I am currently making my way through the Five Minute MBA in Corporate Finance, which is likely to take about a month at the rate i am going (its 657 pages).
Anyway, Having found a particularly good summary of the different types of financial markets, i thought i would copy it across for those that are interested. I give full credit to the author but i have only been able to find a link to the book here. I also give credit to some definitions i found here.
Types of Markets
People and organizations who want to borrow money are brought together with those with surplus funds what are known as financial markets.
- Each market deals with a somewhat different type of instrument in terms of the instrument’s maturity and the assets backing it.
- Different markets serve different types of customers, or operate in different parts of the world.
The major markets identified in the 5 minute MBA are as follows:
1. Primary markets are the markets in which corporations raise new capital. If Google were to sell a new issue of common stock to raise capital (unlikely as they buckets of it), this would be a primary market transaction. The corporation selling the newly created stock receives the proceeds from the sale in a primary market transaction.
2. The initial public offering (IPO) market is a subset of the primary market. Here firms “go public” by offering shares to the public for the first time. Microsoft had its IPO in 1986, Google in 2004. Previously, Bill Gates and other insiders owned all the shares. In the majority of IPOs, the insiders sell some of their shares plus the company sells newly created shares to raise additional capital.
3. Secondary markets are markets in which existing, already outstanding, securities are traded among investors. A common misconception is that when someone buys shares in a secondary market, the company receives their purchase price when in fact you are simply buying the shares from the person who owned the shares at that time. Thus, if you decided to buy 1,000 shares of Walmart stock (feeling evil?), the purchase would occur in the secondary market. The New York Stock Exchange and the Australian Stock Exchange (ASX) are secondary markets, since they deals in outstanding, as opposed to newly issued, stocks. Secondary markets also exist for bonds, mortgages, and other financial assets.
4. Private markets, where transactions are worked out directly between two parties, are differentiated from public markets, where standardized contracts are traded on organized exchanges. Bank loans and private placements of debt with insurance companies are examples of private market transactions. Since these transactions are private, they may be structured in any manner that appeals to the two parties. By contrast, securities that are issued in public markets (for example, common stock and corporate bonds) are ultimately held by a large number of individuals. Public securities must have fairly standardized contractual features, both to appeal to a broad range of investors and also because public investors cannot afford the time to study unique, nonstandardised contracts. Their diverse ownership also ensures that public securities are relatively liquid. Private market securities are, therefore, more tailor-made but less liquid, whereas public market securities are more liquid but subject to greater regulation and standardisation.
For a previous comparision and better understanding of fundraising and investment through ipos and private equity click here.
5. Physical assets markets (also called tangible assets , real assets and commodities markets) are those for such products as wheat, gold, crude oil, real estate, RAM, and machinery. They deal with real tangible commodities instead of swapping instruments that are simply pieces of paper with contractual provisions that entitle their owners to specific rights and claims on real assets. For example, a corporate bond issued by IBM entitles its owner to a specific claim on the cash flows produced by IBM’s physical assets, while a share of IBM stock entitles its owner to a different set of claims on IBM’s cash flows. Unlike these conventional financial instruments, the contractual provisions of derivatives are not direct claims on either real assets or their cash flows. Instead, derivatives are claims whose values depend on what happens to the value of some other asset. Futures and options are two important types of derivatives, and their values depend on what happens to the prices of other assets, say, IBM stock, Japanese yen, or pork bellies. Therefore, the value of a derivative is derived from the value of an underlying real or financial asset.
6. Spot markets and futures markets are terms that refer to whether the assets (in the physical assets markets) are bought or sold for ‘on-the-spot’ delivery (literally, within a few days) or for delivery at some future date, such as six months or a year into the future. Futures will be discussed in detail in a later blog but to introduce them, they are a standardized, transferable, exchange-traded contract that requires delivery of a commodity, bond, currency, or stock index, at a specified price, on a specified future date.
7. Money markets are the markets for short-term, highly liquid debt securities. Examples of these include banker’s acceptances, repos, negotiable certificates of deposit, and Tresury Bills with a maturity of one year or less and often 30 days or less. Money market securities are generally very safe investments which return relatively low interest rate that is most appropriate for temporary cash storage or short term time needs. Whereas capital markets are the markets for intermediate, longterm debt and corporate stocks. The New York Stock Exchange, where the stocks of the largest U.S. corporations are traded, is a prime example of a capital primary market. Regarding timing, there is no hard and fast rule on this, but when describing debt markets, short term generally means less than one year, intermediate term means one to five years, and long term means more than five years.
8. Mortgage markets deal with loans on residential, commercial, and industrial real estate, and on farmland.
9. World, national, regional, and local markets also exist. Thus, depending on an organization’s size and scope of operations, it may be able to borrow all around the world, or it may be confined to a strictly local market.