Financial Markets can be defined as markets wherein financial instruments like securities, currencies, commodities, etc. are created and traded between two ends (buyers and sellers). Financial Markets can be classified into various types on the basis of nature, claim, time, structure, etc. On the basis of what types of instruments are being traded, financial markets are classified into two types, Cash Market and Derivative Market. Cash Market trade assets whereas Derivative Market trade contracts.
What is Cash Market?
Cash Markets are the markets where assets get traded and transactions take place on an immediate basis. Purchase, sale, and transfer of ownership of financial commodities occur as and when potential buyers pay for them. Cash Markets are also known as Spot Markets because transactions are settled on the spot. Transactions are settled in real-time, usually within 2-3 business days. As cash market transactions are settled on an immediate basis, it provides the advantage of liquidity to investors. Liquidity provides greater flexibility and the ability to capitalize on short-term opportunities. For example Stock Exchange, over-the-counter transactions, etc.
Key takeaways of Cash Markets:
- Actual market prices at the time of transactions
- Immediate delivery
- Not suited for hedging
- Provides liquidity advantage
What is Derivative Market?
Derivative Markets are the markets where derivatives instruments like futures and options are traded. Trading derivatives like options contracts and future exchanges help in managing risk, speculation, and making profits. In derivative markets, the return on investment is more as compared to the risk, so the investors tend to invest more. Derivative markets can be divided into two parts, namely: Exchange Traded Derivatives and Over-The-Counter (OTC).
Key takeaways of Derivative Markets:
- Derivative Markets contribute to price discovery, capital allocation, hedging of risk, efficient capital allocation, speculations, etc.
- Investing in the derivative market involves more risk as compared to any other market but the return on investment is huge.
- At the expiration of the contract, the contract becomes null and void. So the investors have a burden to ensure profits timely.
Difference between Cash Market and Derivative Market
|
Basis |
Cash Market |
Derivative Market |
|---|---|---|
| Meaning | Cash Markets are the markets where assets get traded and transactions take place on an immediate basis. | Derivative Markets are the markets where derivatives instruments like futures and options are traded. |
| Ownership | When you trade in cash markets, you become the owner as and when you receive the delivery. | You never become an owner when you trade in derivative markets. |
| Lot Sizes | In cash markets, trading in single units can be done. | In derivative markets, trading in single units is not allowed. |
| Dividends | Investors have the right to dividends in cash markets. | Investors have no right to dividends in derivative markets |
| Trading mode | For trading in cash markets, investors need a Trading and Demat account. | For trading in derivative markets, investors need future trading account. |
| Nature of Assets | Cash markets trade only in tangible assets. | Derivative markets can trade in both tangible and intangible assets. |
| Duration | Cash market transactions give lifetime ownership. | Derivative market transactions have a maturity period. |