Financial markets play an important role in the allocation of scarce resources in an economy by performing the following four important functions.
- Mobilization of Savings and Channeling them into the most Productive Uses: A financial market facilitates the transfer of savings from savers to investors. It gives savers the choice of different investments and thus helps to channelize surplus funds into the most productive use.
- Facilitate Price Discovery: You all know that the forces of demand and supply help to establish a price for a commodity or service in the market. In the financial market, the households are suppliers of funds and business firms represent the demand.
- Provide Liquidity to Financial Assets: Financial markets facilitate easy to purchase and sale of financial assets. In doing so they provide liquidity to financial assets so that they can be easily converted into cash whenever required.
- Reduce the Cost of Transactions: Financial markets provide valuable information about securities being traded in the market. It helps to save time, effort and money that both buyers and sellers of a financial asset would have to otherwise spend to try and find each other.
Financial markets are classified on the basis of the maturity of financial instruments traded in them.