What are the Functions of Financial Markets?
There are different functions that the financial markets perform which includes determination of the prices where financial markets help in price discovery of various financial instruments, mobilization of the funds, providing an opportunity to different 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 sharing of the risk, etc.
List of Top 7 Functions of Financial Markets
- Price Determination
- Funds Mobilization
- Risk sharing
- Easy Access
- Reduction in transaction costs and provision of the Information
- Capital Formation
Let us discuss each of the financial market functions in detail –
#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 market forces i.e., demand and supply in the market.
So the financial market provides the vehicle by which the prices are set for both financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash. 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 dependent on the required rate of return which is demanded by the investors.
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 savings of the investors.
#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 working hours of the market.
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 debt instrumentDebt InstrumentDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans. 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 thereby providing the liquidity.
#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 in finding the potential buyer and seller.
#6 – Reduction in Transaction Costs and Provision of the Information
The trader requires various types of information while doing the transaction of buying and 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 the country which aid in the capital formation of the country.
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
- Financial MarketsFinancial MarketsThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces. 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, commodities, currencies, etc.
- It facilitates the exchange of financial instruments and financial securities.
- There are different types of the financial marketTypes Of The Financial MarketThe financial market is a marketplace where trading financial assets like shares, bonds, debentures, and commodities are traded. which can exist in any country that includes, Money MarketsMoney MarketsThe money market is a financial market wherein short-term assets and open-ended funds are traded between institutions and traders., Over the Counter MarketsOver The Counter MarketsOTC markets are the markets where trading of financial securities such as commodities, currencies, stocks, and other non-financial trading instruments takes place over the counter (instead of a recognized stock exchange), directly between the two parties involved, with or without the help of private securities dealers., Derivatives Market, Bonds Market, forex Market, and commodities market.
- Financial Markets have different roles to play which include price determination, funds mobilization, risk sharing, easy access, liquidity, capital formation and reduction in transaction costs and provision of the required information, etc.
- 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 trade huge amounts of securities daily
- 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.
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 the prices of securities.
This has been a guide to the Functions of Financial Markets. Here we discuss the top 7 most important functions of financial markets including Liquidity, risk sharing, price determination, easy access, capital formation, etc. You can learn more about financing from the following articles –