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The Roles of Financial Markets


January 14, 2021 ( Newswire) Financial markets refer to the market places where transactions relating to financial securities happen. The various financial markets include bond market, stock market, foreign exchange market, derivatives market, CDs, and so much more. Get to learn here how such financial instruments and others can be invested in a bid to diversify your investments.

Financial markets comprise numerous participants, who are always watching the trends in the financial market and hoping to benefit one way or another from the market activities and movements. It plays very vital roles in the economy. Below are some of the roles of financial markets.

1. Facilitate efficient risk sharing

Financial markets facilitate optimal risk distribution amongst the investors. Risk is divided into two types. There is the diversifiable risk plus the non-diversifiable risk. Diversifiable risk can be eradicated by investing in two assets, whose returns are independent from each other.

Apart from aiding investors diversify risk, financial markets provide investors with numerous financial instruments with varying risk-return interactions. Therefore, this facilitates the investor choose their investments' risk profile based on their risk-acceptance points.

Risk-averse investors will opt for risk free investments as their investment avenue, whereas the risk takers will opt for speculative stocks which have great risk.

Additionally, the financial markets provide a means for solving the non-diversifiable risk. The eradication of the non-diversifiable risks can only be realized via the transfer of the risks through the utilization of futures and options. Hence the futures marketplaces in conjunction with the options market places facilitate risk transmission from the risk-averse investors to the risk takers. Therefore, it is evident, financial markets facilitate optimal risk sharing amongst investors.

2. Facilitate individuals attain an equilibrium between current plus future consumption

The economy has a mix of entrepreneurs of all sorts. There are those entrepreneurs who have great ideas that they want to implement but lack the finances to do so. On the other hand, there are these entrepreneurs who want to make their retirement better, and are looking for ways to invest their savings to boost their retirement. Therefore, the financial markets will perform that role of causing the lenders and the borrowers to interact and transact, thus improving their lives.

3. Split-up of Ownership plus Management

Financial markets facilitate the split up of ownership and management, which is a requirement for the efficient operation of large corporations. The stocks or shares of a company are owned by an extended base of shareholders, who entrust the running and management of their investments to a team of professionals. Managers therefore take up the responsibility of making efficient decisions and invest in projects producing excessive yields.

4. Proficient Allocation of Resources Through Information Sharing

The financial markets are a source of information of all sorts. The information is of benefit to both the investors and the issuers of the trading instruments. The information is often reflected in the market prices of the financial securities.

The market prices of security commodities can really benefit an investor such as a farmer who may be uncertain as to the future prices of commodities he/she may have farmed. Thus, by viewing the prices of the futures contracts, they can easily predict the prices their produce is likely to fetch in the future. Hence, the investors can efficiently allocate their scarce resources.

Additionally, financial markets collect varying information of market players and communicate the value of a company's equity under the management in control. Through such information, a company may decide to acquire the equities of a different company, which are maybe not being put to their optimal usage. Also, a properly operational stock market results in the optimal use of assets and aids in streamlining poor management.

5. Conclusion

Properly operating financial markets play very important roles in the economy. The roles include but are not limited to connecting borrowers to investors, facilitating risk sharing, bringing about optimal distribution of resources, acting as a source of relevant information to marketplace players, and enabling the split-up of management and ownership.

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