What Are Financial Markets
What Are Financial Markets
Financial markets, from the name itself, are a type of marketplace that provides an avenue for
the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives. Often,
they are called by different names, including “Wall Street” and “capital market,” but all of them
still mean one and the same thing. Simply put, businesses and investors can go to financial
markets to raise money to grow their business and to make more money, respectively.
To state it more clearly, let us imagine a bank where an individual maintains a savings account.
The bank can use their money and the money of other depositors to loan to other individuals
and organizations and charge an interest fee.
The depositors themselves also earn and see their money grow through the interest that is paid
to it. Therefore, the bank serves as a financial market that benefits both the depositors and the
debtors.
There are so many financial markets, and every country is home to at least one, although they
vary in size. Some are small while some others are internationally known, such as the New York
Stock Exchange (NYSE) that trades trillions of dollars on a daily basis. Here are some types of
financial markets.
1. Stock market
The stock market trades shares of ownership of public companies. Each share comes with a
price, and investors make money with the stocks when they perform well in the market. It is easy
to buy stocks. The real challenge is in choosing the right stocks that will earn money for the
investor.
There are various indices that investors can use to monitor how the stock market is doing, such
as the Dow Jones Industrial Average (DJIA) and the S&P 500. When stocks are bought at a
cheaper price and are sold at a higher price, the investor earns from the sale.
2. Bond market
The bond market offers opportunities for companies and the government to secure money to
finance a project or investment. In a bond market, investors buy bonds from a company, and the
company returns the amount of the bonds within an agreed period, plus interest.
3. Commodities market
The commodities market is where traders and investors buy and sell natural resources or
commodities such as corn, oil, meat, and gold. A specific market is created for such resources
because their price is unpredictable. There is a commodities futures market wherein the price of
items that are to be delivered at a given future time is already identified and sealed today.
4. Derivatives market
Such a market involves derivatives or contracts whose value is based on the market value of the
asset being traded. The futures mentioned above in the commodities market is an example of a
derivative.
The role of financial markets in the success and strength of an economy cannot be
underestimated. Here are four important functions of financial markets:
As mentioned in the example above, a savings account that has money in it should not just let
that money sit in the vault. Thus, financial markets like banks open it up to individuals and
companies that need a home loan, student loan, or business loan.
Investors aim to make profits from their securities. However, unlike goods and services whose
price is determined by the law of supply and demand, prices of securities are determined by
financial markets.
Buyers and sellers can decide to trade their securities anytime. They can use financial markets to
sell their securities or make investments as they desire.
In financial markets, various types of information regarding securities can be acquired without
the need to spend.
There are many things that financial markets make possible, including the following:
Financial markets provide a place where participants like investors and debtors,
regardless of their size, will receive fair and proper treatment.
They provide individuals, companies, and government organizations with access to
capital.
Financial markets help lower the unemployment rate because of the many job
opportunities it offers
Functions of Financial Markets
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There are different functions that the financial markets perform which includes
determination of the prices where financial markets help in price discovery of various
investors to buy or sell their respective financial instrument at the fair value that is
prevailing in market, providing the various types of information to traders, and the
1. Price Determination
2. Funds Mobilization
3. Liquidity
4. Risk sharing
5. Easy Access
7. Capital Formation
#1 – Price Determination
The financial market performs the function of price discovery of the different financial
instruments which are traded between the buyers and the sellers on the financial market. The
prices at which the financial instruments trade in the financial market are determined by the
So the financial market provides the vehicle by which the prices are set for both financial
assets which are issued newly and for the existing stock of the financial assets.
#2 – Funds Mobilization
Along with the determination of the prices at which the financial instruments trade in the
financial market, the required return out of the funds invested by the investor is also determined
by participants in the financial market. The motivation for persons seeking the funds is
Because of this function of the financial market only, it is signaled that how funds which
available from the lenders or the investors of the funds will get allocated among the persons
who are in need of the funds or raise the funds through the means of issuing financial
instruments in the financial market. So, the financial market helps in the mobilization of the
#3 – Liquidity
The liquidity function of the financial market provides an opportunity for the investors to sell
their financial instruments at its fair value prevailing in the market at any time during the
In case there is no liquidity function of the financial market, then the investor forcefully have to
hold the financial securities or the financial instrument until the conditions arise in the market to
sell those assets or the issuer of the security is obligated contractually to pay for the same i.e., at
the time of maturity in case of the debt instrument or at the time of the liquidation of the
company in case of the equity instrument is until the company is either voluntarily or
involuntarily liquidated.
Thus, in the financial market investors can sell their securities readily and convert them into cash
#4 – Risk sharing
Financial market performs the function of the risk-sharing as the person who is undertaking the
investments are different from the persons who are investing their fund in those investments.
With the help of the financial market, the risk is transferred from the person who undertakes the
investments to those persons who provide the funds for making those investments.
#5 – Easy Access
The industries require the investors for raising the funds and the investors require the industries
for investing its money and earning the returns from them. So the financial market platform
provides the potential buyer and seller easily, which helps them in saving their time and money
selling the securities. For obtaining the same time and money is required.
But the financial market helps in providing every type of information to the traders without the
requirement of spending any money by them. In this way, the financial market reduces the cost
of the transactions.
#7 – Capital Formation
Financial markets provide the channel through which the new savings of the investors flow in
Let’s consider an example of the company XYZ ltd, which requires the funds to start a new
project but at present, it doesn’t have such funds. On the other side, there are investors who
have spare money and want to invest in some areas where they can get the required rate of
expected returns.
So, in that case, the financial market will function where the company can raise funds from the
investors and the investors can invest their money through the help of the financial market.
Important points of the Functions of Financial Markets
1. Financial Markets is the market, an arrangement or institution where the traders are
involved in the buying and selling of the financial assets like shares, bonds, derivatives,
3. There are different types of the financial market which can exist in any country that
4. Financial Markets have different roles to play which include price determination, funds
mobilization, risk sharing, easy access, liquidity, capital formation and reduction in
5. With respect to the size of the financial market, many financial markets are very small in
size facilitating the very little amount of the activity, and many of the financial market
6. The financial market may have or not have the physical location and the exchange of the
financial instruments and the financial securities may be exchanged between the parties
over the phone or the internet as well. With respect to the size of the financial market,
many financial markets are very small in size facilitating the very little amount of the
activity, and many of the financial markets trade huge amounts of securities daily.o
Financial Markets perform various functions in any country which gives an opportunity to
the companies and traders for buying and selling the different financial instruments and
the financial securities. It plays a crucial role in the allocation of the limited resources
available in the economy of any country. It acts as an intermediary between savers and
the investors by mobilizing the funds between them and helps in the determination of
Both the money market and the capital market are the two different types of the financial
markets where in the money market is used for the purpose of short term borrowing and
lending whereas the capital market is used for the long term assets i.e., the assets which
Money market and Capital market are types of financial markets. Money markets are used
for short-term lending or borrowing usually the assets are held for one year or less whereas,
Capital Markets are used for long-term securities they have a direct or indirect impact on the
capital. Capital markets include the equity market and the debt market.ney Market?
Money markets are unorganized markets where banks, financial institutions, money dealers and
brokers trade in financial instruments for a short period of time. They trade in short-term debt
instruments like trade credit, commercial paper, certificate of deposit, T bills, etc. which are
Trading in the money market is done mostly through over the counter (OTC) i.e. no or little use
of exchanges. They provide businesses with short-term credit and play a major role in providing
liquidity in the economy over the short term. It helps the business and industries with working
debentures are traded for a long duration of time. They serve the purpose of long-term
financing and long-term capital requirement. The Capital market is a dealer and an auction
Primary market: A primary market where the fresh issue of securities are offered to the
public
Secondary market: A secondary market where issued securities are traded between the
investors.ferences
Capital markets are well organized whereas money markets are not that organized
Liquidity is high in the money market whereas liquidity is comparatively low in capital
markets
Due to high liquidity and low duration of maturity in money markets, Instruments in
money markets are a low risk whereas capital markets are the comparatively high risk
A central bank, commercial banks and non-financial institutions are majorly work in
Money markets are required to fulfill the capital needs in the short-term especially the
working capital requirements and capital markets are required to provide long-term
financing and a fixed capital for purchasing land, property, machinery, building, etc.
Money markets provide liquidity in the economy where capital markets stabilize the
Capital markets generally give higher returns whereas money markets give a low return
on investments.tive Table
Basis for
Money Market Capital Market
Comparison
Nature of Market Money markets are informal Capital markets are more formal
Since the market is liquid and the Due to less liquid nature and long
Risk factor
maturity is less than one year, Risk maturity, the risk is comparatively high
involved is low
The market fulfills the short-term The capital market fulfills the long-term
Purpose
credit needs of the business credit needs of the business
The money markets increase the The capital market stabilizes the
Functional merit
liquidity of funds in the economy economy due to long-term savings
Return on The return in money markets are The returns in capital markets are high
Both are part of the financial markets. The main aim of the financial markets is to
channelize funds and to generate returns. The financial markets stabilize the money
supply by lending borrowing mechanism i.e. surplus funds are provided to borrowers by
the lenders.
Both are required for the betterment of the economy as they fulfill the long-term and
short-term capital needs of the business and industry. The markets encourage individuals
Investors can tap into each of the markets depending on their needs. Capital markets are
generally less liquid but provide good returns at higher risk whereas money markets are
highly liquid but provide lower returns. Money markets are also considered safe assets.
However, due to market anomalies and inefficiency due to some aberrations above may
not hold. Investors try to look for arbitrage opportunities due to such anomalies to get
higher returns. Money markets are considered safe but they sometimes give negative
returns. Thus, investors should study the pros and cons of each financial instrument and
the condition of the financial market before putting their money for the short term or
long term.