theme 4 : role of financial markets

what is a financial market

a brand term describing any marketplace where trading of securities including equities, bonds and currencies occur

equities definition

stocks and shares - owning a piece of a company

bonds definition

where an investor loans money to an entity (typically corporate or govs)

currencies definition

a generally accepted form of money which is circulated within an economy

what is the most obvious form of a financial market

• a bank

• a financial institution that accepts deposits from the public and creates credit

5 roles of the financial markets

• facilitates savings

• lend to businesses and individuals (providing finance)

• facilitates the exchange of goods and services (making payments)

• provide forward markets in currencies and commodities

• provide a market for equities (and corporate bonds in which businesses can raise money to invest in new capacity)

facilitate savings explanation

• a more secure store of money for savings / incomes

• becoming increasingly important in an age where cash is dying and being replaced by contactless payments

lend to businesses and individuals

• often called financial intermediation

• banks (or the financial system in general) brings together savers and borrowers (intermediaries)

• individuals and more significantly businesses can borrow for investment purposes

• this investment should, in theory, lead to economic growth

facilitate the exchange of goods and services explanation

• if businesses have bank details of those to whom they owe payment, they can pay directly into an account

• this saves directly handing over cash

• it is a quicker, more efficient system

provide forward markets in currencies and commodities explanation

• contract-based scheme to counter risk for producers and insurance for buyers

• price of commodity (e.g. corn) financial is set today but the transaction will take place at some future day

• future price of a farmers crop at harvest is uncertain, but if the farmer buys a futures contract they can fix the price and be certain of what they will receive

• contract are binding

provide a market for equities explanation

• also known as ‘stock market’

• shares provide part ownership in a company and provide a company with capital (money) which is an important source of finance for a business

• also these are markets for gov bonds where the gov sells debt to raise money to finance the public sector deficit - in the UK this is the market for gild-edged securities or ‘guilts’