Financial Market”: Some Functions of Financial Market!
The primary function of the financial market is to facilitate the transfer of funds from surplus sectors (lenders) to deficit sectors (borrowers). Normally, households have excess of funds or savings which they lend to borrowers in the corporate and public sectors whose requirements of funds exceed their savings.
A financial market consists of investors or buyers, sellers, dealers and brokers and does not refer to a physical location. The participants in the market are linked by formal trading rules and communication networks for originating and trading financial securities.
The primary market in which public issue of securities is made through a prospectus is retail market and there is no physical location. The investors are reached by direct mailing.
On the other hand, the secondary market or stock exchange where existing securities are traded, is an auction market and may have a physical location such as the rotunda of the Bombay Stock Exchange or the trading floor of Delhi, Ahmedabad and other exchanges where, the exchange members met to trade securities face-to face.
In the Over-The-Counter (OTCEI) market and National Stock Exchange, trading in Securities is screen-based. On line trading is now introduced by the Bombay Stock Exchange, and other exchanges are in the process of introducing the same which is screen-based.
Financial markets trade in money and their price is the rate of return the buyer expects the (manual asset to yield. The value of financial asset changes with the investors’ expectations on earnings or interest rates.
Investors seek the highest return for a given level of risk (by paying the lowest price) and users of funds attempt to borrow at the lowest rate possible. The aggressive interaction of investors and users of funds in a properly functioning capital market ensures the flow of capital to the best user. Investors receive the highest return and the users obtain funds at the lowest cost.
The financial markets also promote financial product innovation. Our primary markets have seen a big explosion of financial product innovation. First, we had convertible debentures which attracted large subscriptions.
Later, especially in the last five years, our merchant bankers and financial institutions have introduced:
i. Participating debentures
ii. Convertible debentures with options
iii. Partly convertible debentures
iv. Convertible debentures redeemable at a premium
v. Debt equity swaps
vi. Zero coupon convertible notes
vii. Secured premium notes with detachable warrants
viii. Zero interest fully convertible debentures
ix. Zero interest partly convertible debentures with detachable warrants.
x. Floating rate bonds and warrants. All-India Financial Institutions have issued zero coupon bonds, easy exist bonds, regular income bonds, requirement bonds, easy exit regular income and retirement bonds, step-up liquid bonds, growth bonds, lakhpati bonds, end cash bonds, index bonds, deep discount bonds and capital gain bonds. The financial markets abroad have seen wide variety of asset-backed securities, junk bonds and indexed bonds.
To sum up, the three important functions of financial markets are:
i. Price discovery process which results from the interaction of buyers and sellers in the market when they trade assets.
ii. Provision of liquidity by providing a mechanism for an investor to sell financial assets, and
iii. Low cost of transactions and information.