FINANCIAL MARKETS

What are financial markets?

Financial markets are places where people and companies come to buy and sell assets like
stocks, bonds (debt), commodities and other products. 

People have traded on financial markets for hundreds of years and they grew out of a very
real practical need – to help people buy and sell things more efficiently, and to help
companies that needed money to raise it more quickly.

Over the years, markets have grown bigger and faster. More people than ever before are now
able to get access to these markets. Once they were the preserve of big banks, finance houses
and very wealthy individuals, but no longer.

Types of asset classes

Traders are able to access a wide range of financial markets but what are the main markets
available and how do they work?

Indices
Made up of a basket of shares, a stock market index can be traded like an individual share. By
buying and selling indices, traders can speculate on the changes in price of the biggest
companies in a single market. For example, the US 500 is one of the most widely traded
indices globally – it is a measurement of some of the largest and most actively traded
companies listed on the New York Stock Exchange or NASDAQ.

Currencies
Also known as Forex or FX, the currency markets represent the constant exchange of
currencies between banks and other market participants. Currencies are quoted as a currency
‘pair’ – for example GBP/USD is the value of US dollar to the pound. All currencies have a
three letter code. The currency markets, unlike many other markets, are open 24 hrs.

Equities
Also known as share markets, these represent the prices of shares in companies that are listed
(quoted) on major stock exchanges. Famous examples include Apple, BP or Microsoft.

Commodities
Many commodities are resources that are eventually consumed, for example oil or wheat.
Most commodity markets fall in energy – like natural gas or crude oil, softs – like soybeans
or wheat, and metals, like gold, silver or platinum. Each commodity market will have its own
particular cycles, determined by specific factors like harvests or energy demands.

Bonds
Bonds are debt instruments issued by government which pay interest to investors, and  which
can also be traded.  Popular bond markets include the UK and US government 10 year
bonds. 

Interest rates
Interest rates are set by central banks and represent the cost of borrowing for currencies
controlled by those banks. The interest rates of the UK, US and Eurozone rates are frequently
traded.

What affects the markets?

Market prices are driven by the supply and demand for goods which can be affected by a
broad range of factors.  Here are some of the most common:

 News: Many market participants keep tabs on news in real-time; bad news affecting a
company or a country will drive prices down, for example. Even political news can
have a wide-reaching effect on markets
 Central bank policy: Central banks make decisions such as setting interest rates, and
these can have a profound effect on the flow of money around the world, and will
have a big impact on markets
 Company results: Companies listed on stock exchanges will release regular results
which will encourage investors to buy or sell their shares
 Government data: Governments will release data which will move markets, like
unemployment information or inflation data for example

Market participants

There are a wide range of people and companies that trade in financial markets.

 Institutional investors: Pension funds, asset managers and mutual fund providers

participate in financial markets to make profits for themselves and  and their
customers
 Banks: Banks act like brokers for other companies, like fund managers. They used to
do plenty of trading themselves, but new regulations mean they have less scope to
trade their own book.
 Brokers: Specialists placing trades for their clients
 Market makers: Some institutions are tasked with selling shares or bonds into the
market. Their job is to get the best price possible for their clients. For example, if a
company decides to issue more shares, a market maker is given the job of selling them
into the market.
 Retail investors: Everyday investors can participate in financial markets through
investing in funds, buying shares, or actively trading the markets through spread bets
and CFDs

How are financial markets traded?

Typically, markets can be traded in two ways:

On-exchange  
In the past, these were actual buildings where brokers met to buy and sale shares in
companies, or other assets, like corn or livestock. Now most trading on exchanges takes place
online, with orders being placed from all over the world.  Trading on exchange means that
contracts are standardised with a clear guidance on the quality, quantity and when you will
receive the goods.
Over-the-counter
This is where two parties agree to buy/sell to each other directly, without trading on an
exchange.

TRADING INDICES

Price movements in Indices reflect the performance of a group of underlying share prices

What is an index?

An index measures the collective price performance of a group of Shares, usually from a
particular country. Indices are often used to track and compare the performance of stock
markets.

The performance of each index is dictated by the performance of the underlying share prices
that make up that index. An index is constructed and calculated independently, sometimes by
a bank or by a specialist index provider like the FTSE Group. The choice of the companies
included in the index is determined by index calculation rules or by a committee. Not all
indices use the same rules, however. 

DNA of a stock market index

Price-weighted indices

The index is calculated by adding together the share price of each stock in the index and then
divided by the number of stocks in that index. Higher priced stocks exert more influence on
the performance of the index.  The Dow Jones Industrial Average is an example of a price
weighted index.

Market capitalisation weighted indices

The index is calculated by adding up the market capitalisation of each stock and then dividing
by the amount of companies.  Larger companies with a higher market cap will exert more
influence on the performance of the index.  The FTSE 100 is an example.

Composite indices
Composite indices provide a statistical measure of a market or sector’s performance over
time. They are useful for measuring an investor’s portfolio performance. They may be price-
weighted or market capitalisation weighted. The NASDAQ is an example of a composite
index as it measures the performance of an index that is heavily weighted towards technology
stocks.

Not all companies in an index are created equal

The composition of an index will change from time to time, based on the rules the index
calculator has established. Some companies can be given a larger weighting than others. This
means they make up more of the index, and their share price will have more influence over
the performance of the index.

Consider for each index:

 Which companies are included

What are the rules for companies to be added or removed?
  How often is the index changed? 
This is sometimes referred to as rebalancing; some companies will be removed and
others added on a periodic basis.
 What area of the market is covered? 
Not all indices cover the largest stocks, some, like the FTSE 350 and the Russell
2000, are calculated to measure the performance of smaller companies.

The price of an index is changing all the time, as the prices of the underlying shares change.

Benchmark indices

Sometimes you will hear journalists and analysts refer to a market’s benchmark index – this
is the index most commonly used to track where a particular market is heading. A few of the
main ones include:

 The Dow – the Dow Jones Industrial Average, the original stock market index, was
created by Charles Dow in 1884. It follows the price of the 30 biggest companies on
the New York Stock Exchange.
 Standard & Poor’s 500 (S&P 500) – this is the most widely tracked measure of the
US stock market. It tracks the prices of the biggest 500 companies listed on the New
York Stock Exchange and the NASDAQ.
 FTSE 100 – launched in 1984, the FTSE tracks the prices of the biggest companies
by market capitalisation listed on the London Stock Exchange.
 Nikkei 225 – this is the main stock market index for Japan, tracking the shares of 225
companies listed on the Tokyo Stock Exchange. 
 Euro Stoxx 50 – this index was created to follow the prices of the biggest 50 shares
in the Eurozone countries.
 DAX – founded in 1988, the DAX follows the shares of the largest 30 companies
listed on the Frankfurt Stock Exchange.
 CAC – tracks the largest 40 companies listed on the Paris bourse.
  ASX – the benchmark index for the Australian stock market is the ASX 200, which
follows the prices of the 200 largest companies listed on the Australian Stock
Exchange, ranked by market capitalisation.

Price movements in Indices reflect the performance of a group of underlying share prices

What is an index?

An index measures the collective price performance of a group of Shares, usually from a
particular country. Indices are often used to track and compare the performance of stock
markets.

The performance of each index is dictated by the performance of the underlying share prices
that make up that index. An index is constructed and calculated independently, sometimes by
a bank or by a specialist index provider like the FTSE Group. The choice of the companies
included in the index is determined by index calculation rules or by a committee. Not all
indices use the same rules, however. 

Benchmark indices

Sometimes you will hear journalists and analysts refer to a market’s benchmark index – this
is the index most commonly used to track where a particular market is heading. A few of the
main ones include:

Indices tend to be affected by broader market moves which affect the price of many
companies. Typical examples include:

 Political unrest or uncertainty

 Economic data – e.g. inflation statistics or unemployment numbers
 Changes to interest rates
 Good or bad news affecting several big companies in the same industry– e.g. mining
or banking
 The performance of the shares within that index
Indices tend to be affected by broader market moves which affect the price of many
companies. Typical examples include:

 Political unrest or uncertainty

 Economic data – e.g. inflation statistics or unemployment numbers
 Changes to interest rates
 Good or bad news affecting several big companies in the same industry– e.g. mining
or banking
 The performance of the shares within that index

Start trading indices with City Index

 At City Index we provide a wide range of global indices

 We use our own names for the major indices – for example, we call the FTSE 100 the
UK 100, and the DJIA is called Wall Street
 Find out more about our index spreads and pricing