FINANCIAL MARKETS AND FUNCTIONS

A financial market is a market for creation and exchange of financial assets. If you buy or sell financial assets, you will participate in financial markets in some way or the others

Functions of Financial Markets

Financial markets play a pivotal role in allocating resources in an economy by performing three important functions.

1. Financial markets facilitate price discovery

The continual interaction among numerous buyers and sellers who throng financial markets helps in establishing the prices of financial assets. Well organised financial markets seem to be remarkably efficient in price discovery. That is why financial economists say. If you want to know what is value of financial assets simply look at its price in the financial market.

2. Financial markets provide liquidity to financial assets.

Investors can readily sell their financial assets through the mechanism of financial markets. In the absence of financial markets which provide such liquidity, the motivation of investors to hold financial assets will be considerably diminished. Thanks to negotiability and transferability of securities through the financial markets, it is possible for companies to raise long term funds from investors with short term and medium term horizons. While one investor is substituted by another when a security is transacted, the company is assured of long term availability of funds.

3. Financial markets considerably reduce the cost of transacting

The two major costs associated with transacting are search costs and information cost. Search costs comprise explicit costs such as the expenses incurred on advertising when one wants to buy or sell an asset and implicit costs such as the effort and time one has to put in to locate a customer. Information costs refer to costs incurred in evaluating the investment merits of financial assets.