The US financial markets are a complex ecosystem of interconnected components. Money markets deal with short-term debt securities, while bond markets involve longer-term government and corporate debt. Equity markets facilitate the buying and selling of company shares through exchanges and over-the-counter trading.

Understanding these markets is crucial for investors and companies alike. Key concepts include securities, capital markets, and financial intermediaries. Factors like liquidity, volatility, and derivatives play important roles in shaping market dynamics and investment strategies.

Overview of US Financial Markets

Components of US money markets

• Money markets involve short-term debt securities with maturities of one year or less (Treasury bills, commercial paper, certificates of deposit)
  • Highly liquid investments can be quickly converted to cash with minimal impact on their value
  • Considered safe investments due to their short maturities and high credit quality of issuers
• Functions of money markets include:
  • Providing short-term funding for governments, financial institutions, and corporations to meet their immediate cash needs
  • Enabling investors to earn interest on their cash reserves while maintaining liquidity
  • Facilitating the implementation of monetary policy by central banks through open market operations

Government vs corporate bond markets

• Government bond markets consist of debt securities issued by federal, state, and local governments
  • Considered low-risk investments due to the backing of the government's taxing authority
  • U.S. Treasury securities include Treasury notes (maturities of 2-10 years), Treasury bonds (maturities of 20-30 years), and Treasury Inflation-Protected Securities (TIPS) which adjust principal based on inflation
  • Municipal bonds issued by state and local governments often offer tax advantages to investors
• Corporate bond markets involve debt securities issued by corporations to raise capital for various purposes (expansion, acquisitions, working capital)
  • Higher risk compared to government bonds due to the possibility of the issuing company defaulting on its obligations
  • Offer higher yields to compensate investors for the increased risk
  • Credit ratings assigned by agencies like Standard & Poor's and Moody's assess the creditworthiness of the issuing company
• Key differences between government and corporate bond markets:
  • Default risk: Government bonds have significantly lower default risk than corporate bonds
  • Yield: Corporate bonds generally offer higher yields to attract investors and compensate for the higher risk
  • Liquidity: Government bonds are typically more liquid and easier to trade than corporate bonds
  • Taxation: Interest from municipal bonds is often exempt from federal income tax and sometimes state and local taxes

Structure of US equity markets

• Primary market refers to the initial public offerings (IPOs) where companies issue new shares to raise capital
  • Investment banks act as underwriters to facilitate the IPO process, setting the initial price and allocating shares to investors
• Secondary market involves the trading of previously issued securities among investors
  • Exchanges like the New York Stock Exchange (NYSE) and NASDAQ provide centralized platforms for equity trading
    • NYSE utilizes an auction-based trading system with designated market makers to facilitate orderly trading
    • NASDAQ operates as an electronic trading platform with multiple market makers competing for orders
  • Over-the-counter (OTC) markets enable decentralized trading directly between buyers and sellers without the involvement of an exchange
• Trading mechanisms in equity markets include:
  1. Market orders which execute a trade immediately at the best available current price
  2. Limit orders which specify a maximum price to buy or a minimum price to sell, providing investors more control over execution prices
  3. Stop orders which are triggered to buy or sell when the stock reaches a predetermined price, helping to limit potential losses or lock in profits
• Key participants in equity markets include:
  • Retail investors who are individual investors trading for their personal accounts
  • Institutional investors such as mutual funds, pension funds, and insurance companies which manage large portfolios on behalf of their clients
  • Broker-dealers who facilitate trades, provide investment advice, and offer various financial services to their clients
• Market capitalization, the total value of a company's outstanding shares, is used to classify stocks (e.g., large-cap, mid-cap, small-cap)

Additional Financial Market Concepts

• Securities: Financial instruments that represent ownership (stocks) or debt (bonds) traded in financial markets
• Capital markets: Long-term financial markets where securities are bought and sold, including both equity and debt markets
• Financial intermediaries: Institutions that facilitate transactions between lenders and borrowers in capital markets
• Liquidity refers to the ease with which an asset can be bought or sold without significantly affecting its price
• Volatility measures the degree of price fluctuation in a security or market over time
• Derivatives are financial contracts whose value is derived from the performance of an underlying asset, index, or entity