The financial markets and the financial institutions play an important role in promoting economic activity such as the production of the goods and the services. It is important to note those with business ideas are not always the one with the resources to put their ideas into action. Similarly, those with the resources may not always be the one who engage in entrepreneurial ventures. The financial markets and the financial institutions help match the entities who want to engage in entrepreneurial activity, with those who would like to generate returns on their savings and other types of assets. In short, the financial markets help the borrowers reach the lenders or provider of funds. The financial markets and the financial institutions also ensure the flow of capital across the borders .
The financial markets and the financial institutions also help keep the borrowing costs lower through large number of lenders and borrowers as well as low search and transaction costs. The large number of products and services means the individuals, businesses, and the governments who need funds, can find something that meets their requirements. The well-established financial markets also enhance the liquidity and reduce the risks faced by the lenders and the borrowers . Some of the ways the financial institutions provide liquidity in the markets include demand deposits and lines of credit. Similarly, the financial institutions often stand ready to buy and sell securities in large volumes at modest costs .
The financial markets and the financial institutions also help improve an efficient allocation of limited resources. The resources are allocated to the economic sectors where they may be used most productively. This, in turn, positive influences the economic growth of the country. The financial markets also result in better pricing of different products and services. In other words, the risk profile of different products and services is more fairly reflected in their prices. For example, the products aimed at high-risk borrowers may require higher interest payments to accommodate the higher risk borne by the lenders .
The primary market is the one in which the securities are offered for sale to the public for the first time. A great example of the primary market is the market for initial public offerings or IPOs. The secondary market is the one in which the previously issued securities are traded between the buyers and the sellers. The trading of a company stock on the stock exchange is a great example of a secondary market . The sale proceedings in the primary market such as from the issue of an IPO go to the firm that offered the security in the first place. But the firm that initially offered the security in the primary market doesn’t get anything from the trading of the security in the secondary market. The traditional participants in the primary market are banks, financial institutions, and corporate entities while the traditional participants in the secondary market include banks, financial institutions, corporate entities, and individual investors . The financial regulators such as the SEC in the U.S. take measures to protect the investors against the fraud in the capital markets. The capital markets include both the primary and the secondary markets.
The money markets support the sale of short-term financial instruments such as the treasury bills, commercial paper, and the certificate of deposit or CD. The maturities of the securities in the money markets usually range from one day to a year and they tend to be highly liquid. The securities in the money markets also tend to be the safest such as the treasury bills because they is large market for such securities and the maturity periods are short .
In contrast, the capital markets deal with the long-term securities such as the equity shares, bonds, and the preferred stock. The size of the capital markets usually reflects the relative size of the economies which may explain why the U.S. has the largest capital market in the world. The maturity periods of the securities in the capital markets are usually long than a year including some with no maturity date. The securities in the capital markets are usually less liquid than those in the money markets and the investors require higher returns to compensate for the additional risk. Similarly, the securities bought in the capital markets also have higher returns because investors usually plan to hold onto them for longer periods of time as compared to the securities bought in the money markets. The capital markets are also preferred over the money markets by the companies and the investors looking to raise large sums of money .
The financial markets and the financial institutions play an important role in the efficient functioning of the economy because they help match the providers of the funds with the borrowers of the funds. They also help ensure efficient allocation of resources and lower transaction costs. The securities are traded in both the primary and the secondary markets. The securities traded in the primary markets include those that are offered by the issuer for the first time and the proceeds from the sale go to the issuers. In contrast, the securities traded in the secondary markets do not result in any proceeds for the original issuer. The secondary markets play an important role in ensuring a liquidity for the securities issued in the primary markets. The securities with short maturity dates are usually issued in the money markets while those with a maturity period longer than a year are issued in the capital markets. The capital markets include both the primary and the secondary markets.
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