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In an economy, the flow of money is circular.
One such flow includes turning idle savings into investments. How do you get these savings? Where to invest these Savings?
A common man wishes to make more money by putting his savings in an instrument that makes more money. A business needs funds to operate and provide its resources for consumers.
These funds are made available to them through the functions of the financial markets.
Here is your introduction to the financial markets which also includes the types and functions of these financial markets.
What is A Financial Market?
The financial market refers to a marketplace where the trading of financial assets such as stocks, bonds, debentures, derivatives, foreign exchange, and currencies takes place.
The price of these financial assets is determined by the market forces of demand and supply.
For example, if the demand for a share is high, more people start buying it. This in turn increases the price of the share as the value of the share is even greater due to higher demand.
The Financial Market acts as an agent between the investor and the company.
Simply put, businesses and investors go to financial markets to raise funds for their businesses and grow their money.
The financial market plays a very important role in the economic development of a country. Without a financial market, a country’s economy can collapse.
Concept of Financial Market
There are two basic flows of money in the economy
- Savings
- Investment
Savings refer to household savings that you earn in the form of income.
Investment refers to the capital required by the industry to run its company.
The economy must provide a link between savings and investment. That’s where financial markets come into play.
The financial market lets you invest your savings in companies you think will make a profit. If the company grows, your money grows too.
This serves your purpose of investing your savings.
Now companies need funding and they achieve this through financial markets. When you invest your money into a company, the company receives the funds that help them to grow and run their business in the long term.
Advantages and Significance of Financial Markets
There are numerous benefits that financial markets make possible, including the following:
- For investors: the return on investment is usually higher than what the bank provides.
- For Companies: they get access to the capital they need to grow their business.
- Due to the flow of money and the growth of companies, the economy develops.
- It reduces unemployment as financial markets provide many job opportunities.
Types of Financial Markets
Most people only think of stocks when discussing financial markets with others. They don’t realize that there are a lot of financial assets that are a part of the financial market and can help investors make money and businesses grow. These markets are interlinked with each other, meaning when one market takes a hit, the other might face high volatility (it may grow or it may also take a hit).
1. The Stock market
This is a marketplace where corporations can raise huge amounts of cash to expand. Investors pay money in exchange for stocks which are shares of ownership of the corporation. Investors make a profit when companies grow and expand or when investors buy shares at low prices and sell when prices increase.
Note: The market’s volatility depends on the decisions, perceptions, and actions taken by both the buyers and sellers regarding the profitability of companies being traded.
Buying stocks is easy but buying the right stocks is tricky as your knowledge and information about each company come into play.
Nifty 50 stands for National Index Fifty which represents the weighted average of 50 Indian company stocks in 17 different sectors. Nifty 50 is revised periodically to maintain quality stocks.
Some well-known Nifty 50 stocks providing great returns are Wipro Ltd., ONGC(Oil & Natural Gas Corporation Ltd.), Nestle India Ltd., etc.
You might have come across Mutual Funds. Mutual Funds make it easier for you to invest in several stocks at once. They help reduce your risk by spreading your stock portfolio evenly. Even then you need to learn how to select a good mutual fund to serve your purposes.
2. The Bond market
When businesses need huge loans, they go to the Bond Market. A bond market is a place where investors loan money on bonds as security at a predetermined rate of interest and for a set period.
Bonds are issued by governments, municipalities, and corporations across the world. When stock prices fall, bond prices go up.
This is because as investors face loss in stocks, they now prefer lower risk and higher security in their portfolios which are offered by bonds.
3. Derivatives market
A Derivative is a contract between two parties that derives its value from an underlying asset.
Underlying assets are financial assets upon which derivatives prices are based. An underlying asset can be stocks, bonds, commodities, indexes foreign exchange(Forex), etc.
Instead of directly trading in stocks, a derivative market trades in futures and options contracts or other advanced financial products that determine their value from underlying assets.
Usually, hedge funds and investors with good experience and knowledge use derivatives to magnify their gains.
4. The Commodities market
The commodities market is where investors and traders buy and sell natural resources such as oil, gold, silver, cotton, rubber, and meat are some commodities included in the market.
These tradings are done based on forecasting and assumptions on the growth of certain commodities.
Many investors trade in the commodities on a profit-only basis. For example, most investors have no interest in taking shipments of large quantities of cotton. They just want to buy it to sell it at higher prices and make a profit.
5. Forex Trading
“Forex” stands for Foreign Exchange and refers to the buying and selling of one particular currency in exchange for another currency.
It is a heavily traded market all over the world and everyone wants to be a part of it as it requires less capital upfront and thus it is the most liquid market in the world.
Forex trading determines the exchange value of currencies all over the world. It also affects a nation’s economic and financial stability.
Functions of financial markets
1. Mobilization of funds
Money should never sit idle. Idle money is wasted money. In an undeveloped and developed economy, the flow of money is critical. People who have savings should invest their money into companies that require investment.
Financial markets bridge the gap and help people put their money according to their risk-undertaking capacity. In turn, this will utilize idle funds and the economy will prosper.
2. Price determination
Price determination in financial markets takes place between buyers and sellers buying and selling financial assets.
If more people want to buy certain assets, it means there is greater demand for those assets and this leads to a higher price of the asset. Similarly, if investors sell their assets instead of buying them, the price of the assets falls. This is the volatility of the market under price determination.
3. Easy access
Both companies and investors need each other. The financial market provides a platform for both buyers and sellers to buy and sell financial assets without wasting too much time and effort.
This is an easy and simple way to satisfy all three needs – the investor’s needs, the company’s needs, and the country’s economic needs.
4. Liquidity
Instruments sold in the financial markets tend to have high liquidity. This means investors can convert their financial assets into money quickly.
This is beneficial to those investors who don’t like to invest long-term as they can use financial markets to sell their securities for instant money.
How To Understand Financial Markets?
To buy an asset or not to buy an asset is difficult to comprehend.
This comes down to figuring out the latest news and its impact on various companies. Let’s say you want to buy shares of XYZ Ltd. You need to read about the company every day and check its positives and negatives by watching the news and reading newspapers and articles.
The basic logic for an increase or decrease in an asset is what the investor interprets the future value of the asset to be today. If the information he learns states that in the future the value of this asset will decrease, he will sell all his shares today or as soon as he gets a better value for it.
Predicting the exact results of how an asset will perform is impossible as many factors determine the price.
By learning more about financial markets, we can have better chances of understanding and interpreting the value of financial assets thus making profits along the way.
Let me know in the comments below which Financial Assets do you prefer investing in
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