In order to finance their operations as well as to expand, business firms must invest capital in amounts that are beyond their capacity to save in any reasonable period of time. Similarly, government must borrow large amounts of money to provide the goods and services that the people demand of them. The fund can be obtained in three ways: Through banks or other financial institutions (financial intermediaries), through financial markets and through private placements, Investors provide these funds.
The financial intermediaries (banks etc.) are intermediate between the providers and users of financial capital. They take deposits (borrow) from the investors and to the users of capital. Financial markets (capital markets, money markets) bring the providers and users in direct contact, without any intermediary. Private placements do away with both the financial intermediaries and the financial markets.
We will be dealing mostly with financial markets
The financial markets permit the businesses and governments to raise the needed funds by selling securities. The issue of securities provides and opportunity for investors with excess funds to invest in these securities and earn a return, thus enhancing their welfare.
Financial markets are absolutely vital for the proper functioning of the economy. They channel funds from those who have savings, but no productive uses for them, to those who ave productive investments, but insufficient funds to carry them out. In other words, financial markets move funds from those who ‘save’ to those who ‘spend’ on productive capital. The chief function of a financial market is to allocate resources optimally.
Financial markets are like any other market for goods and services. A market is a public place where products or services are sold, either directly or through intermediaries. Markets are important for a number of reasons: They provide a place (either physical or virtual) for the trading of goods or services, they provide for competition so that the best price may be found (this is called price discovery) and they provide liquidity. The financial markets exist to facilitate the transfer of money from people with more cash than they currently nee to people with less cash than they currently need. The more efficient they are, the more opportunities for economic growth in a society.
A financial market is a market for creation and exchange of financial assets (securities). Securities are stocks (also called shares), bonds or money market instruments that represent an obligation or the issuer to provide the purchaser an expected return (e.g. dividend) or a stated return (e.g. interest) on the investment.
The two key financial markets are the money market and the capital market. Money markets are markets for short-term, high quality debt securities. These securities carry little or no default risk and have very little price risk due to their short maturities. The capital market is the market for long-term securities. These securities are subject to significant price risk, default risk, purchasing power risk etc. due to their longer maturities.
Financial markets can be divided into primary market and secondary market. A primary market is one in which a borrower issues new securities in exchange for cash from an investor (buyer). New sales of Treasury bills, stock, or bonds all take place in the primary markets. the issuers of these securities- the government, the corporation- receive cash from the buyers of these new securities, who in turn receive financial claims that previously did not exist. The primary market is the only one in which a corporation or government is directly involved in and receives the proceeds from the transaction. If the issuer is selling securities for the first time, these are referred to as Initial Public Offers (IPOs). If some amount of securities is already outstanding before the new sales occur, then such sale is called seasoned new issues.
When the original purchasers of securities sell their securities, they trade in secondary markets. These securities may subsequently trade repeatedly in the secondary market, but the original issuers will be unaffected in the sense that they receive no additional cash from these transactions. In the secondary markets the seller of the securities receives the proceeds, not the issuer.
Primary markets cannot exist if there are no well-functioning, efficient secondary markets. How much will you pay for a security that you can never sell? The existence of well-functioning secondary markets, where investors com
Financial markets can also be divided into organized and OTC markets. Organized market together to trade existing securities, assures the purchasers of primary securities that they can quickly sell their securities of the need arises.
Financial markets can also be divided into organized and OTC markets. Organized markets are those which have a physical location where all trading takes place. For example, the Mumbai (Bombay) Stock Exchange (BSE) and Regional Stock Exchanges are organized markets. Over the Counter (OTC) markets do not have physical locations. Instead, they are characterized by networks of dealers who are connected by telephone or computer networks. The Over the Counter Exchange of India (OTCEI) is an example of an OTC market.