Markets and Financial Instruments
TYPES OF MARKETS
Efficient transfer of resources from those having idle resources to others who have a pressing need for them is achieved through financial markets. Stated formally, financial markets provide channels for allocation of savings to investment. These provide a variety of assets to savers as well as various forms in which the investors can raise funds and thereby decouple the acts of saving and investment. The savers and investors are constrained not by their individual abilities, but by the economy's ability, to invest and save respectively.
Financial (capital) markets provide the means for economic entities to exchange obligations. They interact for the purpose of buying and selling financial assets (debt and equity instruments). Both buyers and sellers seek to increase their wealth through this interaction.
Sellers of securities (‘‘paper’’) expect to invest the funds obtained in investment projects that increase wealth. Purchasers of debt and equity securities expect to increase wealth, essentially through the receipt of interest, dividends or capital growth.
The financial markets, thus, contribute to economic development to the extent that the latter depends on the rates of savings and investment.
Direct and Indirect Finance
Funds transfers between two parties can be classified into two types: 1. Direct - the lender and the borrower may be known to each other and the lender generally bears the credit risk. This takes place in capital markets. An example of this type of funds transfer is an investor buying a bond. If the bond issuer does not pay, the investor will lose their investment. 2. Indirect - the lender and the borrower are brought together through the use of a financial intermediary, with the intermediary generally bearing the credit risk. An example of this type of funds transfer is a person placing a deposit with a bank. The bank then lends the funds to another person and bears the...
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