AKRITI SAXENA

REG-1841003
4BCA-A
CIA 1
FINANCIAL MANAGEMENT
COMPONENTS AND SIGNIFICANCE OF FINANCIAL MARKETS

Financial markets are where financial transactions are conducted. Financial transactions usually refer
to creation or transfer of financial assets, also called financial instruments or securities. Financial
transactions channel funds from investors who have an excess of available funds to issuers or
borrowers who must borrow funds to finance their spending.
World financial markets are huge, are highly integrated, and have a wide range of financial
instruments available for investing and financing.

Financial markets comprise five key components:-

1. the debt market
2. the equity market
3. the foreign-exchange market
4. the mortgage market
5. the derivative market

The Debt Market- Debt instruments are traded in the debt market, also referred to as the bond
market. The debt market is important to economic activities because it provides an important channel
for corporations and governments to finance their operations. Interactions and communication
between investors and borrowers in the bond market determine interest rates. Bonds denominated in
dollars currently represent roughly half the value of all outstanding bonds in the world.

The equity market- Equity instruments are traded in the equity market, also called the stock
market. The stock market is widely followed financial market in the United States. It is important
because fluctuations in stock prices effect investor’s wealth and hence their saving and consumption
behaviour, also the amount of funds that can be raised by selling newly issued stocks to finance
investment spending.

The foreign-exchange market- Foreign-exchange markets are where currencies are converted
so that funds can be moved from one country to another. Activities in the foreign-exchange
market determine the foreign-exchange rate, the price of one currency in terms of another. The
volume of foreign-exchange transactions worldwide averages over $1-2 trillion daily.
The mortgage market- A mortgage is a long-term loan secured by a pledge of real estate.
Mortgage-backed securities (also called securitized mortgages) are securities issued to sell mortgages
directly to investors. The securities are secured by a large number of mortgages packaged into a
mortgage pool. The most common type of mortgage-backed security is the mortgage pass-through, a
security that promises to distribute to investors the cash flows from mortgage payments made by
borrowers in the underlying mortgage pool.
The value of mortgage principal held in mortgage pools increased from $350 billion in 1984 to nearly
$2,500 billion in 1999.

The derivative market- Financial derivatives are contracts that derive their values from an
underlying financial asset. Derivative instruments include options contracts, futures contracts,
forward contracts, swap agreements, and cap and floor agreements. These instruments allow market
players to achieve financial goals and manage financial risks more efficiently.

THE SIGNIFICANCE OF FINANCIAL MARKETS

By channelling funds from investors to issuers and borrowers, financial markets

enhance their production and allocation efficiencies in the overall economy. Financial
markets also perform an important function of price discovery. The activities of
buyers and sellers in a financial market determine the prices of the traded assets,
which provide guidance on how funds in the economy should be allocated among
financial assets.

Along with it, financial markets provide a mechanism for managing risks. Various
financial assets traded in financial markets provide different payment patterns, and
this redistributes and reallocates the risk associated with the future cash flows
among issuers and investors.

Financial markets also offer liquidity by providing a mechanism for investors to sell
or purchase financial assets.

THE FUNCTIONS OF FINANCIAL MARKETING SYSTEM

 To inspire the operators so that they can monitor performance of the investment
 To gain optimum allocation of risk bearing
 It makes available price – related information
 It helps to promote the process of financial deepening and broadening
 To link the savers and investors