The financial system consists of financial markets; suppliers and demanders of capital; the
financial intermediaries that offer market access to the suppliers and demanders of capital; and
the system regulators.
Financial markets are places where financial assets, or securities, are bought and sold. Securities
differ from each other in the types of claims they offer to investors. As a result, they also differ in
their risk and return characteristics. The return on a security is composed of the periodic income
earned plus any capital gains. Risk has many definitions, but volatility of return is the most
The principal securities making up the financial marketplace are Treasury bills (T-bills), bonds,
common and preferred shares, and derivative securities such as options and futures. Many of
these securities are listed for trade on organized exchanges. Others are traded on the market
for unlisted securities; this is the over-the-counter (OTC) market. The market for newly issued
securities is called the primary market. The market for previously issued securities is known as the
Other important financial markets, in addition to the long-term capital, money, and derivatives
markets, are the foreign exchange market and the real estate market.
Over the period from 1991 to 2011, T-bills have had the lowest average return but the lowest
amount of volatility (risk) of the three basic securities: T-bills, long-term bonds, and common
shares (or equities). Bonds have had a higher return than T-bills but have been riskier (more
volatile). Common shares have earned more than T-bills or bonds but have shown the greatest
amount of risk over the period.
The returns on securities can be viewed in either nominal or real (inflation-adjusted) terms.
Maintaining purchasing power for an investor means earning a nominal return at least equal
to the rate of inflation, or, alternatively, earning a real return of zero percent. Increasing wealth
requires earning a positive real return on investment. Investments in all three basic securities have
allowed investors to maintain purchasing power and to increase wealth in the time period of 1991 to 2010.