Financial Market: Definition, Types, Importance, Example, Functions, Components

The financial markets play a vital role in the modern economy by facilitating capital formation, enterprise growth, risk management, and free exchange of capital. Financial markets in particular help direct resources to their most valuable use, fueling innovation and employment. A well-regulated, transparent system allows both small investors and large corporations to raise money in public securities markets. This lowers the cost of capital for businesses while offering optionality and wealth growth opportunities. By incorporating myriad views into pricing, the exchanges also guide capital allocation decisions through information discovery.

Periods of exuberance or panic can distort signals and disrupt flows. But overall, evidence shows liquid equity markets boost productivity, wages and living standards over the long run. They distribute ownership and risk, supporting pension funding and household net worth. Exchange-traded assets also influence macro dynamics through wealth and confidence perceptions. Upswings fuel spending while downturns chill it, magnifying economic forces. Stability is therefore critical to sustain healthy investment and growth conditions.

What are financial markets?

Financial markets refer to the markets where buyers and sellers participate in the trade of assets like equities, bonds, currencies and derivatives. Financial markets provide a platform for investors to invest money in securities and for companies to raise money by issuing securities. The securities are traded on exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) in India. Stock market allows companies to raise capital by issuing shares to the public and investors to purchase shares of companies.

The two main stock exchanges are NSE and BSE which facilitate the trading of stocks by connecting buyers and sellers. Stocks are traded by foreign institutional investors, domestic institutional investors as well as individual retail investors. The price of stocks fluctuates based on factors like company performance, macroeconomic conditions, liquidity and investor sentiment. The Indian stock market helps businesses raise funds for growth and expansion. It also provides investors the opportunity to invest in the India growth story. The development of the stock market is crucial for boosting capital formation and economic development in India.

What are the types of financial markets?

The major types of financial markets include the stock market, where shares of publicly traded companies are bought and sold; the bond market, which trades debt securities issued by governments and corporations; the commodities market for trading physical goods and raw materials; the money market for short-term debt instruments; and the foreign exchange market for trading currencies.

1.Capital market

Capital markets are marketplace where buyers and sellers engage in the trade of securities like bonds, stocks, and derivatives. Capital markets channel savings and investment between suppliers of capital such as retail investors and institutional investors, and users of capital like businesses, government, and individuals. Capital markets in India consist primarily of the stock exchanges like NSE and BSE where investors buy and sell shares, bonds, and derivatives. The main usage of capital markets is to allow Indian companies across sectors to raise long-term capital from investors across India. This capital is used to fund growth and projects for business expansion. It provides an alternative to limited bank lending. For investors, it provides an avenue to allocate savings into financial securities to build wealth over time. 

Stock market

Stock markets allow companies to raise capital by issuing and selling shares or stock to investors. The two main stock exchanges in India are the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Companies list and trade their shares on these exchanges to access equity financing from investors across the country.  Stock markets provide an avenue for companies to access capital for business purposes like investing in new projects or acquisitions. It offers an alternative to traditional bank lending. For investors, it serves as a platform to allocate savings and build wealth. 

Bond market

Bond markets are used by organisations like governments and companies raise debt financing by issuing bonds that are purchased by investors. The bond market segments in India include the government bond market, corporate bond market, and municipal/local bonds. 

The main usage of bond markets in India is to allow governments and companies to raise debt financing for various purposes. For the government, it provides an avenue for deficit financing. For companies, it offers an alternative to bank lending. For investors, bonds provide fixed regular income and stability in investment portfolios. 

2. Commodity market

Commodity markets are markets that facilitate the trading of primary economic goods like agricultural products, metals, oil and natural gas. The main commodity exchanges in India are MCX and NCDEX. 

For example, NCDEX allows farmers, traders, and processors to trade in agricultural commodities like wheat, rice, cotton, spices, etc. through futures contracts. This provides price risk management in agri-commodities. 

Similarly, on MCX traders buy and sell futures contracts on metals like gold, silver, copper, natural gas, crude oil etc. Jewellers hedge their price risk on gold inventory using gold futures.

The main usage of commodity markets in India is to provide price discovery and price risk management for producers, consumers and traders of commodities. It helps integrate localised commodity markets across India into one national market. Commodity derivatives also allow better inventory planning for companies. 

Soft commodities

Soft commodities refer to agricultural commodities that are grown, rather than mined. They include crops like wheat, rice, pulses, spices, coffee, tea, cotton, rubber, fruits and vegetables. 

The National Commodity and Derivatives Exchange (NCDEX) in India provides a platform for trading in various soft commodities. For example, it allows futures trading in wheat, chana, soybean, mustard seed, cotton, cardamom, mentha oil, etc. This helps farmers, producers and exporters hedge against price risks. 

The main usage of soft commodity trading in India is price discovery and risk management. It provides valuable information on demand, supply and prices to all participants. Farmers lock in future selling prices for their produce. Processors like flour mills hedge against raw material price changes. The efficient price signals lead to higher farm productivity and food security.

Hard commodities

Hard commodities refer to natural resources that are mined or extracted, rather than grown agriculturally. They include precious metals like gold, silver, platinum, base metals like aluminium, copper, nickel, lead, zinc and energy commodities like crude oil, natural gas and coal. 

In India, hard commodities are traded on exchanges like the Multi Commodity Exchange (MCX) and National Commodity and Derivatives Exchange (NCDEX). For example, MCX offers futures trading in gold, silver, copper, crude oil, natural gas, aluminium, nickel, mentha oil, cotton etc. This facilitates price discovery and hedging for producers, consumers and traders.

The key usage of hard commodity derivatives in India is managing price volatility and inventory risks. Mining companies hedge against fluctuations in global metal prices. Oil marketing companies lock in crude oil purchase costs in advance. Jewellers offset price risks in gold/silver inventory. 

3. Money market

Money markets are short-term debt markets where participants borrow and lend for durations typically up to one year. Money market instruments in India include treasury bills, commercial paper, certificates of deposit, repo and reverse repo agreements. 

For example, a manufacturing company sometimes issues commercial paper with 3 month maturity to raise short-term working capital funds from investors instead of taking a bank loan. The investors purchasing this commercial paper will earn short-term returns while their money is parked for 3 months.

The main usage of money markets in India is to allow businesses, financial institutions, government and investors to borrow and lend for very short periods. It serves as an alternative to bank borrowing and provides short-term liquidity in the economy. For businesses, it offers flexibility in managing cash flows. For investors, it provides very liquid and low-risk short-term investment options like treasury bills. An active money market is essential for the Reserve Bank of India to conduct effective monetary policy. 

4. Derivatives market

Derivatives markets provide instruments like futures, options, swaps etc. that derive their value from an underlying asset. They allow the transfer of risk from parties who want to hedge their risk exposure to parties more willing to bear that risk. 

For example, an Indian farmer will be able to buy a futures contract to sell his crop at a future date for a predetermined price. This protects him from potential decrease in crop prices at harvest time. The speculator taking the opposite trade is bearing the price risk in exchange for a potential profit if prices rise.

The main usage of derivatives markets in India is to allow hedging and speculation on asset prices. For producers and businesses, it provides a means to hedge against commodity price risk, interest rate risk and currency rate risks. For investors, it provides avenues to speculate and profit from movements in underlying asset prices. India has active derivatives markets in equity, commodities and currencies. These markets impart liquidity and price discovery to the underlying cash markets. 

Futures

Futures markets provide standardised contracts that obligate the buyer to purchase an asset and the seller to sell an asset at a predetermined future date and price. The contracts are standardised by exchanges on the quantity, quality and delivery specifications.

For example, a farmer will be able to enter a futures contract today to sell his soybean crop at harvest time 3 months later for Rs 3000 per tonne. This locks in the price he will receive despite any change in soybean prices in the next 3 months. 

The main usage of futures markets in India is to allow hedging and speculation on future asset prices. For producers like farmers, it provides price protection against potential adverse price movements. For speculators, it provides an opportunity to profit from correct bets on future price trends. India has active futures markets in equities, commodities, currencies and bonds. These provide price discovery of the underlying cash markets and improve their liquidity. 

Forward

The forward market is an over-the-counter market where two parties enter into customised contracts to buy or sell an asset at a specified price on a future date. The terms are agreed bilaterally unlike the standardised contracts traded on futures exchanges.

For example, an Indian exporter expecting to receive USD 1 million after 3 months will sell USD forward to eliminate exchange rate risk. This locks in the INR value he will receive after 3 months regardless of USDINR movements. The importer on the other side is taking the exchange rate risk.

The main usage of the forward market in India is to hedge against currency and commodity price risks. Exporters, importers and commodity producers use forward contracts to lock in future prices and mitigate risks. Speculators provide liquidity and absorb risks in the forward market. While smaller in size compared to futures markets, the forward market provides flexibility as terms are customised as per needs. 

Option

Option markets refer to derivatives exchanges where financial securities known as options are traded. An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before a specific date. 

For example, on the National Stock Exchange (NSE) in India, investors are able to buy or sell Nifty options that give the right to buy or sell the Nifty 50 index at a particular price by the expiry date. 

Ramesh, an investor, might buy a Nifty call option contract that allows him to buy the Nifty at 11,500 at expiry. Ramesh will be able to execute his option to purchase at 11,500 and sell for a profit at the higher market price if Nifty moves over 11,500. Once the Nifty closes below 11,500, the option loses all of its value.

The main usage of option markets in India is to allow investors to hedge stock portfolios or speculate on market direction. Options help limit downside risk in volatile markets, making option trading a preferred method for managing financial exposure. Traders use options to bet on expected moves in the broader market or individual stocks, with option trading offering a strategic tool for both hedging and speculation purposes.

Swap

Swap markets refer to over-the-counter (OTC) markets where counterparties exchange financial instruments known as swaps. A swap is a derivative contract where two parties agree to exchange financial flows at certain intervals during the life of the swap. 

For example, an interest rate swap involves exchanging a fixed interest rate cash flow for a floating rate cash flow. 

ABC Ltd, an Indian company, holds a loan at 10% fixed interest rates. To hedge this, ABC enters into an interest rate swap to receive fixed 10% and pay floating rates linked to MIBOR. ABC gains from paying lower rates via the swap, balancing its fixed loan outflow, if MIBOR declines.

The main usage of swap markets in India is for corporates to hedge interest rate and currency risk on foreign borrowings. Swaps help convert floating rate loans to fixed rates or vice versa. Banks trading swaps earn fees while facilitating client hedging needs. Swaps also allow speculators to bet on the direction of interest rates and currencies. 

5. Foreign exchange market

The foreign exchange market is a decentralised global market where participants trade currencies. It consists of banks, commercial companies, central banks, investment management firms, hedge funds and retail forex brokers and investors. 

The Reserve Bank of India, for example, wants to intervene in the forex market to strengthen or weaken the rupee against the dollar. They will be able to do this by buying or selling rupees in the market. 

Multinational corporations like Infosys use the forex market to pay overseas suppliers or staff in other countries. They need to convert their domestic currency into foreign currency through their bank.

The main usage of the foreign exchange market is to facilitate the conversion of one currency into another. It allows businesses, investors, travellers and governments to pay or receive currencies for goods, services, investments and other transactions globally. 

6. Cryptocurrency market

The cryptocurrency market refers to the exchanges and over-the-counter platforms where various digital currencies or crypto tokens are traded. Cryptocurrencies like Bitcoin, Ethereum, and Cardano operate on blockchain networks as peer-to-peer decentralised digital money. 

In India, investors purchase cryptocurrencies like Bitcoin on exchanges like WazirX, CoinDCX, and CoinSwitch Kuber. Retail investors buy cryptos as investments, while traders aim to profit from price fluctuations.

Companies also create their own cryptocurrencies or tokens through an initial coin offering (ICO) to raise capital. For example, Matic Network raised funds in 2017 via an ICO to build its Layer 2 scaling solution for Ethereum.

The main usage of the cryptocurrency market is to facilitate the trading of crypto coins and tokens as an alternative digital asset class. It provides a venue for investors, traders and companies to access decentralised cryptocurrencies outside the traditional financial system. The cryptocurrency market aims to allow the transfer of digital value and enable various blockchain-based applications.

7. Spot market

The spot market, also known as the cash or physical market, refers to the buying and selling of financial instruments or commodities for immediate delivery. Settlement happens within 1-2 days after the trade date. 

In India, stocks traded on the NSE and BSE are settled on a T+2 basis. For example, shares of Reliance Industries bought on Monday are delivered to the buyer’s account on Wednesday. 

Commodities like gold and crude oil also have active spot markets where buyers and sellers trade for immediate delivery. Gold jewellers or oil refiners sometimes use the spot market for their raw material needs.

The main usage of the spot market is to facilitate the exchange of assets at current market prices for near-term requirements. It provides immediate liquidity, unlike derivatives contracts or bonds. Companies use the spot market to fulfil business needs, traders profit from price swings, and the spot prices determine derivatives pricing. 

8. Interbank lending market

The interbank lending market refers to the system through which banks lend and borrow short-term funds from each other. It enables banks to meet temporary shortages or excesses in liquidity. 

For example, Bank A has surplus funds while Bank B faces a temporary deficit. Bank B borrows overnight funds from Bank A in the interbank market to square its books. The loans are made at the prevailing interbank interest rates.

Banks in India actively use the interbank market to fine-tune liquidity. The Clearing Corporation of India facilitates interbank lending and borrowing through its collateralized lending and borrowing mechanism. 

The key usage of the interbank market is to allow banks to efficiently manage their short-term liquidity needs. It provides a mechanism to channel funds from banks with surpluses to those facing deficits. This ensures the stability of the banking system by preventing liquidity crunches and helps optimise the use of available funds.

The financial markets encompass a broad range of segments that allow entities to raise capital, invest funds, and manage financial risks. Efficient and well-regulated financial markets are essential for a thriving economy that channels resources productively and fosters growth.

What is the importance of the financial market?

The financial markets like stock exchanges are important because they allow companies to raise capital through equity issuance and investors to allocate capital efficiently, facilitating economic growth and development. The stock market provides companies with access to capital by allowing them to sell shares to investors.

Companies use this equity financing to fund expansions, hire more employees, develop new products, and invest in other value-creating activities. Without the ability to sell stock, most companies would be limited to using their own retained earnings or debt to fund growth. The liquidity provided by public stock markets gives companies more flexibility in raising large amounts of capital. This capital formation supports business expansion and broader economic growth.

What is an example of a financial market?

The Indian stock exchanges like NSE and BSE are examples of financial markets that provide a platform for trading in equity shares of listed companies. Money markets deal with short-term debt instruments like treasury bills, commercial paper and certificates of deposit with maturities of up to one year. The key money market in India is the call money market where banks lend to and borrow from each other to meet short-term liquidity needs.

Banks with surplus funds lend in the call money market at the prevailing interest rate. Banks facing liquidity shortfalls borrow funds collateralized by government securities. The rates are determined by demand and supply. The Clearing Corporation of India facilitates settlement. Other money markets are market for treasury bills where RBI issues T-bills weekly for 91 and 364 days and the commercial paper market where corporates issue unsecured promissory notes to investors for maturities between 7 days to 1 year. 

How to analyse the financial market?

Comprehensive analysis of the financial markets requires monitoring macroeconomic trends, financial metrics, technical indicators, and market sentiment to gain insights into equity, debt, and derivative market movements. By gaining a robust understanding of market fundamentals, technical indicators, macroeconomic conditions, and market psychology, investors develop effective strategies for buying, selling, and holding stocks. Analysing market fundamentals involves assessing the financial performance and valuation of companies.

This provides insights into the intrinsic value and growth prospects of stocks. Key fundamentals to analyse include revenue growth, profit margins, debt levels, and price-to-earnings ratios. Revenue growth indicates how rapidly a company’s business is expanding. Higher revenue growth suggests stronger demand for its products or services. Profit margins measure how efficiently a company converts revenue into profits. Expanding margins imply the company is becoming more operationally efficient over time. 

What are the functions of the financial market?

The key functions of the stock market include enabling companies to raise capital through issuing shares, facilitating price discovery and liquidity for efficient allocation of resources, etc. 

Price Discovery 

A key function of the stock market is price discovery – the process of determining the price of securities based on supply and demand. On a stock exchange, the prices of shares are set through the continuous auction process. Buyers and sellers place bids and offers, with exchange rules determining when orders match. The interaction of buyers and sellers results in the emergence of a market price. 

Liquidity

Stock markets provide liquidity, enabling investors to quickly and easily buy and sell shares. On an exchange, there are always buyers and sellers willing to trade. Investors convert shares into cash equivalents almost immediately. Liquidity helps investors manage financial risk. With greater liquidity, investors swiftly alter their portfolios in response to new information or changing circumstances. It provides an exit option for investors who want to leave a company. High liquidity also reduces the cost of raising capital for firms and makes investment more attractive for savers.

Lower Transaction Costs

Stock exchanges lower the costs of trading through economies of scale and by standardising procedures. Having one centralised marketplace pools together a large number of buyers and sellers. This increases the odds of finding a match and reduces search costs. It also concentrates order flow, leading to efficiencies that reduce transaction fees. Standardised trading procedures, listing requirements and trading rules also cut down on the cost of trading. Lower transaction costs mean it’s cheaper for companies to raise funds and investors to assemble portfolios.

Raising Capital

A vital function of stock markets is enabling companies to obtain capital needed to fund operations, investments and expansion. Companies tap into a wide pool of investors by listing and selling shares on a public exchange. Without an organised stock market, companies would have to raise funds directly from a limited group of private investors. Selling shares through an exchange opens up fundraising opportunities, especially for young, innovative companies without an established reputation. Stock markets also provide an acquisition currency – shares in the acquiring company are issued to purchase other companies.

What are the components of the financial market?

The financial market consists of the primary market where new securities are issued, the secondary market where existing securities are traded, the capital market for stocks and bonds, the money market for short-term debt, and the derivatives market for instruments based on the value of underlying assets.

Based on market levels

Based on market levels, the primary market is where companies initially offer shares to the public through an IPO, while the secondary market is where investors subsequently trade previously issued shares among themselves on exchanges like the NYSE and NASDAQ.

Primary market

The primary market is the market where securities are first offered and issued to investors. It is the channel through which companies raise capital by issuing new stocks and bonds to the public for the first time. The proceeds from the sale go directly to the company issuing the securities.

The main usage of the primary market is to provide companies access to capital. It allows companies to raise funds directly from investors through instruments like IPOs, rights issues, preferential allotments etc. The capital raised is then used to finance investments, expand operations, pay off debts or fund other expenses.

Secondary market

The secondary market is where investors trade securities that have already been issued in the primary market. It enables trading of existing or previously-issued securities without the involvement of the issuing companies. Secondary market transactions happen between investors after the initial public offering.

After a company holds its IPO on the primary market, its shares start trading on the secondary market on a stock exchange. Investors who were not able to buy shares during the IPO are able to buy them on the secondary market from existing shareholders. 

For example, Zomato held its IPO in 2021, selling new shares on the primary market to raise funds. After the IPO, Zomato shares began trading on the secondary market on the National Stock Exchange of India. Investors who did not participate in the IPO could now buy existing Zomato shares from initial investors on the secondary market. Similarly, initial investors could sell their shares to other investors through secondary market trading. This secondary market trading of previously issued Zomato shares among investors was happening on the NSE after the primary market IPO. 

The main usage of the secondary market is to provide liquidity and marketability to securities. It gives investors a platform to sell and buy securities at prevailing market prices at any given time. The constant trading and price discovery on the secondary market also makes the primary market more vibrant as it provides investors exit options.

Based on security types

Based on security types, the stock market comprises the capital market for trading shares of corporate equity and the derivative market for associated financial instruments, while adjacent to these are the money market for short-term debt securities, the depository market for securities safekeeping, and the broader financial services market which facilitates trading and investments.

Money market

The secondary market is where investors trade securities that have already been issued in the primary market. It enables trading of existing or previously-issued securities without the involvement of the issuing companies. Secondary market transactions happen between investors after the initial public offering.

For example, HDFC Life Insurance held its IPO in 2017, selling new shares on the primary market to raise funds. After the IPO, HDFC Life shares began trading on the secondary market on the National Stock Exchange of India. Investors who did not participate in the IPO could now buy existing HDFC Life shares from initial investors on the secondary market. Similarly, initial investors could sell their shares to other investors through secondary market trading. This secondary market trading of previously issued HDFC Life shares among investors was happening on the NSE after the primary market IPO. 

The main usage of the secondary market is to provide liquidity and marketability to securities. It gives investors a platform to sell and buy securities at prevailing market prices at any given time. The constant trading and price discovery on the secondary market also makes the primary market more vibrant as it provides investors exit options.

Capital market

The capital market is a financial market where buyers and sellers engage in trade of financial securities like bonds, stocks, etc. It helps mobilise funds between suppliers of capital such as retail investors and institutional investors and the users of capital like businesses, governments and individuals.

A corporation has the ability to utilise the primary capital market to issue stocks and bonds in order to raise money for business development. Investors then buy these stocks and bonds during the initial public offering (IPO). The investors later sell these securities to other investors in the secondary capital market. 

For example, Reliance Industries issued bonds in the primary capital market to raise funds and investors bought these Reliance bonds during the bond offering. These Reliance bonds were then traded in the secondary capital market between investors after the initial offering. In a similar vein, investors bought shares in Indian Oil Corporation’s first public offering (IPO) on the primary market. Later, these Indian Oil shares were traded between investors in the secondary capital market. 

The main usage of the capital market is to channel money from investors who have surplus funds to entities who have a shortage of funds. It provides the business sector with an avenue to raise long-term funds while providing investors with returns in the form of interest, dividends or market gains. The efficient movement of capital allows businesses and economies to grow.

Derivative market

The derivatives market refers to the financial market for derivatives – financial contracts whose values are derived from an underlying asset like commodities, currencies, stocks, bonds, interest rates etc. It allows parties to trade specific financial risks such as market risk, credit risk, etc.

Futures contracts are one of the most common types of derivatives. A futures contract allows a farmer to sell his harvest at a predetermined price to a buyer in the future. This helps the farmer hedge against price risk. The buyer of the futures contract also hedges against price risk by locking in a purchase price upfront. Though the actual exchange of assets happens in the future, the futures contract itself is traded in the derivatives market.

The main usage of the derivatives market is to allow risk transfer and hedging. Derivatives help mitigate financial risk for parties involved and allow speculators to bet on the future price movements. It helps discover accurate prices in the cash market and improves overall market efficiency. The derivatives market helps segregate and trade distinct financial risks, making the derivative market an essential tool for managing financial uncertainties and leveraging opportunities in global finance.

Financial service market

The financial service market refers to the market where financial services like banking, insurance, asset management, securities brokerage etc. are offered by financial institutions to individuals, businesses and organisations. It enables participants to manage finances, invest capital and mitigate risks.

Banks offering savings accounts, loans and various facilities to customers are operating in the financial service market. Insurance companies providing health, auto and life insurance policies belong to the financial service market. Stock Brokerages executing share trading orders for investors are also part of this market. All these institutions charge fees and commissions for providing financial services.

The main usage of the financial service market is to facilitate transactions and interactions between savers, investors and borrowers. It enables pooling of funds from savers and deploying them to productive investments while managing risks. The financial service market helps in the overall management of the financial system and flow of funds in the economy.

Depository market

The depository market refers to the institutions and mechanisms that enable holdings and transfer of securities and financial instruments in dematerialized or paperless form. It eliminates the need for physical certificates and documents.

The two depositories in India – NSDL (National Securities Depository Limited) and CDSL (Central Depository Services Limited) allow holding and trading of stocks and bonds in electronic form through demat accounts. Rather than receiving physical certificates upon purchase, investors have their shares electronically credited to their demat account. The investor then conveniently sells these shares later through their depository participant.

The main usage of the depository market is to simplify and facilitate the processes of issuing, holding, transacting and transferring financial assets and securities. It aims to reduce paperwork involved in buying, selling and transferring securities while increasing efficiency and reducing the risk of forgery.

Non-depository market

A non-depository market refers to a financial market where the buying, selling and transfer of financial assets like stocks, bonds, commodities etc. involve physical certificates and documents. The ownership and transactions are not recorded electronically or in dematerialized form.

In the earlier times, buying shares involved getting physical share certificates issued in the investor’s name. These certificates had to be physically submitted and transferred whenever the shares were sold. Similarly commodities markets earlier involved physical warehouse receipts being exchanged during buy/sell. This was a non-depository or physical system of financial transactions.

The main usage of non-depository markets historically was for trading of financial instruments before the advent of modern depository and electronic trading systems. It required physical share certificates and documents to be exchanged during transactions involving stocks, bonds, commodities etc. This led to delays, inefficiencies and frauds.

The financial market consists of multiple interlinked components that allow buyers and sellers to trade financial assets, manage risk, and transfer capital efficiently through regulated institutions and mechanisms.

How does the financial market impact the economy?

The stock market impacts the economy by directing investment capital, reflecting information, affecting consumer wealth and confidence, and transmitting financial risks.

A core function of stock markets is to direct capital flows into profitable investments. Companies raise funds by issuing and selling shares on stock exchanges. Investors buy these shares in anticipation of capital gains and dividends. Ideally, money will flow towards more productive firms and business activities, boosting innovation and economic expansion. Stock prices provide signals to investors about expected returns, guiding how capital gets allocated. More efficient capital allocation leads to higher productivity and long-term growth.