Financial Markets – Functions, Importance And Types

The financial market is a broad term that primarily refers to a marketplace where buyers and sellers participate in the trade, i.e., buying and selling assets. Simply saying, it is a platform that facilitates traders to buy and sell financial instruments and securities. These instruments and securities can be shares, stocks, bonds, commercial papers, bills, debentures, cheques, etc.

Financial markets are known for transparent pricing, strict regulations, costs and fees, and clear guidelines. One big characteristic of such markets is that the market forces determine the price of the assets. Also, a financial market may or may not have a physical location, meaning investors can buy and sell assets over the Internet or phone.

Importance

Financial markets are common to each country, and they play a major role in the economic growth of the country. Some countries have small markets, while some have big financial markets, like NASDAQ. Such markets act as a financial intermediary between savers and investors, or they help savers to become investors. On the other hand, they also help businesses raise money to expand their business.

It won’t be wrong to say that investors and businesses access the financial markets to raise money and also to make more money. Moreover, they also help lower unemployment as these markets create massive job opportunities.

Functions

Price Determination

The demand and supply of an asset in a financial market help determine its price. Investors are the supplier of the funds, while the industries are in need of the funds. Thus, the interaction between these two participants and other market forces helps determine the price.

Mobilization of savings

For an economy to be successful, it is crucial that the money does not sit idle. Thus, a financial market helps in connecting those with money with those who require money.

Ensures liquidity

Assets that buyers and sellers trade in the financial market have high liquidity. It means that investors can easily sell those assets and convert them into cash whenever they want. Liquidity is an important reason for investors to participate in trade.

Saves time and money

Financial markets serve as a platform where buyers and sellers can easily find each other without making too much effort or wasting time. Also, since these markets handle so many transactions, it helps them achieve economies of scale. This results in lower transaction costs and fees for the investors.

Classification of the Financial Market

As we mentioned before, financial is a very broad term, so just mentioning their types will not give readers a good idea of the financial markets. That is why we are mentioning classification and giving types under each category.

By Nature of Assets

Stock market

This is the market where shares of the company are listed and traded after their IPO. The stock market is also known by the name of the stock exchange.

Bond market

The bond market allows companies and the government to raise money for a project or investment. Investors buy bonds from a company, which later returns the amount of the bond with the agreed interest.

Commodities market

In this market, investors buy and sell natural resources or commodities like corn, oil, meat, and gold.

Derivatives market

The derivative market deals in derivatives or contracts whose value is based on the underlying asset being traded.

By Nature of Claim

Equity Market

The equity market is where investors deal in stocks or other equity instruments. It is basically the market for residual claims.

Debt Market

In the debt market, investors buy and sell fixed claims or debt instruments, like debentures or bonds.

By Maturity of Claim

Money Market

The markets where investors buy and sell securities that mature within a year are the money market. Assets that investors buy and sell in this market are commercial paper, certificates of deposits, treasury bills, and more.

Capital Market

Markets where investors buy and sell medium and long-term financial assets are capital markets. There are two types of capital market: Primary Market (where a company issues its shares for the first time (IPO), or an already listed company issues fresh shares) and Secondary Market or Stock Market (where buyers and sellers trade already issued securities in the primary market).

Read Money Market vs. Capital Market to learn about the differences between both.

By Timing of Delivery

Cash Market

The cash market where settlementof transaction are in real-time.

Futures Market

In futures market, settlement and delivery occur at a future specified date.

By Organizational Structure

Exchange-Traded Market

An exchange-traded market A market with centralized authority and set regulations are Exchange Traded Market, like NYSE and NASDAQ.

Over-the-Counter Market (OTC)

Markets with customized procedures and decentralized organization is an OTC market. It is a type of secondary market. Smaller organizations prefer this market as it has fewer regulations and is less expensive.

Gray Market

In gray market, securities are traded in an unofficial manner.

Auction Market

In the auction market, securities are traded by matching the highest bid.