Handbook of Market Risk

Chapter One

Introduction to Financial Markets

Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.

—George Soros

Traditionally, a market is a place where people go to buy or sell things to meet their needs. Financial markets are very similar except that we find stocks, bonds, and other things. A financial market is a market in which financial assets are traded. In addition to enabling exchange of previously issued financial assets, financial markets facilitate borrowing and lending by facilitating the sale by newly issued financial assets. Examples of financial markets include the New York Stock Exchange (resale of previously issued stock shares), the U.S. government bond market (resale of previously issued bonds), and the U.S. Treasury bills auction (sales of newly issued T-bills). A financial institution is an institution whose primary source of profits is through financial asset transactions. Examples of such financial institutions include discount brokers, banks, insurance companies, and complex multifunction financial institutions.

Traditionally, financial markets serve six basic functions. These functions are briefly listed below:

• Borrowing and Lending. Financial markets permit the transfer of funds (purchasing power) from one agent to another for either investment or consumption purposes. Borrowers can be either government or companies. Borrowers are driven by costs when accessing financial ...