Understanding financial markets

Financial markets are places where liquidity-surplus economic agents (those with surplus cash) meet liquidity-deficient economic agents (those who lack or need cash for their activities). Financial markets enable and facilitate these players to meet. What's more, financial markets will enable the diversification of exchanges and the allocation of resources.

Once physical places, today's financial markets are almost all completely dematerialized and resemble computer networks interconnected worldwide.

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Primary and secondary markets: definition and example

In the primary market, companies sell new stocks and bonds to the public for the first time, such as with an initial public offering (IPO). In fact, when products are issued for the first time (shares, bonds, etc.), they are said to trade on the primary market.

The secondary market is basically the stock market and refers to the New York Stock Exchange, the Nasdaq, and other exchanges worldwide. On the secondary market, securities are traded at a price determined by supply and demand.

Safe-haven assets: definition and example

A safe haven asset is one which is expected to maintain or increase in value during periods of economic uncertainty and market turbulence. Gold can be considered a safe haven par excellence for investors.

With the covid crisis, the value of gold has soared by +50% in 5 years.

The various categories of financial assets

There are several asset classes. These include:

• The Equity market, comprising equities, certain indices, ETFs and funds.
• TheFixed Income market, comprising everything to do with bonds, interest rates, credit, certain ETFs and funds.
• The Commodities market, covering natural resources and commodities (gas, oil, soy, coffee, sugar, etc.).
• The FX or Foreign Exchange market, which includes currencies and their exchange rates.

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Financial risks

Among the various risks in finance, we can mention the following:

• Market risk: the fact that the evolution of a financial asset is adverse to your position (e.g. if you buy a share and the share price falls).
• Liquidity risk: the fact that you may not be able to sell your investment within the normal timeframe, or at a lower price. This is usually the case when a crisis occurs. (Example: for a company, liquidity risk is when its cash position no longer allows it to meet its short-term receivables).
• Counterparty risk: the fact that the counterparty you have contracted with is unable to meet its commitments to you.
• Credit risk: the fact that an entity in which you have an interest may default or go bankrupt.
• Operational risk: for example, if you place an order for EUR 1,000,000 on the market when the order was for EUR 100,000. When the error is corrected, the entity may have lost money!
• Reputational risk: This is the financial risk incurred by companies or financial institutions regarding their image. (For example, the case of Volkswagen, the flagship of German industry renowned for its respect for the environment, accused of having fitted some of its cars with a system enabling them to conceal the real level of pollutant gas emissions).

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