HOW DO FINANCIAL MARKETS OPERATE?
Financial markets operate quite simply because we all have different needs and requirements and these requirements need to be matched together. Where this occurs on a wider scale, markets develop. Market forces can thus be described as the supply of an item or service where there is a demand for that item or service. Trading by nature therefore creates a price mechanism: the price is based on the value to the traders (buyers and sellers) which heavily depends on certain market forces
The by-product of people having needs creates Supply and Demand; this principle is one of the core factors which explain as to how and why markets operate. Alfred Marshall (1842-1924) demonstrated this with the simple diagram above called the Demand/Supply Cross. It clearly shows that price is determined by the forces of supply and demand. Put simply the price we pay for things will generally be a function of how much demand there is for it! This principle affects us every time we purchase things from the fuel we buy, to the clothes we wear and the food we eat.
To facilitate the various forms of activities undertaken by participants financial markets operate six basic functions. These functions are briefly listed below:
- BORROWING AND LENDING
- PRICE DETERMINATION
- INFORMATION AGGREGATION AND COORDINATION
- RISK SHARING
- LIQUIDITY
- EFFICIENCY
Financial markets permit the transfer of funds (purchasing power) from one agent to another for either investment or consumption purposes
Financial markets provide vehicles by which prices are set both for newly issued financial assets and for the existing stock of financial assets
Financial markets act as collectors and aggregators of information about financial asset values and the flow of funds from lenders to borrowers
Financial markets allow a transfer of risk from those who undertake investments to those who provide funds for those investments
Financial markets provide the holders of financial assets with a chance to resell or liquidate these assets
Financial markets reduce transaction costs and information costs.
There are four kinds of operators in the Financial Markets. These are:
- Investors
- Companies
- Financial Institutions
- Governments
Financial market operations play an important role in the well-being of everyone. Markets interact and will influence worldwide issues such as wealth, inflation, and stability in a country or region.