Today’s topic is financial markets. So, let’s discuss in a simple and layman language the importance, features and the role of financial markets.
We can bifurcate the financial markets into two segments: –
- International market
- Domestic market
Before we move ahead with this let’s understand the landscape of this topic. It has merits as well as some demerits. There are people who would say that financial markets have done phenomenally well over a period of time and it has given some benefits to the public, household and investors. We’ll also find people who would say it has done a great damage to the world. So, it has its own pros and cons.
The one thing we know for sure is that financial markets is very important for economic growth. A country cannot sustain without financial markets. It has to have financial markets to grow and compete with other companies globally.
As far international markets are concerned let’s try to understand some common factors: –
- Stakeholders: – Financial markets do a fantastic job in bringing in certain stakeholders. It helps to bring in the business, government and the household together.
- Price discovery: – In financial markets the price of an asset or a security is decided by the forces of demand and the forces of supply. So, the price cannot be decided by an individual and that is reason the price discovered is genuine and it something that the investors believe in. There is another aspect also which is known as the OTC (over the counter) market. It is definitely a part of the financial markets on a wider term. In the OTC market the prices are decided on mutual understanding between the parties to the trade or contract.
- Liquidity: – For example, Mr. A has $1000 with him and instead putting this cash idle he decides to invest it somewhere. He wants to invest this in a security which is legitimate and has a price. Let’s say he invests this amount in a financial instrument like Bonds or Shares. The government or the private companies can get benefit of this money and can be utilized for its working capital or its business diversification.
Financial market is a place where a saver and investor can come together and do a trade.
On the other hand, let’s say MR. A wants his money back. He can go to the market and sell that security. Say he invested the money for 1 year at a rate of 7%. At the end of the day, he gets his principal amount back and an additional interest which in total is definitely more than what he invested a year back and that’s how financial markets bring in liquidity which is most important factor to run an economy.
- Reduction in transaction cost: – If somebody wants to invest a certain amount of money somewhere so rather than doing a lot of research and paying the broker the financial markets have given us the liberty to directly put the money in the international or domestic market. So, it’s a market which will reduce your transaction costs so that more money gets invested in market.
- Uncertainty: – You can look at this from two perspectives. First being you can benefit or you can make money out of uncertainty. There’s always uncertainty attached to your cashflow. Now let’s take an example of the derivative market-
In the derivative market you can get into a contract or trade wherein you can get benefit out of this uncertainty. When there are two parties one with a long view and one with a short view. Here both the parties are uncertain but they are getting into a contract and making money out of it. So, what happens is at the end of the contract one person will be losing money and one person will be making money.
If we look at it from a different perspective which is nothing but insurance industry which works predominantly on the uncertainty factor. If you want to get secured by a certain uncertainty you can pay a premium to insurance companies. Whenever the event occurs you have somebody who can compensate you for the amount of money you have given to that institution. Financial markets help you to mitigate the risk.
- Economic Growth: – Because of the savings that gets into the market which helps the company’s, businesses, organizations to have that cashflow and the person who’s investing money into the market gets a certain amount of surplus. If we consider all these points together the financial markets help to bring in the economic growth of that nation.
I HOPE THIS HELPED YOU ALL!!