How Are Markets Classified?

Different types of assets are traded in different markets and depending on the type of asset traded, the markets are also classified differently. In general, markets are distinguished as primary and secondary markets, spot markets and futures markets, money markets and capital markets, and finally, traditional and alternative investment markets.

Primary Market and Secondary Market

When companies need capital, they will sell securities to investors and the trade takes place in the primary market. For example, investors purchase shares directly from the issuing company in an initial public offering (IPO). When investors sell these securities to others, the trade takes place in the secondary market. For example, after the security’s price rises, investors will sell their shares bought during the IPO to other investors. Funds flow from the buyer to the security issuer in the primary market, while funds flow between traders in the secondary market.

Spot Market and Futures Market

Depending on whether the instruments are traded for immediate delivery or future delivery, the market can be classified into spot markets and futures markets. Delivery refers to the act of exchanging cash for the instrument. Markets that trade contracts for delivery on a specific date in the future are futures markets. Markets that trade for immediate delivery are called spot markets.

Let’s take trading industrial metals as an example. An industrial metal processor can store goods and there is demand for them. When the price is low, he could choose to sign a spot contract for immediate delivery and the market he trades in is a spot market. However, an ordinary investor is not capable of storing goods and only intends to gain from price fluctuations of industrial metals. Physical trading is not wanted. In this case, he could sign a contract to buy goods at a low price for future delivery and sell the goods at a higher price before the expiration. The market he trades in is a futures market.

Money Market and Capital Market

Financial markets can be classified as money markets and capital markets.

Money markets trade instruments that mature in less than one year. Examples of instruments traded in money markets are repurchase agreements, short-term treasury bonds, certificates of deposit and commercial paper. Characteristics of trades in markets are that they are short-term, have high liquidity and are low risk. On the one hand, it satisfies the short-term capital needs of borrowers, and on the other hand, it provides a temporary investment option for investors with idle funds.

In contrast, capital markets trade instruments of medium to long-term assets (more than one year) such as bonds and equities. Characteristics of trades in the capital markets are that they are long-term, have low liquidity and are high risk. However, if the trade is profitable, the returns can be favourable.

Corporations often rely on the capital market to finance their long-term development plans, but they will sometimes also issue short-term securities to support daily operations.

Traditional Investment Market and Alternative Investment Market

Finally, markets can also be classified into traditional investment markets and alternative investment markets. Traditional investments cover all publicly traded assets such as bonds, stocks, currencies and futures. Alternative investments are investments that do not fall into any of the traditional investment categories. Instead, alternative investments include commodities, infrastructures, hedge funds, private equities (including venture capital), real estate securities, real estate properties, collectibles and more. Compared to traditional investments, alternative investments tend to be less liquid and less correlated to the market. Therefore, alternative investments are likely to be traded at a discount or premium.[1]

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[1] CFA Institute, CFA Program Curriculum 2022 Level 1 Volume 4, Corporate Finance, Equity, and Fixed Income, 130-132