Question

1.List the three financial system components and their financial functions in an effective financial system.

2.Identify the four main types of financial markets.

3.Describe: a. money markets b. capital markets c. primary markets secondary markets

Answer 1

1. Financial system components and their functions in an effective financial system are as follows:

a. Money: Money can be defined anything that can be used as a medium to buy goods or services between two or more parties.

b. Financial Services: These consists of services offered by different portfolio managers, asset management companies, mutual funds to help people to diversify their fund and help them to get a better return on their investments.

c. Financial Instruments: These can be defined as anything that represents a ownership. For example we can say that equity-based financial instruments represent ownership of an asset while Debt-based financial instruments represent a loan made by an investor to the owner of the asset.

d. Financial Institutions: These institutions provide services to different organisations on various problems ranging from restructuring as well as extending to providing diversification strategies.

e. Financial Markets: It can be defined as a platform where trading of different securities like stocks, bonds, derivatives takes place. For Example: New York Stock Exchange, Dow Jones etc.

2. 4 main types of financial markets are as follows:

1. Stock Market

2. Bond Market

3. Derivative Market

4. Commodity Market

3. Money Market: Money market can be defined as a financial market where mostly financial instruments that have high liquidity and maturities of short term are traded. In these types of market, mainly securities having less than 1 year of maturity are traded such as treasury bills and commercial papers.
Due to the high liquidity involved in the money market it is typically considered as a safe place to invest. However it also contains certain risk such as chances of default on securities such as commercial papers
It usually gives low returns to investors who invest in it but also provides a range of products such as commercial papers, treasury bills etc.
Capital Markets: It refers to the market where buyers and sellers meet to do trade in securities like stocks, bonds etc. It typically consists of primary markets and secondary markets. Primary markets deals with trading of new issues of stocks, whereas secondary market deals with the trading of existing or already-issued securities.

Primary Markets: When a company sells new stocks and bonds for the first time, it is referred to issue stock and bonds in the primary market. In many cases, it takes the form of an initial public offering (IPO). Mostly, when investors purchases stocks or bonds in the primary market, the company that issues the securities hires an underwriting firm also known as underwriter to review the issue and then create a prospectus containing the price and other details of the securities that the company is proposing to be issued.

Secondary Markets: It can be defined as a market where securities are traded after the company has already sold its securities in the primary market. It is commonly known as stock market. The New York Stock Exchange (NYSE), Nasdaq are some examples of secondary markets.