Derivatives markets vs financial markets vs money market. Are there any differences?
If you have ever felt confused between the different types of financial markets, you have come to the right place. Let’s start with a brief overview of the three types of markets. The first is the derivatives market, which is the most liquid and has the most significant trading volume and highest prices. They include contracts whose value is determined based on the market estimated value of the asset being traded.
Financial markets are less liquid than derivatives markets, but they have much lower price volatility than derivatives markets. It requires financial planning and analysis after which, people can buy and sell stocks and bonds, as well as other types of investments.
Money market securities are less liquid and volatile than both financial and derivatives markets. Derivatives can be used to hedge risk, or they can be used as speculative tools. The difference between them and money market investments is that derivatives are not backed by any physical asset such as gold bars or silver dollars—they're just contracts between two parties that have been agreed upon by both sides.
Multiple product categories such as bonds, stocks, and debentures are combined together in the umbrella term ‘financial market’. The market is built up of two case types:
The primary market, where the public gets access to freshly-issued securities.
The secondary market is where big market players or investors get access to trade with securities.
Types of financial markets
Stocks- Used by companies to raise money through initial public offerings, with shares that are traded between buyers and sellers in the secondary market. Stocks play the pillar position in any economy.
Bonds- It’s security used by investors when a lender and borrower agree on a loan for a defined period of time. Private corporations and even government entities issue these bonds.
Financial markets rely on coherent information-sharing to ensure appropriate pricing. In a financial market, investors can get loans or access credit based on their business and capital needs. They are typically used to fund large-scale projects or operations.
The image below shows the world’s largest stock operators with the market capitalisation of top-listed companies.
A money market is a place where short-term financial instruments are held. It is a short-term market but includes high-quality liquid assets, such as treasury bills, commercial papers, and repurchase agreements. It's also called a cash market because the term "money" refers to the amount of money that can be borrowed or lent within the market.
Money market rates are typically fixed for the term of the investment and backed by the credit of the issuing entity. They are considered safe assets usually. However, due to some anomalies, there have been incidents that have reflected negative returns.
Here, investors can only get cash in exchange for their investments. It is usually used for smaller investments and businesses that don't require much money to operate.
Derivatives markets are financial markets where securities or commodities that derive their value from other assets are traded. Derivatives are also called "financial contracts". They are products, such as futures contracts and options, which represent an underlying asset (for example, a stock, bond, or commodity). There are three types of derivatives:
- Futures: These are contracts to buy or sell a commodity at a fixed price in the future. For example, if you own gold and want to know how much it will cost you to sell it in three months' time, you would use a futures contract.
- Swaps: Swaps are pairs of contracts that enable two parties to exchange cash flows without owning the underlying asset. For example, if you buy 100 shares of a stock at $50 per share and your friend wants to borrow $10 from you for 30 days, then he or she can do so through a swap.
- Options: Options give buyers the right but not the obligation to purchase (buying) or sell (selling) any stock on a defined weighted average.
|Key differences||Financial Market||Money Market||Derivative market|
|Nature||Moderately stable||Stable with low volatility||Complex, risky and volatile|
|Return on investment||High returns due to long-term savings||Low returns due to short-term savings||High-risk, high reward due to short-term duration|
|Function||Stabilises the economy with long-term savings||Stabilises the economy by increasing liquidity||Serves as an effective instrument for hedging (minimises losses)|
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