account at a bank;
- contributes to a pension plan;
- pays premiums to an insurance company;
- invests in government bonds; or
- invests in company shares.
Companies
Companies tend to be borrowers of capital. When companies have surplus cash that is not needed for a short period of time, they may seek to make money from their cash surplus by lending it via short term markets called money marketMoney market
The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit,...
s.
There are a few companies that have very strong cash flows. These companies tend to be lenders rather than borrowers. Such companies may decide to return cash to lenders (e.g. via a share buyback.) Alternatively, they may seek to make more money on their cash by lending it (e.g. investing in bonds and stocks.)
Borrowers
Individuals borrow money via bankers' loans for short term needs or longer term mortgages to help finance a house purchase.Companies borrow money to aid short term or long term cash flow
Cash flow
Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...
s. They also borrow to fund modernisation or future business expansion.
Government
Government
Government refers to the legislators, administrators, and arbitrators in the administrative bureaucracy who control a state at a given time, and to the system of government by which they are organized...
s often find their spending requirements exceed their tax revenue
Tax revenue
Tax revenue is the income that is gained by governments through taxation.Just as there are different types of tax, the form in which tax revenue is collected also differs; furthermore, the agency that collects the tax may not be part of central government, but may be an alternative third-party...
s. To make up this difference, they need to borrow. Governments also borrow on behalf of nationalised industries, municipalities, local authorities and other public sector bodies. In the UK, the total borrowing requirement is often referred to as the Public sector net cash requirement (PSNCR).
Governments borrow by issuing bonds
Government bond
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country...
. In the UK, the government also borrows from individuals by offering bank accounts and Premium Bond
Premium Bond
A Premium Bond is a lottery bond issued by the United Kingdom government's National Savings and Investments scheme. The government promises to buy back the bond, on request, for its original price. They were introduced by Harold Macmillan in his 1956 budget....
s. Government debt seems to be permanent. Indeed the debt seemingly expands rather than being paid off. One strategy used by governments to reduce the value
Value (economics)
An economic value is the worth of a good or service as determined by the market.The economic value of a good or service has puzzled economists since the beginning of the discipline. First, economists tried to estimate the value of a good to an individual alone, and extend that definition to goods...
of the debt is to influence inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
.
Municipalities
Municipality
A municipality is essentially an urban administrative division having corporate status and usually powers of self-government. It can also be used to mean the governing body of a municipality. A municipality is a general-purpose administrative subdivision, as opposed to a special-purpose district...
and local authorities
Local government
Local government refers collectively to administrative authorities over areas that are smaller than a state.The term is used to contrast with offices at nation-state level, which are referred to as the central government, national government, or federal government...
may borrow in their own name as well as receiving funding from national governments. In the UK, this would cover an authority like Hampshire County Council.
Public Corporations
Government-owned corporation
A government-owned corporation, state-owned company, state-owned entity, state enterprise, publicly owned corporation, government business enterprise, or parastatal is a legal entity created by a government to undertake commercial activities on behalf of an owner government...
typically include nationalised
Nationalization
Nationalisation, also spelled nationalization, is the process of taking an industry or assets into government ownership by a national government or state. Nationalization usually refers to private assets, but may also mean assets owned by lower levels of government, such as municipalities, being...
industries. These may include the postal services, railway companies and utility companies.
Many borrowers have difficulty raising money locally. They need to borrow internationally with the aid of Foreign exchange market
Foreign exchange market
The foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...
s.
Borrowers having similar needs can form into a group of borrowers. They can also take an organizational form like Mutual Funds. They can provide mortgage on weight basis. The main advantage is that this lowers the cost of their borrowings.
Derivative products
During the 1980s and 1990s, a major growth sector in financial markets is the trade in so called derivative products, or derivativesDerivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
for short.
In the financial markets, stock prices, bond prices, currency rates, interest rates and dividends go up and down, creating risk. Derivative products are financial products which are used to control risk or paradoxically exploit risk. It is also called financial economics.
Derivative products or instruments help the issuers to gain an unusual profit from issuing the instruments. For using the help of these products a contract has to be made. Derivative contracts are mainly 3 types:
1. Future Contracts
2. Forward Contracts
3. Option Contracts.
Currency markets
Seemingly, the most obvious buyers and sellers of currencyCurrency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
are importers and exporters of goods. While this may have been true in the distant past, when international trade created the demand for currency markets, importers and exporters now represent only 1/32 of foreign exchange dealing, according to the Bank for International Settlements
Bank for International Settlements
The Bank for International Settlements is an intergovernmental organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks." It is not accountable to any national government...
.
The picture of foreign currency transactions today shows:
- Banks/Institutions
- Speculators
- Government spending (for example, military bases abroad)
- Importers/Exporters
- Tourists
Analysis of financial markets
- See Statistical analysis of financial markets, statistical financeStatistical financeStatistical finance, sometimes called econophysics, is an empirical attempt to shift finance from its normative roots to a positivist framework using exemplars from statistical physics with an emphasis on emergent or collective properties of financial markets...
---
Much effort has gone into the study of financial markets and how prices vary with time. Charles Dow
Charles Dow
Charles Henry Dow was an American journalist who co-founded Dow Jones & Company with Edward Jones and Charles Bergstresser....
, one of the founders of Dow Jones & Company
Dow Jones & Company
Dow Jones & Company is an American publishing and financial information firm.The company was founded in 1882 by three reporters: Charles Dow, Edward Jones, and Charles Bergstresser. Like The New York Times and the Washington Post, the company was in recent years publicly traded but privately...
and The Wall Street Journal
The Wall Street Journal
The Wall Street Journal is an American English-language international daily newspaper. It is published in New York City by Dow Jones & Company, a division of News Corporation, along with the Asian and European editions of the Journal....
, enunciated a set of ideas on the subject which are now called Dow Theory
Dow Theory
The Dow theory on stock price movement is a form of technical analysis that includes some aspects of sector rotation. The theory was derived from 255 Wall Street Journal editorials written by Charles H. Dow , journalist, founder and first editor of the Wall Street Journal and co-founder of Dow...
. This is the basis of the so-called technical analysis
Technical analysis
In finance, technical analysis is security analysis discipline for forecasting the direction of prices through the study of past market data, primarily price and volume. Behavioral economics and quantitative analysis incorporate technical analysis, which being an aspect of active management stands...
method of attempting to predict future changes. One of the tenets of "technical analysis" is that market trends
Market trends
A market trend is a putative tendency of a financial market to move in a particular direction over time. These trends are classified as secular for long time frames, primary for medium time frames, and secondary for short time frames...
give an indication of the future, at least in the short term. The claims of the technical analysts are disputed by many academics, who claim that the evidence points rather to the random walk hypothesis
Random walk hypothesis
The random walk hypothesis is a financial theory stating that stock market prices evolve according to a random walk and thus the prices of the stock market cannot be predicted. It is consistent with the efficient-market hypothesis....
, which states that the next change is not correlated to the last change.
The scale of changes in price over some unit of time is called the volatility
Volatility (finance)
In finance, volatility is a measure for variation of price of a financial instrument over time. Historic volatility is derived from time series of past market prices...
.
It was discovered by Benoît Mandelbrot
Benoît Mandelbrot
Benoît B. Mandelbrot was a French American mathematician. Born in Poland, he moved to France with his family when he was a child...
that changes in prices do not follow a Gaussian distribution, but are rather modeled better by Lévy stable distributions. The scale of change, or volatility, depends on the length of the time unit to a power
Power law
A power law is a special kind of mathematical relationship between two quantities. When the frequency of an event varies as a power of some attribute of that event , the frequency is said to follow a power law. For instance, the number of cities having a certain population size is found to vary...
a bit more than 1/2. Large changes up or down are more likely than what one would calculate using a Gaussian distribution with an estimated standard deviation
Standard deviation
Standard deviation is a widely used measure of variability or diversity used in statistics and probability theory. It shows how much variation or "dispersion" there is from the average...
.
A new area of concern is the proper analysis of international market effects. As connected as today's global financial markets are, it is important to realize that there are both benefits and consequences to a global financial network. As new opportunities appear due to integration, so do the possibilities of contagion. This presents unique issues when attempting to analyze markets, as a problem can ripple through the entire connected global network very quickly. For example, a bank failure in one country can spread quickly to others, which makes proper analysis more difficult.
Financial market slang
- Poison pill, when a company issues more shares to prevent being bought out by another company, thereby increasing the number of outstanding shares to be bought by the hostile company making the bid to establish majority.
- Quant, a quantitative analystQuantitative analystA quantitative analyst is a person who works in finance using numerical or quantitative techniques. Similar work is done in most other modern industries, but the work is not always called quantitative analysis...
with a PhDPHDPHD may refer to:*Ph.D., a doctorate of philosophy*Ph.D. , a 1980s British group*PHD finger, a protein sequence*PHD Mountain Software, an outdoor clothing and equipment company*PhD Docbook renderer, an XML renderer...
(and above) level of training in mathematicsMathematicsMathematics is the study of quantity, space, structure, and change. Mathematicians seek out patterns and formulate new conjectures. Mathematicians resolve the truth or falsity of conjectures by mathematical proofs, which are arguments sufficient to convince other mathematicians of their validity...
and statisticalStatisticsStatistics is the study of the collection, organization, analysis, and interpretation of data. It deals with all aspects of this, including the planning of data collection in terms of the design of surveys and experiments....
methods. - Rocket scientist, a financial consultant at the zenithZenithThe zenith is an imaginary point directly "above" a particular location, on the imaginary celestial sphere. "Above" means in the vertical direction opposite to the apparent gravitational force at that location. The opposite direction, i.e...
of mathematical and computer programming skill. They are able to invent derivativesDerivative (finance)A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
of high complexity and construct sophisticated pricing models. They generally handle the most advanced computing techniques adopted by the financial markets since the early 1980s. Typically, they are physicists and engineers by training; rocket scientists do not necessarily build rockets for a living. - White KnightWhite knight (business)In business, a white knight, or "friendly investor," may be a corporation or a person that intends to help another firm. There are many types of white knights...
, a friendly party in a takeoverTakeoverIn business, a takeover is the purchase of one company by another . In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company.- Friendly takeovers :Before a bidder makes an offer for another...
bid. Used to describe a party that buys the shares of one organization to help prevent against a hostile takeover of that organization by another party.
See also
- Finance capitalismFinance capitalismFinance capitalism is a term in Marxian political economics defined as the subordination of processes of production to the accumulation of money profits in a financial system. It is characterized by the pursuit of profit from the purchase and sale of, or investment in, currencies and financial...
- Financial crisisFinancial crisisThe term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these...
- Financial instrument
- Financial market efficiencyFinancial market efficiencyIn the 1970s Eugene Fama defined an efficient financial market as "one in which prices always fully reflect available information”.The most common type of efficiency referred to in financial markets is the allocative efficiency, or the efficiency of allocating resources.This includes producing the...
- Brownian Model of Financial MarketsBrownian Model of Financial MarketsThe Brownian motion models for financial markets are based on the work of Robert C. Merton and Paul A. Samuelson, as extensions to the one-period market models of Harold Markowitz and William Sharpe, and are concerned with defining the concepts of financial assets and markets, portfolios, gains and...
- Investment theoryInvestment theoryInvestment theory encompasses the body of knowledge used to support the decision-making process of choosing investments for various purposes. It includes portfolio theory, the Capital Asset Pricing Model, Arbitrage Pricing Theory, and the Efficient market hypothesis.-References:*...
- Quantitative behavioral financeQuantitative behavioral financeQuantitative behavioral finance is a new discipline that uses mathematical and statistical methodology to understand behavioral biases in conjunction with valuation. Some of this endeavor has been led by Gunduz Caginalp and collaborators including Vernon L...
- Slippage (finance)
- Stock investor