Securities: Introduction to Financial Markets

Understanding Financial Markets

Types of Markets

Financial markets are places where people buy and sell things like stocks and other special things called financial assets. Let's learn about four types of markets:

Direct Search Markets

In a direct search market, buyers and sellers have to find each other on their own. It's like if you want to sell your used refrigerator, you have to tell people by asking your parents to help you put an ad in a newspaper. These markets are not very organized, and they sell things that are not the same or standard. It's hard for businesses to specialize and make money in these markets.

Brokered Markets

Brokered markets are a bit more organized. In these markets, there are people called brokers who help buyers and sellers find each other. For example, in the real estate market, brokers help people who want to buy a house find houses for sale. Brokers have special knowledge about the things being bought and sold in that market.

The primary market is a type of brokered market where new things, like stocks, are sold to the public for the first time. Companies have people called investment bankers who act as brokers and help sell these new things directly to people who want to buy them.

Dealer Markets

Dealer markets are even more organized. In these markets, there are people called dealers who specialize in certain things, like stocks or bonds. Dealers buy these things for themselves and then sell them to make a profit. They have different prices for buying and selling, and that's how they make money. Dealer markets save people time because they can easily see the prices dealers are offering without searching too much. Most bonds are traded in dealer markets.

Auction Markets

Auction markets are the most organized type of market. They are like a big gathering where everyone comes together to buy or sell something. The New York Stock Exchange (NYSE) is an example of an auction market. In auction markets, people don't have to search for the best price because they can all meet at one place and agree on a price. This saves them money.

Electronic Communication Networks (ECNs)

Electronic communication networks are special systems that let people trade things over the internet. They have a book that shows all the orders to buy or sell things. If two orders match, they are automatically executed without needing a broker. ECNs are fast and save people money because they don't have to pay the difference between buying and selling prices. They also keep people's trades private.

Specialist Markets

Specialist markets used to be common, but now they are not as popular because of electronic systems. In specialist markets, there are experts called specialists who take care of trading for certain stocks. Brokers bring orders to these specialists, and they help make the trades happen. Specialists also make sure the market stays fair and organized when there aren't many orders. They buy and sell stocks from their own inventory to help other traders.

This article takes inspiration from a lesson found in FIN 4504 at the University of Florida.