Financial Market - Meaning, Types, Functions

Financial markets - an overview

Think of your local marketplace. There are perhaps many stalls selling different kinds of goods and products, aren’t there? And they’re constantly buzzing with activity. If we asked you what your local marketplace is, you’ll probably say that it’s a space where both buyers and sellers come together to buy and sell goods. 

So, what are financial markets? Much like your local marketplace, the financial markets are also virtual or physical spaces that are dedicated to the purchase and sale of one kind of product - financial assets. These financial assets can be anything, ranging from stocks and bonds to commodities and currencies.

Financial markets are also sometimes referred to as the ‘capital markets’ or simply ‘the markets.’ Whatever the name may be, the core nature of the financial markets always remains the same -  they’re designated spaces where financial assets are traded.

What are financial markets?

The term ‘financial markets’ refers to those marketplaces where financial assets are bought and sold. Financial assets include instruments like stocks and bonds. Broadly speaking, the financial markets include various smaller marketplaces like the stock market, the bond market, the forex market, the commodities market and the derivatives market.

Some financial markets are regulated, while some may not be. And as with any marketplace, the prices of the financial assets traded in financial markets also keep fluctuating based on a number of factors. Interested traders and investors can take advantage of these price movements to earn returns on their investments.

A quick look at how the financial markets have evolved

If you head to semi-urban areas or weekend markets, you’ll find an array of sellers, all calling out to the customers and shouting out the prices of their goods. This was mostly how people bought and sold things back in the day. Now, however, we have air-conditioned supermarkets and sophisticated malls to buy goods from. And that’s not to mention the scores of online marketplaces that have cropped up in recent years.

Much like how your regular marketplace has evolved, the financial markets too have transformed radically over the years. A few decades earlier, financial markets were essentially physical spaces where buyers and sellers would meet in person to execute a financial transaction. This system of trading was commonly known as the ‘open outcry system.’ 

But with the advent of technology, these markets are now fully electronic. So, buyers and sellers like you can conduct transactions from anywhere in the world, through the power of the internet. However, there are still a few financial markets where financial assets are traded through the traditional ‘open outcry system.’

Ever since technology took over the financial markets, their popularity has skyrocketed. As a matter of fact, millions of trades now take place every second in the financial markets, generating a business of trillions of dollars in just a single day. That’s incredible, isn’t it? 

Functions of financial markets

So, you now know the answer to the question - What do you mean by financial markets? Let’s get into what their functions are. Contrary to what you may think, the functions of financial markets are not limited to just being trading spaces for buyers and sellers. Let’s take a look at some of the other functions of financial markets in order to understand them better.  

• They enable the mobilisation of money

Think about it. When you save a portion of your income, the money just sits idle till you decide to use it for something. But financial markets allow you to mobilise your savings by providing you with a way to invest. Financial markets thereby help connect individuals and businesses that require capital with those who are in possession of the said capital.      

They also help you redirect the stagnated money back into the economy and put it to good use, instead of merely leaving it idle. After all, the economy of a nation can only be successful if there’s adequate circulation of money. 

• They help determine the price of assets 

The price of an asset fluctuates based on its demand and supply. Remember grade school economics? When the demand is greater than the supply, the price of goods rises. And when the supply is greater than the demand, the price falls. That’s how demand and supply help determine the price of goods. And this principle applies to financial markets as well. 

Clearly, demand and supply are two of the most important forces out there, driving global economic systems constantly and consistently. An economy cannot exist in balance without either demand or supply. And since financial markets are powered entirely by these two forces, they help determine the price of the financial assets being traded. Without these markets, the prices of financial assets would be unregulated and nearly impossible to determine fairly.

• They ensure liquidity of the assets

Liquidity is essentially a metric that determines the ability of an asset to be quickly purchased, sold, or converted to cash. Let’s simplify it even further with a comparative example. 

Gold is considered to be a highly liquid form of investment since it can be quickly sold and converted to cash. That’s because of the high levels of demand for the yellow metal. A real estate property, on the other hand, is generally considered to be much less liquid because it cannot be sold off as quickly. 

Financial markets act as fair platforms for sale and purchase of assets. By allowing you to purchase and sell the said assets smoothly, they also ensure that these financial assets are liquid. In other words, you don’t have to go too far to find a buyer or a seller in these markets. 

• They help save time and money

Building up on the idea of liquidity and considering the fact that you can find a buyer or a seller almost instantly, financial markets save a lot of time for everyone involved. That’s not all. They also save you a lot of effort, which you may have otherwise spent on finding probable buyers or sellers. 

Furthermore, thanks to the financial markets going completely electronic, the costs and fees associated with each transaction have reduced significantly. This, in turn, helps you save a lot of money.

Advantages and Disadvantages of Financial Markets

Advantages

The benefits of the financial market are as follows.

• It offers a platform for businesses to raise funds for both long and short-term investments.
• Companies may obtain financing at a lesser cost than if they took out a high-interest loan from a commercial bank. Furthermore, commercial banks do not provide large loans.
• Companies have the freedom to obtain money from the market as needed until their authorized share capital is depleted.
• Financial market intermediaries, such as banks and financial institutions, give financial and strategic advice to both corporations and investors. They give information, advice, and professional services that might otherwise be unavailable.
• It offers a platform for simultaneously trading and dealing with various shares, equities, bonds, derivatives, and other financial instruments.
• Financial market laws and regulations that are stricter assist to strengthen the economy by instilling trust in both investors and businesses.
• Provide a platform for worldwide money lending and borrowing in several currencies.

Disadvantages

We can observe some of the financial market's drawbacks here.

• Too many procedures imposed by regulatory organizations might lengthen the process.
• Due to strict laws and restrictions, certain businesses are unable to access the financial sector. They are unable to establish resources that need constant monitoring and compliance checks.
• Investors may lose money owing to a lack of knowledge or because they are uninformed of the situation.
• Companies may shift from being investor-driven to being profit-driven. It's critical that the Board of Directors makes choices that benefit all of the company's stakeholders and avoids manipulating investors' funds for personal gain.

Wrapping up

So, we’ve now seen what these markets are. But to gain comprehensive knowledge about this area, you need to get to know what are financial markets and their types. This is what we’ll be dealing with in the next chapter. 

A quick recap 

• Financial markets are virtual or physical spaces that are dedicated to the purchase and sale of financial assets.
• Earlier, the ‘open outcry system’ was used to trade financial assets in physical financial markets. With the advent of technology, however, most financial markets have now become virtual spaces where assets are traded electronically.
• Financial markets enable the mobilisation of money.
• They also help determine the price of financial assets.
• The capital markets ensure that financial assets are liquid.
• They save time, money and a lot of effort by making trading easier.