6 min read • Published 17 Feb 25
Financial Market Meaning and Functions
Table of Contents
What is Financial Market?
Financial markets are the avenues that transact financial securities and help connect investors and financial assets. It includes different markets such as capital market, forex market, commodities market, etc. Therefore, understanding the financial market can be crucial to navigate through the investing journey.
As per a report, 45% of the young investors in India prefer stock market investment. This trend and inclination towards financial markets, like the stock market, debt market, etc., is a key feature of modern-day investing. Let us understand the financial market meaning, the importance of financial market, different types of financial markets and their examples to better ascertain their suitability.
Example of Financial Market
Investors can clarify the financial market definition and its scope by seeing different types of financial markets and selecting the suitable ones. Let’s explore some common examples of financial markets:
Stock Exchange
It includes both the stock exchanges and the debt market. The former is a crucial income source for the corporations. There are two types of issues in the stock exchange setup – Primary (IPO market) and Secondary (regular exchange). Two of the most prominent stock indices in India are Nifty 50 and BSE Sensex. These indices belong to two prominent exchanges in the country – the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The stock market does not prescribe a minimum investment limit and is an attractive avenue for earning direct market returns. However, due to this feature, the risk factor of this market is very high.
Bond Market
Another part of the capital market is debt. It includes bonds, debentures, Securitised Debt Instruments (SDIs), etc. It can be considered a more secure market as debt becomes a mandatory obligation for the entities. In FY24, the total bond market in India is valued at ₹217 trillion.
Commodity Market
This is one of the markets that have the closest effect on human activities and life. It trades commodities like raw materials, agri-produce, minerals, metals, and more. Therefore, prices decided in this market by these necessary commodities become a part of the expense for humans.
How does the Financial Market Work?
Exchange is a crucial part of human history, and most innovations are set in the background of this objective. Such exchange activity underscored the importance of the market.
- Financial markets are also the virtual place for the exchange of financial instruments, which allows fractional ownership of corporate organizations.
- The financial market meaning is associated with an avenue for connecting investors with those who need capital. This space allows individuals to buy, sell, or trade financial assets.
- The investors, their demand-supply force, economic cycle, government policies, geopolitical situations, etc., contribute significantly to the financial market. Based on instruments, the financial market meaning has a wider scope.
In India, a person needs to open a dematerialized (Demat) account to transact such securities. As of November 2024, there are nearly 18 crores active demat accounts in India. It shows how people are growingly inclined towards financial markets in India.
What are the Different Types of the Financial Market?
Due to the availability of different instruments, there are varied types of financial markets, such as:
Capital Markets
In these platforms long-term securities are traded, and companies raise funds by issuing instruments like stocks and bonds. Here supply and demand of these securities determine the price levels.
Here, the financial market meaning is associated mainly with the stock market and bonds market. Investors are part owners of the issuing entity with these instruments.
Money Market
It is a short-term asset market where instruments have less than a year of maturity. Even overnight tenured assets are categorized under the money market. It includes instruments like treasury bills, commercial papers, repurchase agreements, etc. However, this market may prescribe specific entry or exit barriers for the investors.
Forex Market
These are the platforms for transacting currencies. Based on these transactions, demand-supply is determined, and foreign exchange is decided. Due to global exposure, their effect on overall economic policies and conditions in a country can be significant. Investors with a potential risk appetite may find it a suitable avenue.
Derivatives Market
These are contracts based on the price movement of the underlying. In this category, futures will have delivery facilities, but options are only binding contracts. Here, market forces are more crucial rather than exchange.
Commodity Market
In this market, commodities like agricultural produce, metals, finished raw materials, etc., are transacted. It has derivatives contracts and affects the prices of these commodities a lot.
Over-the-Counter Market
Popularly abbreviated as OTC, the market is responsible for trading unlisted securities. Due to this missing regulatory feature, the risk is significantly high, but investors can get exposure to different market instruments through it.
Functions and Role of Financial Markets
Financial markets can play a crucial role in providing investment opportunities to the investors and financial resources to the companies. Some of the common functions of financial market are:
- It helps investors invest their savings and mobilizes these savings to their desired companies.
- Provides most liquidity to the investment.
- Acts as a meeting point for buyers and sellers.
- Reduces overall time and effort due to being the one-stop destination for a particular financial security.
- Helps in price discovery with the help of market forces.
Importance of Financial Markets
Let us understand the importance of financial markets:
1. Capital Flow: Financial Markets are important because they help in the efficient flow of capital from savers and investors to those who need it, such as businesses, individuals, etc. This ensures that investment flows to the right place, thus, creating a win-win situation for all the parties involved.
2. Risk Management: Financial markets are a source that allows investors to manage risk. If an investor feels that an asset is more risky than their risk tolerance, they can get rid of the asset through financial markets. There are instruments like futures and options to manage risk. These instruments help investors in hedging their investments.
3. Transparency and Stability: The presence of organized financial markets gives investors a relief that their investments are flowing to safe avenues and they are not being defrauded. The Indian financial markets are regulated by the SEBI. The companies or businesses that raise funds for financial markets have to provide all the information to investors, ensuring transparency.
4. Economic Growth: By enabling businesses to raise funds for expansion and innovation, financial markets contribute to economic development. A well-functioning financial market attracts foreign investments, enhances business confidence, and strengthens a country’s financial stability, ultimately leading to higher GDP growth and prosperity.
Conclusion
Understanding the financial market meaning is not enough, its horizon is wide enough to accommodate a range of instruments, such as commodities, stocks, derivatives, bonds, currencies, etc. Understanding it thoroughly can help investors align the suitable market with their financial and investment objectives. But understanding what is financial markets is a good first step towards building your knowledge in this domain.
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Q: What are the factors that influence financial markets?
The price movements and market forces are the result of multiple factors together. Geopolitical events, natural disasters, government policies, domestic crises, economic events, investor sentiment, etc., can affect the financial markets and instruments.
Q: What are some probable risks that influence financial markets?
Market exposure is considered risky due to the heavy influence of different factors. Some of the common risks in the market are default, liquidity, demand-supply factors, operational, etc. Assessing their levels is crucial to sailing through the investment journey.
Q: Are financial markets the stock exchanges?
Usually, these two terms are used synonymously. However, they differ as stock exchange or stock market is a type of financial market. Mainly, financial market is a large term and includes different types of asset markets.
Q: What is a forex market?
It is a decentralised market format that allows trading currencies to determine the value in comparison with one another. It is a crucial market affecting exchange rates, government policies, trade between the governments, etc. It is mainly done for speculation and hedging.
Q: What are different types of derivatives?
Derivatives are a contract to transact a particular asset at future date and price. Mainly there are 4 types of derivatives such as futures, options, forwards and swaps. These are further classified based on their nature of buy or sell.
Q: What are two main types of financial markets?
The two main types of financial markets are capital markets and money markets. Capital markets are commonly known as the stock markets and facilitate trading of stocks, Mutual funds, and ETFs. Money markets facilitate the trading of fixed-income securities.
Q: What are the two main functions of the financial market?
The two main functions of the financial market are capital allocation and price discovery. Capital allocation ensures that savings from individuals and institutions are efficiently directed toward businesses and governments for productive use. Price discovery helps determine the fair market value of financial assets based on supply, demand, and available information.
