The economy and financial market are interrelated entities shaping the global landscape. The financial market plays a significant role in the growth of an economy, as it provides a platform for individuals, businesses, and governments to invest, borrow, and raise capital. Thus, it results in the subsequent rise in efficiency, new businesses, and employment.
This blog will give a complete picture of the financial market and its role in driving economic growth, focusing on the important areas along the way.
Table of Contents
What is a financial market?
A financial market is an exchange platform where you may trade derivatives, equities, bonds, and other financial products. As they make it possible for organisations and people to manage risk and invest in assets, financial markets are essential to the operation of the global economy.
Financial markets can be divided into two main categories, primary and secondary markets. Apart from these, other types of markets include forex markets, money markets and derivatives markets.
A primary market is a financial market in which freshly issued assets, such as stocks and bonds, are offered for the first time to the general public. Companies often sell shares directly to potential investors to raise capital via an initial public offering (IPO) in the primary market.
Let’s say you own an organisation and can list your company on the financial market. You can list your company through the primary market, as it is designed to enable issuers like you to obtain the funds you require to finance your growth prospects.
Secondary markets allow you to trade existing securities with other traders, unlike the primary market, where new securities are produced and offered to the public for the first time.
A vital part of the monetary system, the secondary market provides investors with a place to buy and sell their assets when they need to raise capital.
Many variables, like economic conditions, company performance, and investor sentiments, affect the price of assets in this market, which may significantly impact their yield.
National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) dominate the secondary markets in India. These markets provide a platform for Indian traders to buy and sell stocks and other financial instruments.
How does the financial market contribute to the growth of an economy?
Through its complex web of operations, the financial market has a major bearing on economic expansion. Capital formation, resource allocation, risk management, and liquidity provision are just a few areas in which it contributes to the economy’s growth.
Let’s go through each of them to gain a deeper insight into the contributions it makes to the growth of the economy.
Capital formation and redistribution of funds
Financial markets facilitate capital creation by providing a forum for individuals and organisations to invest in businesses through the purchase of stocks and bonds. In turn, this investment facilitates firms' access to the capital it needs to prosper, stimulating the economy and creating more employment.
Further, financial markets are important as they allow for the redistribution of funds, laying the groundwork for the ongoing reorganisation of the economy essential to its expansion.
Allocation of resources in the most effective way
A financial market also plays a vital role by allocating resources effectively. It ensures that the economy makes good use of its resources and promotes productivity by directing funding towards the businesses with the greatest potential for development and profit.
Financial markets are helpful when they come to risk management. Businesses participate in derivative markets to protect themselves from possible financial losses, such as those for futures on commodities and currency exchanges.
Liquidity is a crucial factor in the financial market. Notably, markets may have a more challenging time finding buyers or sellers for their assets if they need more liquidity, which might increase transaction costs and widen bid-ask gaps.
As a consequence, enterprises and individuals may find it tough to access money and obtain cash for investment, which may lead to a drop in market activity and overall growth of the economy.
The importance of the financial sector to economic growth is indisputable. The financial market is crucial to the global economy's success because of its role in capital generation, efficient resource allocation, prudent risk management and much more.
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