Question

(a) What are the five functions of a financial market?

(b) Usually, basic financial markets have five basic functions in a capitalistic economy: For each of the functions cited below, explain how financial markets perform each function in detail.

1. They make it possible for corporations and governmental units to raise capital.

2. They help to allocate capital toward productive uses.

3. They provide an opportunity for people to increase their savings by investing in them.

4. They reveal investors’ judgments about the potential earning capacity of corporations, thus giving guidance to corporate managers.

5. They generate employment and income.

Answer 1

(A) The five functions of a financial market.: (Basic Functions)
1. Price Determination,
2. Funds Mobilization,
3. Liquidity,
4. Easy Access,
5. Capital Formation.
(Apart form, above Risk sharing & Reduction in transaction costs n Provision of information is also covered into functional part of a financial market.)

(B) Usually, basic financial markets have five basic functions in a capitalistic economy :
  For each of the functions cited below, explain how financial markets perform each function in detail.

1) They make it possible for corporations and governmental units to raise capital..
Ans : Capital Formation : Financial markets provide the mechanism by which the investors' new investment flow into the country that assist in the capital formation of the country as whole. If ANY Co. which needs a funds to start a new project, but insufficient fund at the moment. and at another hand, there are a investors who have spare capital and also want to invest where can they get expected return on their investment. In this situations, the financial market must work where the company will collect funds from the investors and the investors will spend their money through financial market assistance.

2) They help to allocate capital toward productive uses.
Ans : Price Determination : Financial Instruments exchanged in a financial market are getting their prices from the demand and supply rules. The creditors or the households are the fund suppliers and the usinesses are the ones that need them. The relationship between the two variables and the other sector would help to determine the prices for productive uses purpose.

3) They provide an opportunity for people to increase their savings by investing in them.
Ans : Funds Mobilization : In a successful economy, money should never sit idle. Investors that have savings must be linked with industries that require investment. So financial markets will enable this transaction, where investors can invest their savings according to their choices and risk assessment. This will utilize idle funds and the economy will boom and provide an opportunity to people for enhancing their wealth or savings.

4) They reveal investors’ judgments about the potential earning capacity of corporations, thus giving guidance to corporate managers.
Ans : Liquidity : In the financial market, the securities traded tend to have high liquidity. That means investors can sell their financial assets at any given time and tern them into cash in a very short duration.Thus, it is most important consideration for investors who don't want to make long term investments.

5) They generate employment and income.
Ans : Easy Access : Both investors and industries need each other. The financial market provides a platform where both the buyers and sellers can find each other easily without spending too much time, money or effort, which indirectly or directly generate employment and income itself.