1.1 What Are Financial Markets?

Perhaps the most widely known of financial markets are stock markets, which trade trillions of dollars of securities daily. A stock market is a venue where companies list their shares (equities), and these shares are bought and sold by traders and investors. Stock markets are used by companies to raise capital via an initial public offering (IPO) The practice of offering ownership shares of a private corporation to the public in a new stock issuance for the first time. , which is the process of offering shares of a private corporation to the public in a new stock issuance. Shares of newly issued stock are subsequently traded among various buyers and sellers in what is known as a secondary marketThe market where investors purchase and sell the securities they already own.. Most trading in stocks is done via regulated exchanges, such as the New York Stock Exchange and the Nasdaq.

The New York Stock Exchange (NYSE)The world’s largest stock exchange, which is located in the financial district of New York City., nicknamed “The Big Board,” is an American stock exchange located on Wall Street in New York City. It is the world’s largest stock exchange by market capitalization of its listed companies, which is over $30 trillion. The NYSE relied for many years on floor trading only, in which traders would use verbal and hand signal communications to convey trading information, intentions, and acceptance in the trading pit. Since 2010, this system has largely been replaced by electronic trading of securities. 

The Nasdaq (National Association of Securities Dealers Automated Quotations)An acronym for the National Association of Securities Dealers Automated Quotations; the world’s second largest stock exchange. is the world’s second largest stock exchange. Historically, stock exchanges were actual buildings where traders would gather to buy and sell securities in face-to-face negotiations. Founded in 1971, the Nasdaq was radically different—there was no trading floor and no in-person trading. All the buying and selling took place via a network of computer systems; that is, Nasdaq is the world’s first electronic exchange. Over 3,700 public companies are listed for trade on the Nasdaq, with a collective market capitalization of over $19 trillion. The Nasdaq remains the first choice of many leading tech companies such as Apple and Facebook.

Referring to the daily business news, have you ever heard the term Dow Jones Industrial AverageA stock market index of thirty major corporations listed on stock exchanges in the United States., or simply DJIA or the Dow? It is a stock market index of thirty blue-chip companies listed on stock exchanges in the United States. The DJIA was created in 1896 by Charles Dow, the editor of The Wall Street Journal and the co-founder of Dow Jones & Company, and named after him and his business associate, statistician Edward Jones. Dow was known for his ability to explain complicated financial news to the public. He believed that investors needed a simple benchmark to indicate whether the stock market was rising or declining. Dow also believed it was possible to predict stock market movements based on the price movements of different types of stocks. The word industrial in the name of the index initially emphasized the heavy industry sector, such as automobiles and steel.

As the economy changes over time, so does the composition of the DJIA. A component of the Dow may be dropped when a company becomes less relevant to current trends of the economy, to be replaced by a new name that better reflects the shift. The Dow currently includes companies like Coca-Cola, American Express, Apple, and The Home Depot. Examples of companies that have been removed from the DOW include General Electric, AT&T, Sears, General Motors, and Exxon Mobil. 

Although the DJIA is a commonly followed stock index, many professionals consider it to be an inadequate representation of the overall U.S. stock market compared to broader market indexes such as the S&P 500 or Russell 3000 Index. Figure 1.1 illustrates the Dow’s performance on October 19, 1987 (Black Monday) when the average unexpectedly dropped by 26 percent. Indeed, stock prices can be extremely volatile.

A bondA fixed-income instrument that represents a loan made by an investor to a borrower, usually a government or corporation. is a security in which an investor loans money for a defined period at a pre-established interest rate. You may think of a bond as an agreement between the lender and borrower that contains the details of the loan and its payments. Bonds are issued by corporations as well as by municipalities, states, and sovereign governments to finance projects and operations. The bond market sells securities such as notes and bills issued by the United States Treasury. The bond market also is called the debt, credit, or fixed-income market.

In the foreign exchange (forex) marketA worldwide decentralized market for the trading of currencies., participants can buy, sell, hedge, and speculate on the exchange rates between currency pairs, such as the U.S. dollar and the euro. The forex market is the most liquid market in the world, as cash is the most liquid of assets. The currency market handles about $7 trillion in daily transactions, which is more than the futures and equity markets combined.

The foreign exchange market is mostly an over-the-counter-market because trading is done directly between two parties, without the supervision of an exchange. The foreign exchange market is decentralized and consists of a global network of computers and brokers from around the world. This market is made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors.

The past several years have seen the introduction and rise of cryptocurrencies such as Bitcoin and Ethereum. A cryptocurrencyA digital currency designed to operate as a medium of exchange through a computer network. is a digital currency designed to operate as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain. Today, hundreds of cryptocurrency tokens are available and trade globally across a patchwork of independent online crypto exchanges. These exchanges host digital wallets for traders to swap one cryptocurrency for another, or for fiat monies such as dollars or euros. Because the majority of crypto exchanges are centralized platforms, users are susceptible to hacks or fraud. Decentralized exchanges are also available that operate without any central authority. These exchanges allow direct peer-to-peer trading of digital currencies without the need for an actual exchange authority to facilitate the transactions.