Financial markets help to efficiently direct the flow of savings and investment in the economy. Financial markets (stocks or bonds), instruments (from bank CDs to futures and derivatives), and institutions (banks to insurance companies to mutual funds and pension funds) provide opportunities for investors to specialize in particular markets or services, diversify risks, or both.
Categorization of Financial Markets
Financial market categorically refers to markets that are used to raise either long or short term finance. Long term finance is achieved in the capital markets while short term is achieved in the money markets.
- Capital Markets – Capital markets are the first category of financial markets. These markets trade long term equity or debt backed securities. These markets channel wealth to institutions that make long term use such as companies and governments investments. These markets operate in such a way that money is provided for at least one year but mostly a much longer period than that. For example, the SEC (Securities and Exchange Commission) in the United States oversees the trading in its jurisdiction in this country. These markets are mostly on electronic trading.
- Money Markets – These markets provide short term financing for assets that are taking part in short term lending, borrowing, selling and buying. The period of time for maturity does not exceed one year. These markets use instruments such as: Commercial Paper which are basically promissory notes issued by companies at a discount but redeemed at face value; Treasury Bills that are short term debts that mature in three to twelve months where the government is obliged to pay its creditors.
Functions of financial markets
- 1 – Price Determination
- 2 – Funds Mobilization
- 3 – Liquidity
- 4 – Risk sharing
- 5 – Easy Access
- 6 – Reduction in Transaction Costs and Provision of the Information
Benefits of Financial Markets
Because trading costs are low, investors are willing to pay more for a firm’s shares, and the cost of capital falls. The lower cost of capital, in turn, leads to more investment, growth, and jobs. Vibrant financial markets also provide better risk sharing opportunities for firms.
Features of Financial Markets
- Acts as a Link: Financial markets connect the investors to the borrowers and bridge the gap between the two for mutual benefits.
- Easy Accessibility: These markets are readily available anytime for both the investors and the borrowers.
- Trades in Marketable and Non-Marketable Securities: Financial markets initiate buying and selling of marketable commodities. Some of these are bonds, debentures and shares along with non-marketable securities like bank deposits, post office deposits and other loans and advances.
- Government Rules and Regulations: The government controls the operations of a financial market in the country by imposing different rules and regulations.
- Involves Financial Intermediaries: These markets require financial intermediaries such as a bank, non-banking financial companies, stock exchanges, mutual fund companies, insurance companies, brokers, etc. to function.
- Deals in Long and Short-Term Investment: For the investors, financial markets provide an opportunity of putting in their funds into various securities or schemes for short or long-term investing benefits.