Individuals, companies and other entities use financial markets to trade a variety of fungible financial products. Financial markets deal in securities, which are financial instruments including stocks and bonds, and commodities, which are marketable physical goods and services including agricultural goods and precious metals. Trade prices are applied through supply and demand and trades are made for low transaction fees.
There are numerous reasons that investors trade in financial markets. Such outlets allow companies and institutions to raise capital, transfer liquidity, trade international currencies, transfer risk, integrate trading with various global markets, and recover expenses.
Capital Markets Explained
Capital markets are provided for traders to buy and sell securities that are backed by equity or long-term debt. Investors are able to place their accumulated wealth with selected companies or governments that, in turn, utilize the investments to increase or improve production and operation thereby providing a return. Capital markets are overseen by regional regulators, like the SEC (U.S. Securities and Exchange Commission) and the BoE (UK Bank of England), which ensure that investments are protected against fraud and other unlawful activities.
Capital markets are further reduced to stock markets which are, in turn, divided into primary markets and secondary markets.
Stock Markets Explained
Stock or equity markets are where networks of buyers and sellers can make economic transactions of stocks (or shares). Trades can be made in publicly listed securities or those offered privately.
Stocks are divided and labeled through various means. A common method is to partition stocks according to the base country of the offering company or institution. For example, the companies of Isuzu Motors, Mitsubishi Motors and Panasonic are based in Japan and are therefore represented on the Tokyo Stock Exchange (JPX).
Stock Market – Primary Market
Companies, government agencies and other institutions directly offer newly issued securities (stocks or bonds) through the primary market. Proceeds from the sale of securities are used to fund and expand business operations. The issuance of new securities in primary markets normally occurs through a process known as underwriting.
Stock Market – Secondary Market
The exchange of outstanding securities, including stocks, bonds, derivatives, currencies and other structured products, between traders and investors occurs through secondary markets. Transactions are usually made via OTCs (over-the-counter markets) and trading venues that are regulated. Secondary markets encourage investor participation in primary market trading since quick investment cash outs can be made when required. With secondary market trading, proceeds go directly to the trader instead of the issuing company.
Stock Market – Security Underwriting
Companies, governments and other institutions wishing to issue new securities must reach an active investment pool for the process to be successful. Securities underwriting is the process often used to accomplish this goal. Investment banks are tasked with finding investors and raising either equity or debt capital on behalf of such entities. Underwriter services are seldom used in private offerings, but mainly remain in the realm of public offerings.
Underwriting is a common method used for the distribution of newly issued securities from companies or institutions to interested investors with the end goal of raising capital. Transactions are underwritten by the top managers of a network of participating banks which places the risk of distributing securities and raising the required capital on those banks. If the underwriting banks do not find enough investors to purchase all securities, remaining securities are shouldered by those banks.
Underwriters use what is called an underwriting spread to make money on securities transactions. This spread occurs between the price they agree to pay the issuer for the securities and the price at which the securities are sold to investors. Dealers may also be called upon that buy portions of the total securities package to sell independent of the banks.