Financial Market

Financial Market is a market that creates and exchanges financial assets. In general, the investors are known as the surplus units and business enterprises are known as the deficit units. Hence, a financial market acts as a link between surplus units and deficit units and brings the borrowers and lenders together.

Studying Financial Market will be helpful for UPSC IAS Exam preparation. Mains GS paper-3 Indian Economy.

Table of Content

• What is Financial Market?
• Types of Financial Markets
• Functions of Financial market
• Conclusion
• Frequently Asked Questions (FAQs)

What is Financial Market?

• Financial Markets include any place or system that provides buyers and sellers the means to trade financial instruments, including bonds, equities, the various international currencies, and derivatives.
• Financial markets facilitate the interaction between those who need capital (Money) with those who have capital (Money) to invest.
• In addition to making it possible to raise capital, financial markets allow participants to transfer risk (generally through derivatives) and promote commerce.

Types of Financial Markets         

Capital market:

• A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold.
• Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments.
• Financial regulators like Securities and Exchange Board of India (SEBI) and the U.S. Securities and Exchange Commission (SEC) oversee capital markets to protect investors against fraud, among other duties.

Types of Capital market:

Primary market:

• The primary market deals with the issuance and sale of securities to purchasers directly by the issuer, with the issuer being paid the proceeds.
• A primary market means the market for new issues of securities.
• A market is primary if the proceeds of sales go to the issuer of the securities sold and buyers buy securities that were not previously traded.
• Since the securities are issued directly by the company to its buyers, the company receives the money and issues new security certificates to the buyers.
• The primary market plays the crucial function of facilitating capital formation within the economy.
• The securities issued at the primary market can be issued in face value, premium value, or at par value.

Secondary market:

• The secondary market, also called the aftermarket and follow on public offering, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold.
• Securities issued by a company for the first time are offered to the public in the primary market.
• Once the IPO is done and the stock is listed, they are traded in the secondary market.
• In the secondary market, investor purchases securities from other investors willing to sell the same.
• Secondary markets are primarily of two types: Stock exchanges and over-the-counter markets.
• Stock exchanges are centralised platforms where securities trading take place, sans any contact between the buyer and the seller.
• Over-the-counter markets are decentralised, comprising participants engaging in trading among themselves.

Money market:

• The money market is a component of the economy that provides short-term funds.
• The money market deals in short-term loans, generally for a period of a year or less.
• Money market consists of negotiable instruments such as treasury bills, commercial papers and certificates of deposit.
• It is used by many participants, including companies, to raise funds by selling commercial papers in the market.
• Money market is considered a safe place to invest due to the high liquidity of securities.

Instruments of Money market:

• Certificate of deposit: Time deposit, commonly offered to consumers by banks, thrift institutions, and credit unions.
• Treasury bills: Short-term debt obligations of a national government that are issued to mature in three to twelve months
• Commercial paper: Short term instruments promissory notes issued by company at discount to face value and redeemed at face value.

Derivatives market:

• Derivatives are financial instruments whose value depend upon or is derived from some underlying assets.
• The underlying assets can be real assets such as commodities, gold etc. or financial assets such as index, interest rate etc.
• A derivative does not have its own physical existence.
• It emerges out of the contract between the buyer and seller of the derivative instrument.
• Returns from derivative instruments are linked to the returns from underlying assets.

Currency market:

• The forex (foreign exchange) market is the market in which participants can buy, sell, hedge, and speculate on the exchange rates between currency pairs.
• The forex market is the most liquid market in the world, as cash is the most liquid of assets.
• It is a global decentralized or over-the-counter market for the trading of currencies.
• This market determines foreign exchange rates for every currency.

Functions of Financial market

Price Evaluation:

• The prices for the various financial instruments traded between buyers and sellers on the financial market are determined by the financial market.
• Demand and supply, which are two important market forces, influence the prices at which financial instruments trade on the financial market.
• As a result, the financial market provides a vehicle for pricing all newly delivered financial assets as well as existing stocks of financial assets.

Mobilization of Financial Resources:

• Participants in the financial market decide not only the prices at which financial instruments trade but also the required return on the investor’s capital invested.
• The required rate of return, which the investors desire, determines the incentive of those looking for the funds.
• Only this function of the financial market serves as a signal that money that is available from lenders or investors will be distributed to people who need it or who want to raise money by issuing financial instruments on the market.
• As a result, the financial market aids in the mobilisation of investor savings.

Liquidity:

• The liquidity function of the financial market provides an opportunity for the investors to sell their financial instruments at their fair value prevailing in the market at any time during the working hours of the market.

Risk of sharing:

• The individual making the investments and the person investing their money in those investments are two different people, the financial market offers the purpose of risk sharing.
• The risk is transferred from the person making the investments to the people offering the funding for those investments with the aid of the financial market.

Easy access:

• Investors need industries to invest their money so they can make huge profits, and the industries require investors to raise capital.
• Therefore, the financial market platform makes everything very easy for potential buyers and sellers to connect, saving them both time and money in the whole process.

Providing information and lowering transaction costs:

• Without the trader’s having to invest any money, the financial market assists in giving them access to all kinds of information.
• The cost of the transactions is decreased by the financial market in this way.

Capital formation:

• Capital formation in the nation is facilitated by financial markets, which act as a conduit for new investor’s savings.

Conclusion

Financial Markets perform various functions in any country, allowing companies and traders to buy and sell the different financial instruments and financial securities. It acts as an intermediary between savers and the investors by mobilizing the funds between them and helps determine the prices of securities. It plays a crucial role in allocating the limited resources available in the economy of any country.

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FAQs Frequently Asked Questions