FUNCTIONS OF FINANCIAL MARKETS PDF : Economic functions, finance functions and intermediary functions
MEANING OF FINANCIAL MARKETS
Financial markets refer to the institutional arrangements for dealing in financial assets and credit instruments of different types such as currency, cheques, bank deposits, bills, bonds, etc.
Financial markets, may be broadly classified as negotiated loan markets and open markets. The negotiated loan market is a market in which the lender and the borrower personally negotiate the terms of the loan agreement, e.g. a businessman borrowing from a bank or from a small loan company. On the other hand, the open market is an impersonal market in which standardized securities are treated in large volumes. The stock market is an example of an open market.
The financial markets in a nutshell, could mean:
1. Organization that facilitate the trade in financial products i.e. stock exchanges facilitate the trade in stocks, bonds and warrants.
2. The coming together of buyers and sellers to trade financial products i.e. stocks and shares are traded between buyers and sellers in a number of ways.
3. The participants of these markets are financial institutions, agents, brokers, dealers, borrowers, lenders, savers and other who are inter linked by the laws, contracts and communication networks.
FUNCTIONS OF FINANCIAL MARKETS
Financial markets provide the following three major economic functions:
(a) Price discovery: The forces of demand and supply help to establish a price for a commodity or service in the market. In financial markets, interaction between buyers and sellers of financial instruments determine the price of a traded product. At the same time the required return from the investment of funds is determined by the participants in a financial market. The inducement for firms to acquire funds depends on the required rate of return that investors demand.
It is these functions of financial markets that signal how the funds available from those who want to lend or invest funds will be allocated among those needing funds and raise those funds by issuing financial instruments. This is called price discovered process.
(b) Provide liquidity to financial assets: An attractive feature where circumstances either force or motivate an investor to sell is that financial markets provide a mechanism for an investor to sell a financial asset. In doing so, they provide liquidity to financial asset. Without liquidity, the owner will be forced to hold a debt instrument till it matures and an equity instrument till the company is either voluntarily or otherwise liquidated. While all financial markets provide some form of liquidity, the degree of liquidity is one of the factors that characterise different financial markets.
(c) Reduce the cost of transactions: One of the other important functions of financial market is that it reduces the search and information costs of transacting by providing valuable information about securities to the investors being traded in the market. It helps to save time, effort and money that both buyers and sellers of a financial asset would have to otherwise spend to try and find out each other. The presence of organised and efficient market reflect the aggregate information collected by all market participants.
The intermediary functions of a financial markets include the following:
(a) Transfer of Resources: Financial markets facilitate the transfer of real economic resources from lenders to ultimate borrowers. It give lenders the choice of different investments and thus helps to channelise surplus funds into the most productive use.
(b) Enhancing Income: Financial markets allow lenders to earn interest or dividend on their surplus invisible funds, thereby, increasing their incomes and as a result, enhancing national income finally.
(c) Productive Usage: Financial markets allow the productive use of the funds borrowed. Borrowers will have to use borrowed funds productively, if invested in new assets, and hence increasing their income and gross national product finally.
(d) Capital Formation: Financial markets provide a channel through which new saurings flow into capital formation of a country. In other words, different components of financial markets help an accelerated growth of industrial and economic development of a country, thus contributing to raising the standard of living of the well being.
(e) Welfare of general public: Financial markets by facilitating transfer of real resources, it serves the economy and thus, assist in achieving the desired national objectives.
These functions are listed below:
(a) To provide the borrowers with funds which they need to carry out their various investment plans.
(b) To provide the lender with earning assets so as to enable them to earn wealth by deploying their funds in productive form.
(c) To provide liquidity in the market through which the claims against money can be resold at any time, and thus, reconverting them into current funds.