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In this article we will discus about:- 1. Meaning and Composition of
Financial Markets 2. Types or Classification of Financial Markets
3. Efficiency 4. Functions 5. Working 6. Role in Economic
Development.
Contents:
1. Meaning and Composition of Financial Markets
2. Types or Classification of Financial Markets
3. Efficiency of Financial Markets
4. Functions of Financial Markets
5. Working of Financial Markets
6. Role of Financial Markets in Economic Development
Depository Institutions:
Depository institutions are those which accept deposits from individuals
and, firms and use these funds for advancing loans in the debt market or
purchasing other debt instruments such as Treasury Bills.
The main depository institutions are as follows:
1. Commercial Banks:
They are the largest and most important depository institutions which
keep deposits of individuals and firms in various types of accounts in the
form of cash and assets, and use them for advancing loans.
Non-Depository Institutions:
Non-depository institutions operate in financial markets as financial
intermediaries and provide insurance against financial risks.
2. Insurance Companies:
Insurance companies protect individuals and firms against risks. The
premium they receive from individuals by insuring their lives, they invest
the same in advancing loans for long-term assets, mortgages,
construction of houses, etc. On the other hand, the premium received by
them for insurancing against loss from fire, theft, accident, etc. of trucks,
cars, buildings, etc. is invested in short-term assets.
3. Pension Funds:
Private and government corporates, and central, state and local
governments deposit some amount in pension funds by deducting a
certain amount from the salaries of their employees. Pension fund
institutions or corporates invest these funds in long-term assets.
4. Brokerage Firms:
Brokerage firms link buyers and sellers of financial assets. As such, they
function as intermediaries and earn a fee for each transaction, known as
brokerage. They operate only in the secondary debt market and equity
market.
When a new company issues its shares or an existing company sells its
new shares that have not been bought by anyone earlier, they are
bought and sold in the primary market. On the other hand, when a
person sells his already purchased shares of a company, they will be
bought in the secondary market. Financial markets are further classified
on the basis of traded instruments. This classification consists of debt,
equity and financial service markets.
3. Debt Markets:
In the debt market, lenders provide funds to the borrowers for a certain
period. In return for the funds, the borrower agrees to pay to the lender
the principal amount of the loan and a certain rate of interest. People
borrow new cars, houses, etc. from debt markets. Companies borrow
from investors for working capital and new equipments by issuing
bonds. Central, state, and local governments obtain funds from debt
markets to finance various public projects.
4. Equity Markets:
Shares of corporates are bought and sold in an equity market. Equity
market is further divided into primary and secondary market. New shares
are sold in the primary market and existing shares are traded in the
secondary market.
Given the available information, the price of bond will rise or fall from the
equilibrium level to reflect the relative demand for and supply of bond.
Thus risk-adjusted expected returns on various bonds would be equal in
equilibrium.
The equality between the market price and intrinsic value of an asset is
possible in a perfectly competitive financial market.
2. Operationally Efficient:
An efficient market should be operationally efficient.
This requires:
(i) Minimisation of administrative and transaction costs;
5. Information Arbitrage:
Market efficiency depends on information arbitrage. If a person gains
much on the basis of commonly available information, the financial
market is not efficient. It is only under perfect competition that a market
is efficient where prices of financial assets reflect fully all relevant and
available information and possibilities of such a gain are very rare.
1. Capital Formation:
Economic development depends upon capital formation for which saving
is essential. For capital formation only saving is not enough, their
accumulation is also necessary. This is done by financial institutions
which operate in financial markets.
Savers earn interest and/or dividend which they again reinvest in shares,
bonds, etc. On the other hand, businessmen also borrow from financial
institutions to carry out their investment plans. In this way, they also help
in capital formation and economic development.
3. Help to Governments:
Financial markets help state governments, local bodies and central
government financially by buying and selling their bonds and securities
through which they invest in various local, state level and central projects
to accelerate economic development.
Since FIs also own each others liabilities, they create increments of
assets and liabilities. Ackley concludes that although the increment of
assets and liabilities does not increase real wealth or income, even then
by financially helping the different categories of the economy they
increase economic welfare and promote economic development.
5. Provide Liquidity:
Financial markets provide liquidity to the economy which is very
essential for the economic development of the country. When FIs in the
financial markets convert an asset into cash easily and quickly without
loss in its money value, they provide liquidity in the economy. When FIs,
especially banks, issue claims against themselves and supply funds,
they always try to maintain their liquidity.