Trading & Markets
This article focuses on how traders and funds have an effect on the financial market. The success of the financial market is important to everyone the world over. The article explores the role of a trader and reviews hedge funds and how their emergence has changed the market.
Keywords Bond Markets; Capital Markets; Commodity Markets; Financial Markets; Futures Markets; Hedge Funds; Money Markets; Stock Markets; Traders; Trading
The success of the financial market is important to everyone across the world. "We live in a world that is shaped by financial markets and we are profoundly affected by their operation. Our employment prospects, our financial security, our pensions, the stability of political systems and nature of the society we live in are all greatly influenced by the operations of these markets" (Fenton-O'Creevy, Nicholson, Soane, & Willman, 2005, p. 1-2). If the market is not healthy, there is potential for crises.
Financial markets could be defined in two ways. The term could refer to organizations that facilitate the trade of financial products or it can refer to the interaction between buyers and sellers to trade financial products. Many who study the field of economics tend to utilize both definitions, but finance scholars more often use the second definition. Economic markets can be both domestic and international.
Financial markets can be seen as an economics term because it highlights how individuals purchase and sell economic securities, merchandise and other products at low transaction prices that emulate effective markets. The overall objective of the process is to gather all of the sellers and put them in one place so that they can meet and interact with potential buyers. The goal is to create a process that will make it easy for the two groups to conduct business.
When looking at the concept of "financial markets" from a finance perspective, one could view financial markets as a way to facilitate the process of raising capital, transferring risk and conducting international trade. The overall objective is to provide an opportunity for those who want capital to interact with those who have capital. In most cases, a borrower will issue an acknowledgement to the lender agreeing to return the capital in full. These receipts are also known as securities and they are both purchasable and sellable. Lenders expect to be compensated for lending the money. Their compensation tends to be made through interests or dividends.
Types of Financial Markets
There are different categories of financial markets, and some of them are:
- Capital markets. Capital markets are comprised of primary and secondary financial venues, and are considered a critical factor in American capitalism. Newer securities that were formed more recently are purchased and sold in the primary market and investors sell their securities in the secondary markets. Companies rely on these markets to raise funds for the purchase of equipment required to run the business; conduct research and development; and assist in securing other items needed for the operations of the company.
- Stock markets — In order to raise a large amount of cash at one time, public corporations will sell shares of ownership to investors. Investors gain profits when the corporations increase their earnings. Many view the Dow Jones Industrial Average as the stock market, but it is only one of many components. Two other components are the Dow Jones Transportation Average and the Dow Jones Utilities Average. Stocks are traded on world exchanges such as the New York Stock Exchange and NASDAQ.
- Bond markets — Bonds are the opposite of stocks. Usually, when stocks go up, bonds go down. The differing forms that bonds come in include Treasury bonds, corporate bonds, and municipal bonds. The most significant results are usually from mortgage interest rates.
- Commodity markets. Commodity markets help the trading of raw or primary commodities run more smoothly. The commodities are traded on regulated commodities exchanges. According to Amadeo (n.d.), the most significant commodity to the American economy is oil, and the cost is decided upon by the commodity’s prospective market. Futures “are a way to pay for something today that is delivered tomorrow, which helps to remove some of the volatility in the American economy. However, futures also increase the trader's leverage by allowing him to borrow the money to purchase the commodity. If the trader guesses wrong, it can have a huge impact on the stock market, and the American economy” (Amadeo, n.d., “What are commodities”).
- Money markets. Money markets offer short-term debt financing and investment. The financial market is the international money market for briefer, more temporary borrowing. The market allows for temporary liquid funding for the international economic system. Borrowers tend to accept loans for shorter time periods that rarely extend beyond 13 months. Money markets trade by using paper as their financial instruments.
- Derivatives markets. Derivatives markets offer tools to facilitate the governance of and control over economic risks.
- Futures markets Allow for standardized forward contracts that trading products can use in the future.
- Insurance markets. Help to further and redistribute the variety of risks that might be dealt with.
- Foreign exchange markets. Help to make trading easier for foreign exchange.
- Hedge fund markets. In recent times, hedge funds have accelerated in popularity because of their assumed higher returns for high-end financiers. Because hedge funds invest most often and more heavily in future stocks, some investors believe that they have slowed the once steady evaporation of the stock market and, by extension, the American financial state. But in 1997, Long Term Capital Management, the then biggest hedge fund in the world, nearly diminished the U.S. economy entirely (Amadeo, n.d.).
Hedge funds have become popular over the last years due to their ability to take both short (sold) and long (bought) positions (Lubochinsky, Fitzgerald & McGinty, 2002). In other words, positions are "market neutral" but with leverage (Edwards, 1999). The funds are well received because they have the ability to utilize "active management skills to earn positive returns on capital regardless of the market direction" (Lubochinsky, Fitzgerald & McGinty, 2002, p. 33).
A hedge fund is a small group of investors who have formed a private club. Given the extent of the risks involved and the need to bypass regulation, most of the members of the small investor group are high-net-worth investors with over one million dollars in net worth or more than $200,000 in annual income. Therefore,...
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