Functions of Financial Markets

Article by

Madhuri Thakur

Reviewed by

Dheeraj Vaidya, CFA, FRM

What are the Functions of Financial Markets?

There are different functions that the financial markets perform which includes determination of the
prices where financial markets help in price discovery of various financial instruments, mobilization of
the funds, providing an opportunity to different investors to buy or sell their respective financial
instrument at the fair value that is prevailing in market, providing the various types of information to
traders, and the sharing of the risk, etc.

List of Top 7 Functions of Financial Markets

Price Determination

Funds Mobilization

Liquidity

Risk sharing

Easy Access

Reduction in transaction costs and provision of the Information

Capital Formation

Let us discuss each of the financial market functions in detail –

Functions-of-Financial-Market

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#1 – Price Determination

The financial market performs the function of price discovery of the different financial instruments
which are traded between the buyers and the sellers on the financial market. The prices at which the
financial instruments

trade in the financial market are determined by the market forces i.e., demand and supply in the
market.

So the financial market provides the vehicle by which the prices are set for both financial assets

which are issued newly and for the existing stock of the financial assets.

#2 – Funds Mobilization

Along with the determination of the prices at which the financial instruments trade in the financial
market, the required return out of the funds invested by the investor is also determined by participants
in the financial market. The motivation for persons seeking the funds is dependent on the required rate
of return which is demanded by the investors.

Because of this function of the financial market only, it is signaled that how funds which available from
the lenders or the investors of the funds will get allocated among the persons who are in need of the
funds or raise the funds through the means of issuing financial instruments in the financial market. So,
the financial market helps in the mobilization of the savings of the investors.

#3 – Liquidity

The liquidity function of the financial market provides an opportunity for the investors to sell their
financial instruments at its fair value prevailing in the market at any time during the working hours of
the market.

In case there is no liquidity function of the financial market, then the investor forcefully have to hold the
financial securities or the financial instrument until the conditions arise in the market to sell those assets
or the issuer of the security is obligated contractually to pay for the same i.e., at the time of maturity in
debt instrument

or at the time of the liquidation of the company in case of the equity instrument is until the company is
either voluntarily or involuntarily liquidated.

Thus, in the financial market investors can sell their securities readily and convert them into cash
thereby providing the liquidity.

#4 – Risk sharing

Financial market performs the function of the risk-sharing as the person who is undertaking the
investments are different from the persons who are investing their fund in those investments.

With the help of the financial market, the risk is transferred from the person who undertakes the
investments to those persons who provide the funds for making those investments.

#5 – Easy Access

The industries require the investors for raising the funds and the investors require the industries for
investing its money and earning the returns from them. So the financial market platform provides the
potential buyer and seller easily, which helps them in saving their time and money in finding the
potential buyer and seller.

#6 – Reduction in Transaction Costs and Provision of the Information

The trader requires various types of information while doing the transaction of buying and selling the
securities. For obtaining the same time and money is required.

But the financial market helps in providing every type of information to the traders without the
requirement of spending any money by them. In this way, the financial market reduces the cost of the
transactions.

#7 – Capital Formation
Financial markets provide the channel through which the new savings of the investors flow in the
country which aid in the capital formation of the country.

Example

Let’s consider an example of the company XYZ ltd, which requires the funds to start a new project but at
present, it doesn’t have such funds. On the other side, there are investors who have spare money and
want to invest in some areas where they can get the required rate of expected returns.

So, in that case, the financial market will function where the company can raise funds from the investors
and the investors can invest their money through the help of the financial market.

Important points of the Functions of Financial Markets

Financial Markets

is the market, an arrangement or institution where the traders are involved in the buying and selling of
the financial assets like shares, bonds, derivatives, commodities, currencies, etc.

It facilitates the exchange of financial instruments and financial securities.

There are different types of the financial market

which can exist in any country that includes, Money Markets

, Over the Counter Markets

, Derivatives Market, Bonds Market, forex Market, and commodities market.

Financial Markets have different roles to play which include price determination, funds mobilization, risk
sharing, easy access, liquidity, capital formation and reduction in transaction costs and provision of the
required information, etc.

With respect to the size of the financial market, many financial markets are very small in size facilitating
the very little amount of the activity, and many of the financial market trade huge amounts of securities
daily

The financial market may have or not have the physical location and the exchange of the financial
instruments and the financial securities may be exchanged between the parties over the phone or the
internet as well. With respect to the size of the financial market, many financial markets are very small
in size facilitating the very little amount of the activity, and many of the financial markets trade huge
amounts of securities daily.
Conclusion

Financial Markets perform various functions in any country which gives an opportunity to the companies
and traders for buying and selling the different financial instruments and the financial securities. It plays
a crucial role in the allocation of the limited resources available in the economy of any country. It acts as
an intermediary between savers and the investors by mobilizing the funds between them and helps in
the determination of the prices of securities.