FINANCIAL MARKETS-AN OVERVIEW
A market as defined by economists refers to an institution or arrangement that facilitates the purchase and sale of goods and services, and other things. A financial market is an institution or arrangement that facilitates the exchange of financial instruments, including deposits and loans, corporate stocks and bonds, government bonds, and more exotic instruments such as options and futures contracts.
A market wherein financial instruments such as financial claims, assets and securities are traded is known as a ‘financial market’. Financial market transactions may take place either at a specific place or location, e.g stock exchange, or through other mechanisms such as telephone, telex, or other electronic media. In financial markets, the price for the use of investible funds is the interest paid on the funds transacted.
DEFINITION
According to Brigham, Eugene F, “The place where people and organizations wanting to borrow money are brought together with those having surplus funds is called a financial market.”
LOCATION
A financial market may or may not have a particular physical existence. For instance, the New York Stock Exchange (NYSE) is physically located on Wall Street in New York City. Alternatively, the over-the-counter (OTC) market for stocks, called the National Association of Securities Dealers (NASD) has no fixed place of existence. It consists of brokers throughout the country who track prices via computer and telecommunication lines NASD is best known for the newspaper quotes of stock prices it generates called NASDAQ (National Association of Securities Dealers Automatic Quotation System).
ROLE
One of the important requisites for the accelerated development of an economy is the existence of a dynamic and a resilient financial market. A financial market is of great use for a country as it helps the economy in the following manner:
Savings Mobilization
Obtaining funds from the savers or ‘surplus’ units such as household individuals, business firms, public sector units, Central Government, State Governments, Local Governments, etc is an important role played by financial markets.
Investment
Financial markets play a key role in arranging to invest funds thus collected, in those units which are in need of the same.
National Growth
An important role played by financial markets is that they contribute to a nation’s growth by ensuring an unfettered flow of surplus funds to deficit units. Flow of funds for productive purposes is also made possible.
Entrepreneurship Growth
Financial markets contribute to the development of the entrepreneurial class by making available the necessary financial resources, etc.
Industrial Development
The 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 and the society’s well-being.
FUNCTIONS
A financial market renders the following functions:
Intermediary Functions
The intermediary functions of a financial market include the following:
- Transfer of resources Financial markets facilitate the transfer of real economic resources from lenders to ultimate borrowers.
- Enhancing income Financial markets allow lenders earn interest/dividend on their surplus investible funds, thus contributing to the enhancement of the individual and the national income.
- Productive usage Financial markets allow for the productive use of the funds borrowed, thus enhancing the income and the gross national production.
- Capital formation Financial markets provide a channel through which new savings flow to aid capitals formation of a country.
- Price determination Financial markets allow for the determination of the price of the traded financial asset through the interaction of buyers and sellers. They provide a signal for the allocation of funds in the economy, based on the demand and supply, through the mechanism called ‘price discovery process’.
- Sale mechanism Financial markets provide a mechanism for selling of a financial asset by an investor so as to offer the benefits of marketability and liquidity of such assets.
- Information The activities of the participants in the financial market result in the generation and the consequent dissemination of information to the various segments of the market, so as to reduce the cost of transaction of financial assets. Financial Functions
The financial functions of a financial market include the following:
- Providing the borrowers with funds so as to enable them to carry out their investment plan’s
- Providing the lenders with earning assets so as to enable them to earn wealth by deploying the assets in productive ventures
- Providing liquidity in the market so as to facilitate trading of funds
CONSTITUENTS
The Constituents Of A Typical Financial Market
PRIMARY MARKETS
Primary market deals with the issue of new securities. In this market, the government or corporate sector issues securities that change hands from the issuer to the investor. Also, new issue of financial assets are bought and sold. For instance, if L&T issues new shares, the shares are sold in the primary market.
SECONDARY MARKET
Secondary market deals with existing claims. There is no new flow of funds for instruments in this market No fresh capital is made available to the producers on account of the transactions in the secondary market, as they deal only in existing securities.
The secondary market renders a very important service to the primary market by providing a ready market for trading in securities. The volume and the magnitude of the transactions taking place in the secondary market influence the activities in the primary market. For instance, if there is an active trading for the scrips of a particular company, it is possible for that company to raise addition capital with ease and convenience because of the goodwill already generated for the scrips. Existing financial assets of a company are bought and sold in the secondary market. The existence of a secondary market for a financial asset enhances its liquidity. For example, suppose a person purchases a share of L&T in the primary market he can easily sell it for cash because, the shares are actively traded in the secondary market. All that is required is to inform a broker about the decision to sell the scrips. The broker, in turn, locates a buyer and sells the scrips for the client.
The presence of a secondary market helps lower the transaction costs, as finding buyers and sellers becomes an easy job. In the absence of a secondary market for a stock, one has to personally locate someone willing to purchase the stock. This would not only take considerable time, but it may not be possible to locate the buyer who is willing to pay the highest possible price for the stock. A secondary market is, therefore, that which allows dealing between buyers and sellers of existing shares which ultimately serves to enhance the liquidity of corporate stock. This induces investors to own stock and therefore makes it easier for firms to acquire funds in the primary stock market.