Hey there! Welcome back to another blog on finance. In the previous blog, we discussed what are financial markets and their types. In this blog, we will discuss the functions of financial markets and their importance. Let us quickly get started and understand in detail:
Importance of Financial Markets
- The financial market plays an important role in the economy of any country, providing a framework that allows various participants, such as investors and creditors, companies, and traders, to trade fairly and appropriately, regardless of their size of business or other factors.
- In short, financial markets are platforms for buyers and sellers to transact, exchange or deal in different types of financial instruments.
There are different factors that classify the financial markets based on the nature of the claim, the maturity of the claim, the timing of the delivery, or the organizational structure. The financial industry provides a variety of employment options too, like the role of Portfolio Managers, Financial Analysts, Investment Advisers, Financial Planners, etc. It helps to reduce the country’s unemployment rate by creating job opportunities for multiple roles and positions.
Different types of financial markets can exist in a country that usually includes Money market, Over the Counter market, Derivatives market, Bond market, Forex market, and Commodities market. The size of a financial market may vary; some financial markets are very small in size, facilitating very little activity whereas many of the financial markets trade huge amounts of securities daily. The financial market may or may not have a physical location, instruments and the financial securities may be exchanged between the parties over the phone or the internet.
The functions of the financial market are as follows:
Financial markets act as a link between sellers and buyers as it helps in the transfer of assets at the most appropriate investment opportunities. It assists in determining the capital worth of securities by allowing market forces to function on their own and determine the pricing of a tradable asset. The motivation for candidates seeking the funds is dependent on the required rate of return. Financial markets reintroduce money into the economy by allowing it to be used in the purchase and sale of securities. Thus, the financial market helps in the smooth mobilization of the investors’ savings.
- Price Determination:
- The financial market performs various functions for price discovery of different financial instruments traded among the buyers and the sellers on the platform.
- The price depends upon the demand and supply factors (market forces) which thereby assists in deciding the prices of various financial securities as well.
- Liquidity in financial markets:
- Financial markets provide a platform for security to be bought and sold easily, hence (cash) liquidity for tradable assets increases.
- Investors can sell the asset at any moment, at their fair price prevailing in the market if they feel it is necessary to recoup their investment. Thus, financial markets provide liquidity.
- Risk sharing:
- The financial market performs the function of risk sharing as the person who is making the investments is different from the person who is selling their assets/fund.
- Here, the risk is transferred from the person who is selling the investments to those who are buying the assets.
- Further, it can be liquidated from the buyer to the next buyer of the financial security. Hence, risk sharing is swiftly completed between parties.
- Easy Access:
- Industries require the investors to raise funds, and the investors require the industries to invest their money and earn profitable returns.
- Financial markets provide a venue for potential buyers and sellers to meet, interact, agree, and deal.
- This feature of the financial market not only helps in saving resources like time and money but also makes trading much easier.
- Reduction in transaction costs and provision of the information:
- It takes a lot of effort and time to operate in a typical market where people trade. The financial market provides complete information regarding the price of securities, availability of relevant derivatives, and cost of various financial securities.
- Investors and companies do not have to spend much on resources for getting any kind of information as it is readily available in financial markets.
- Usually, any trader requires various types of information for doing the transaction of buying and selling the securities, which is obtained with the disposal of time and money.
- Here, the financial market helps provide every type of information to the traders without the requirement of spending any money by them, hence reducing the cost of the transactions.
- Capital formation:
- Financial markets provide the channel for the new savings or cash flow, thus aiding in the country’s capital formation.
Financial Markets are extremely vital for inducing liquidity in the economy. Without financial markets and financial instruments to invest in, funds would stay locked up in banks accounts and lockers.
If you find this article interesting and want to learn more about financial markets that too in detail, you can enroll in the CFA course. The CFA course full form is Chartered Financial Analyst, and the CFA course in India is one of the most popular courses to build a successful career in the field of Finance. To know more about the CFA course, please feel free to contact our counsellors, who would be more than happy to assist you at each step. All the best and happy learning!