Function of Financial Markets

Channels funds from person or business without investment opportunities (i.e., “Lender-Savers”) to one who has them (i.e., “Borrower-Spenders”).

Improves economic efficiency.

Financial Markets Funds Transferees:

Lender-Savers:

1.Households

2.Business firms

3.Government

4.Foreigners

Borrower-Spenders:

1.Business firms

2.Government

3.Households

4.Foreigners

Segments of Financial Markets:

Direct Finance:

Borrowers borrow directly from lenders in financial markets by selling financial instruments which are claims on the borrower’s future income or assets.

Indirect Finance:

Borrowers borrow indirectly from lenders via financial intermediaries (established to source both loan-able funds and loan opportunities) by issuing financial instruments which are claims on the borrower’s future income or assets.

Importance of Financial Markets:

This is important. For example, if you save $1,000, but there are no financial markets, then you can earn no return on this – might as well put the money under your mattress.

However, if a carpenter could use that money to buy a new saw (increasing her productivity), then she’d be willing to pay you some interest for the use of the funds.

Financial markets are critical for producing an efficient allocation of capital, allowing funds to move from people who lack productive investment opportunities to people who have them.

Financial markets also improve the well-being of consumers, allowing them to time their purchases better.