Question

Describe any four functions of financial market.

Hint:

The four main functions of financial markets are mobilizing savings, capital formation, price discovery, and ensuring liquidity. These functions drive the economy by enabling efficient investment and resource allocation.

Answer 1

The financial market plays a vital role in the economy by facilitating the exchange of funds between savers and investors. Below are the four major functions of the financial market: Step 1: Mobilization of Savings.
The financial market acts as a mechanism for mobilizing savings from households, businesses, and institutions. It channels these savings into investments that drive economic growth. Investors and savers can deposit funds in various financial instruments such as stocks, bonds, and mutual funds. These markets allow individuals to pool their resources, creating capital for businesses and governments to fund development projects. In essence, the financial market helps convert individual savings into productive investments, which enhances overall economic growth.
Step 2: Capital Formation.
Capital formation refers to the process by which savings are invested in long-term assets such as buildings, machinery, and infrastructure. The financial market enables businesses to raise capital by issuing financial instruments like shares, bonds, and debentures. These instruments allow companies to obtain funding to expand their operations, which leads to increased production capacity and overall economic development. The market also provides a platform for investors to buy and sell shares, contributing to liquidity and market efficiency.
Step 3: Price Discovery.
The financial market plays a key role in the price discovery process. Prices of financial assets such as stocks, bonds, and commodities are determined by supply and demand forces in the market. This ensures that prices reflect the true value of an asset based on current market conditions. Price discovery helps investors make informed decisions about buying or selling assets and allows companies to gauge the market’s valuation of their products or services. Additionally, it provides transparency, as prices are openly available and publicly traded, benefiting all market participants.
Step 4: Liquidity.
Liquidity refers to the ability to quickly buy or sell an asset without significantly affecting its price. The financial market ensures liquidity by providing a platform for investors to buy and sell securities. This is important because it gives investors the flexibility to enter and exit positions in financial assets whenever they choose, thus reducing the risk of holding illiquid assets. Liquidity also enhances market efficiency and promotes a stable investment environment, making it easier for investors to realize their gains or mitigate losses.