What is a financial market? If you want to learn about the functions of the financial market, you also need to understand what this term implies. Isn’t it? The financial market is a broad term that describes all marketplace in a specific economy responsible for handling trading of the security. It means it is a virtual platform where buying and selling of trading, aka finances and securities, takes place.
It includes trading currencies or bonds, equities, and even derivatives. Every country and region has a financial market of its own which helps the economy of the country grow. The size of this market also differs depending upon the country and its economic conditions. The major role of the financial market is to act as the middleman between the companies who want money and the business that needs it for their growth. They also have other functions, which we will be discussing below.
Five important functions of a financial market
Function 1: Determination of price for financial institutions
The major function of a financial market is to perform the role of price determination for the various financial institutions traded between sellers and buyers in the market. All financial instruments trade at a fixed price in the market, which market forces like supply and demand determine. A financial market provides a vehicle through which it sets prices for new financial assets and existing stock of these financial assets. Proper financial education teaches everything from supply and demand to saving and investing money wisely and about the financial market. Thus, it is necessary for schools to have financial education as part of the curriculum.
Function 2: Mobilization of the funds
When allocating capital to any business or firm, a major deciding criterion is what return the investors are expecting? These terms are crucial to investing, and the financial market determines these terms. If your company is seeking capital, you should be aware of the rate because that is necessary for fundraising.
Their fund’s mobilization doesn’t end here! The financial market also determines how these funds will now be allocated to the individuals or companies who require funds for supporting their firm.
Function 3: Sharing of risks
When you invest in a business, you automatically invest in the risk and liabilities that the business will face. Always the investors and the people seeking investments differ from each other. Through its risk-sharing function, the financial market ensures that the party investing knows about the risks before entering any deal. In doing so, they transfer the risk from the individual seeking to invest to the firm investing in them.
Function 4: Liquidity
Imagine a scenario where there is no organized financial market. In this case, the investors cannot trade and will have to hold financial instruments or securities till any event of liquidity occurs. What is this liquidity event? Well, if it’s debt instruments, the event will occur when the issuer has to pay the debt at the time of maturity as mentioned in the contract. If it’s an equity instrument, the liquidity event will occur when the firm liquidation happens.
Now, having an organized financial market comes in handy in such times because it provides trading opportunities to investors ensuring they can sell & buy financial instruments at a value that is fair and also follows the market value.
Function 5: It looks after the efficiency of the market
The financial market makes buying and selling securities a safe exchange. If there were no financial markets, all investors would have to put in a lot of time and money before they sell or buy any financial security as they need information. It can lead to multiple problems for both investors and individuals seeking investment. Nevertheless, with the establishment of the financial market, they ensure that relevant information is available to the investor without spending too much money or time. It helps reduce transaction prices, which is quite a lucrative offer for any investor.
You understand the financial market need and why it is critical for a country’s economic growth. Right? Then understanding that financial education is necessary for everyone is critical. It informs them of these markets and their responsibilities to ensure everyone is on the right path economically. The role of the financial market is critical in helping the formation of capital in any country.