Mary Rose T.

Toralba (BABA 2A)

A financial system is a set of institutions, such as banks, insurance companies, and stock
exchanges, that permit the exchange of funds. Financial systems exist on firm, regional, and
global levels. Borrowers, lenders, and investors exchange current funds to finance projects,
either for consumption or productive investments, and to pursue a return on their financial
assets. The financial system also includes sets of rules and practices that borrowers and lenders
use to decide which projects get financed, who finances projects, and terms of financial deals.
Financial markets refer broadly to any marketplace where securities trading occurs,
including the stock market, bond market, forex market, and derivatives market. Financial
markets are vital to the smooth operation of capitalist economies. Financial markets involve
borrowers, lenders, and investors negotiating loans and other transactions. In these markets,
the economic good traded on both sides is usually some form of money: current money (cash),
claims on future money (credit), or claims on the future income potential or value of real assets
(equity).
Types of Financial Markets
1. Stock Markets
Perhaps the most ubiquitous of financial markets are stock markets. These are venues
where companies list their shares, which are bought and sold by traders and investors. Stock
markets, or equities markets, are used by companies to raise capital and by investors to search
for returns. Stocks may be traded on listed exchanges, such as the New York Stock Exchange
(NYSE), Nasdaq, or the over-the-counter (OTC) market. Most stock trading is done via regulated
exchanges, which plays an important economic role because it is another way for money to flow
through the economy. Typical participants in a stock market include (both retail and
institutional) investors, traders, market makers (MMs), and specialists who maintain liquidity
and provide two-sided markets. Brokers are third parties that facilitate trades between buyers
and sellers but who do not take an actual position in a stock.
2. Over-the-Counter Markets
An over-the-counter (OTC) market is a decentralized market—meaning it does not have
physical locations, and trading is conducted electronically—in which market participants trade
securities directly (meaning without a broker). While OTC markets may handle trading in
certain stocks (e.g., smaller or riskier companies that do not meet the listing criteria of
exchanges), most stock trading is done via exchanges. Certain derivatives markets, however, are
exclusively OTC, making up an essential segment of the financial markets. Broadly speaking,
OTC markets and the transactions that occur in them are far less regulated, less liquid, and more
opaque.
 3. Bond Markets
A bond is a security in which an investor loans money for a defined period at a pre-
established interest rate. You may think of a bond as an agreement between the lender and
borrower containing the loan's details and its payments. Bonds are issued by corporations as
well as by municipalities, states, and sovereign governments to finance projects and operations.
For example, the bond market sells securities such as notes and bills issued by the United States
Treasury. The bond market is also called the debt, credit, or fixed-income market.
4. Money Markets
Typically, the money markets trade in products with highly liquid short-term maturities
(less than one year) and are characterized by a high degree of safety and a relatively lower
interest return than other markets. At the wholesale level, the money markets involve large-
volume trades between institutions and traders. At the retail level, they include money market
mutual funds bought by individual investors and money market accounts opened by bank
customers. Individuals may also invest in the money markets by purchasing short-term
certificates of deposit (CDs), municipal notes, or U.S. Treasury bills, among other examples.
5. Derivatives Markets
A derivative is a contract between two or more parties whose value is based on an
agreed-upon underlying financial asset (like a security) or set of assets (like an index). Rather
than trading stocks directly, a derivatives market trades in futures and options contracts and
other advanced financial products that derive their value from underlying instruments like
bonds, commodities, currencies, interest rates, market indexes, and stocks. Futures markets are
where futures contracts are listed and traded. Unlike forwards, which trade OTC, futures
markets utilize standardized contract specifications, are well-regulated, and use clearinghouses
to settle and confirm trades. Options markets, such as the Chicago Board Options Exchange
(Cboe), similarly list and regulate options contracts. Both futures and options exchanges may
list contracts on various asset classes, such as equities, fixed-income securities, commodities,
and so on.
6. Forex Market
The forex (foreign exchange) market is where participants can buy, sell, hedge, and
speculate on the exchange rates between currency pairs. The forex market is the most liquid
market in the world, as cash is the most liquid of assets. The currency market handles more than
$7.5 trillion in daily transactions, more than the futures and equity markets combined. As with
the OTC markets, the forex market is also decentralized and consists of a global network of
computers and brokers worldwide. The forex market is made up of banks, commercial
companies, central banks, investment management firms, hedge funds, and retail forex brokers
and investors.
 7. Commodities Markets
Commodities markets are venues where producers and consumers meet to exchange
physical commodities such as agricultural products (e.g., corn, livestock, soybeans), energy
products (oil, gas, carbon credits), precious metals (gold, silver, platinum), or "soft"
commodities (such as cotton, coffee, and sugar). These are known as spot commodity markets,
where physical goods are exchanged for money. However, the bulk of trading in these
commodities takes place on derivatives markets that utilize spot commodities as the underlying
assets. Forwards, futures, and options on commodities are exchanged both OTC and on listed
exchanges around the world, such as the Chicago Mercantile Exchange (CME) and the
Intercontinental Exchange (ICE).
8. Cryptocurrency Markets
Thousands of cryptocurrency tokens are available and traded globally across a patchwork
of independent online crypto exchanges. These exchanges host digital wallets for traders to swap
one cryptocurrency for another or for fiat monies such as dollars or euros. Because most crypto
exchanges are centralized platforms, users are susceptible to hacks or fraudulent activity.
Decentralized exchanges are also available that operate without any central authority. These
exchanges allow direct peer-to-peer (P2P) trading without an actual exchange authority to
facilitate the transactions. Futures and options trading are also available on major
cryptocurrencies.
 The term “free market” is sometimes used as a synonym for laissez-faire capitalism.
When most people discuss the “free market,” they mean an economy with unobstructed
competition and only private transactions between buyers and sellers. However, a more
inclusive definition should include any voluntary economic activity so long as it is not controlled
by coercive central authorities.
Using this description, laissez-faire capitalism and voluntary socialism are each
examples of a free market, even though the latter includes common ownership of the means of
production. The critical feature is the absence of coercive impositions or restrictions regarding
economic activity.
Coercion may only take place in a free market by prior mutual agreement in a voluntary
contract, such as contractual remedies enforced by tort law.

The Free Market's Connection With Capitalism and Individual Liberty

No modern country operates with completely uninhibited free markets. That said, the
most free markets tend to coincide with countries that value private property, capitalism, and
individual rights.
This makes sense since political systems that shy away from regulations or subsidies for
individual behavior necessarily interfere less with voluntary economic transactions.
Additionally, free markets are more likely to grow and thrive in a system where property rights
are well protected and capitalists have an incentive to pursue profits.

Common Constraints on the Free Market

All constraints on the free market use implicit or explicit threats of force. Common
examples include: prohibition of specific exchanges, taxation, regulations, mandates on specific
terms within an exchange, licensing requirements, fixed exchange rates, competition from
publicly provided services, price controls, and quotas on production, purchases of goods, or
employee hiring practices. Common justifications for politically imposed constraints on free
markets include consumer safety, fairness between various advantaged or disadvantaged groups
in society, and the provision of public goods. Whatever the outward justification, business firms
and other interest groups within society often lobby to shape these constraints in their own favor
in a phenomenon known as rent-seeking. When free market behavior is regulated, the scope of
the free market is curtailed but usually not eliminated entirely, and voluntary exchanges may
still take place within the framework of government regulations.
 Some exchanges may also take place in violation of government rules and regulations on
illegal markets which may be in some ways considered an underground version of the free
market. However, market exchange is still heavily constrained because, on an illegal market,
competition often takes the form of violent conflict between rival groups of producers or
consumers as opposed to free market competition or rent-seeking competition via the political
system. As a result, in an illegal market, competitive advantage tends to flow to those who have a
relative advantage at violence, so monopolistic or oligopolistic behavior is likely and barriers to
entry are high as weaker players are driven out of the market.

Measuring Economic Freedom

In order to study the effects of free markets on the economy, economists have devised
several well known indexes of economic freedom. These include the Index of Economic Freedom
published by the Heritage Foundation, and the Economic Freedom of the World and Economic
Freedom of North America indexes published by the Fraser Institute. These indexes include
items such as the security of property rights, the burden of regulation, and openness of financial
markets, among many other items. Empirical analysis comparing these indexes to various
measures of economic growth, development, and standards of living shows overwhelming
evidence of a relationship between free markets and material well being across countries

In a command economy, the government determines what is produced, how it is

produced, and how it is distributed. Private enterprise does not exist in a command economy.
The government employs all workers and unilaterally determines their wages and job duties and
product pricing.

There are benefits and drawbacks to command economy structures. Command economy
advantages include low levels of inequality and unemployment and the common objective of
replacing profit as the primary incentive of production. Command economy disadvantages
include lack of competition, which can lead to a lack of innovation and lack of efficiency.

The Advantages of a Command Economy

Less Inequality
Because the government controls the means of production in a command economy, it
determines who works where and for how much pay. This power structure contrasts sharply
with a free market economy, in which private companies control the means of production and
hire workers based on business needs, paying them wages set by invisible market forces.
 In a free-market economy, the law of supply and demand dictates that workers who have
unique skills in high-demand fields receive high wages for their services, while low-skill
individuals in fields that are saturated with workers settle for meager wages if they can find
work at all.

Low Unemployment Levels

Unlike the invisible hand of the free market, which cannot be manipulated by a single
company or individual, a command economy government can set wages and job openings to
create the unemployment rate and wage distribution that it sees fit.

Common Good vs. Profit Priority

Whereas the motivation for profit drives most business decisions in a free market
economy, it is a non-factor in a command economy. A command economy government,
therefore, can tailor products and services to benefit the common good without regard to profits
and losses. For example, most true command economy governments, such as Cuba, offer free,
universal healthcare coverage to their citizens.

The Disadvantages of a Command Economy

Lack of Competition Inhibits Innovation
Critics argue that the inherent lack of competition in command economies hinders
innovation and keeps prices from resting at an optimal level for consumers. Although those who
favor government control criticize private firms that esteem profit above all else, it is undeniable
that profit is a motivator and drives innovation. At least partly, for this reason, many
advancements in medicine and technology have come from countries with free-market
economies, such as the United States and Japan.

Inefficiency
Efficiency is also compromised when the government acts as a monolith, controlling
every aspect of a country's economy. The nature of competition forces private companies in a
free market economy to minimize red tape and keep operating and administrative costs to a
minimum. If they get too bogged down with these expenses, they earn lower profits or need to
raise prices to meet expenses.
 Ultimately, they are driven out of the market by competitors capable of operating more
efficiently. Production in command economies is notoriously inefficient as the government feels
no pressure from competitors or price-conscious consumers to cut costs or streamline
operations. They also may be slower to respond—or are even completely non-responsive—to
consumer needs or changing tastes.

What are the pros and cons of a free market economy vs. a command economy?
Because a command economy is centrally planned, its pros include efficiency, theoretical
equality between citizens (lack of inequality), focus on the common good as opposed to profits,
speed, and low or non-existent unemployment. Some of the cons include a lack of efficient
resource allocation, lack of innovation, and the needs/preferences of society may be ignored due
to poor planning.
Free market economies are the opposite, they encourage innovation, efficient resource
allocation, and competition, resulting in better prices for individuals and the needs and
preferences of citizens being met. The cons of free markets include profits prioritized above
equality and the worker and market failures.

What are some of the ways a command economy benefits and harms people?
A command economy benefits its citizens because the government ensures that all
individuals are employed. Furthermore, profit isn't prioritized but rather the worker. It leads to
more equality, theoretically. It is harmful to people because it is an inefficient way to allocate
resources and the needs/preferences of citizens may go unmet. Furthermore, due to the lack of
competition, which leads to a lack of innovation, the quality of products may be poor.