In an economy, money flows in circles. One very important aspect of this is turning savings into investment. Every business needs funds to get started and to run in the long term. These funds will be made available to them through various functions of the financial market. Let us learn about the concept of the financial market.
When we talk about markets we think about a place to sell and buy goods and services. However, in reality, the term has a much wider scope. A market is basically a sum total of demand and supply of any particular commodity or service.
So a financial market is a market, or an arrangement or an institution that facilitates the exchange of financial instruments and securities. These instruments include shares, stocks, bonds, debentures, commercial papers, bills, cheques etc. The price of these instruments is determined by the laws of demand and supply in the market.
The Concept of Financial Market
To understand the structure and the importance of financial markets, we must first understand their role in our economy. Now every economy has two basic sectors when it comes to funds – savings and investment. Savings is what we refer to when individual households save money. And investment is the capital that industries require to start and run their businesses.
Now the economy must provide a link between savings and investments. One obvious way to convert savings into investment is via banks. Alternatively, savings can be turned into investments through financial markets. Households will use their savings to buy financial instruments and commodities such as shares, stocks, debentures etc. This is the whole concept of the financial market.
This way a financial market serves an allocative function and mobilize idle funds to be put to more productive use. When the allocation of funds is done well, there are some added benefits, such as
- The rate of return on their savings will be higher for householders, than what a bank offers.
- The resources will be invested in firms that have high productivity and show great promise in the economy.
Functions of Financial Markets
1] Mobilizing Funds
In a successful economy, money should never sit idle. Investors that have savings must be linked with industries that require investment. So financial markets will enable this transaction, where investors can invest their savings according to their choices and risk assessment. This will utilize idle funds and the economy will boom.
2] Price Determination
The financial commodities traded in a financial market get their prices from the rules of demand and supply. The investors or the household are the suppliers of the funds, and the industries are the ones demanding them. The interaction between the two and other market factors will help determine the prices.
The instruments sold in the financial market tend to have high liquidity. This means at any given time the investors can sell their financial commodities and convert them to cash in a very short period. This is an important factor for investors who do not want to invest long term.
4] Easy Access
Both investors and industries need each other. The financial market provides a platform where both the buyers and sellers can find each other easily without spending too much time, money or effort.
Solved Question for You
Q: Banking and Financial markets are competing financial intermediaries. True or False?
Ans: The above statement is True. Both banks and financial markets provide households with an option on what to do with their savings, They can deposit the money in a bank or buy financial instruments directly. Both will ultimately lead to allocation of funds, but these two are the two major competing mechanisms through which that happens.