Question

1. 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

1. Financial markets accumulate money from those who have surplus and help in channelizing it to those who need it. They create a platform where in the corporations and governmental units can borrow funds for their investment needs and create capital. Corporations issue stock to raise capital and US Governments issue debt securities to raise money.

2. In financial markets there is interaction of demand ,supply and price which ideally ensures that there is best possible allocation of resources. The stock prices reflect the present value of the investors expectations of the returns and security markets allow for stocks to compete for investors money. A prudent investor will invest in a stock that will give him higher returns and this is only possible when organizations utilize resources in the most efficient manner.

3. Financial markets provide avenues for all kinds of investors to increase their wealth and create savings. For those investors who are risk averse can invest in safer instruments such as deposits and bonds .Those willing to take risks and desirous of higher profits put their money in high risk stocks. For those wanting to own stocks but have smaller savings can also put in money through mutual and pension funds.

4. Stock prices are the best reflection of how investors judge the potential earning capacity and the quality of the management. Investors ideally are willing to put in more money into stocks that they believe will fetch them higher returns in the future.

5. Financial markets such as stock exchanges, mutual funds generate about 10% of the total employment in the country. The concern here is that the jobs are concentrated in major cities only.