What is Financial System? Financial Assets, Financial Markets

  • Post last modified:20 February 2024
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  • Post category:Corporate Finance
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What is Financial System?

A financial system is a collection of entities that allow money to be exchanged, such as banks, insurance firms and stock exchanges. On a firm, regional and global scale, financial systems exist. Borrowers, lenders and investors all exchange current monies to fund projects for consumption or productive investment as well as to earn a profit on their financial holdings.

The financial system also contains a set of rules and practices those borrowers and lenders use to determine which projects are funded who finances initiatives and the terms of financial transactions.

Functions of Financial System

The economy is strewn with financial resources. This is why a financial system is required to provide for the timely deployment of these resources across all sectors of the economy. A well-functioning financial system should be able to carry out a number of tasks.

The following are a few of these capabilities:

Payments streamlining

Only if a system exists to ensure that payments are received on time can the transfer of goods and services go successfully. The payment system is responsible for this function.

A subset of the financial system is the payment system. It is made up of a number of different entities, including banks, depository institutions and private businesses.

Resources transfer

Individuals and businesses may find that their cash flow does not always match their desired cash flow. A retired individual, for example, may have a one-time payment. They may, however, be more interested in a certain amount of money that is paid on a regular basis.

A firm, on the other hand, may require a large quantity of cash upfront to invest it in a project. They could agree to make a series of payments in exchange.

Controlling risks

The financial system relies heavily on the derivatives and insurance markets. These markets were formed only for the goal of reducing risk, which is an unavoidable element of everyone’s life.

Information management

The financial sector offers crucial data for the economy’s overall health. The markets give one of the most crucial pieces of information: pricing. All economic theory is based on pricing data. All economic decisions are made on this foundation.

Cost-effective middleman

The financial system serves as a cost-effective intermediary. This is due to the financial system’s ability to redirect funds toward productive activity with the least amount of transaction expenses. The financial system is made up of several different systems that were designed to meet the demands of individual markets.

Resource combination

The financial system allows a collection of investors to do something that they could not have done on their own. When it comes to stock investment, for example, individual investors are constrained by their expertise.

When a group of investors joins together; however, the pool of cash grows large enough that they can afford to recruit a team of experts. As a result, they can compete on an equal level with the bigger funds.

What is Financial Assets?

A financial asset is a liquid asset whose value is determined by a contractual right or ownership claim. Cash, equities, bonds, mutual funds and bank deposits are examples of financial assets. Financial assets, unlike land, property, commodities and other tangible physical assets, may not always have physical value or even a physical form. Rather, their worth is determined by supply and demand in the market where they trade, as well as the level of risk they bear.

The three sorts of assets are real, financial and intangible assets. Real assets are tangible assets whose worth is derived from things or attributes such as precious metals, land, real estate and commodities such as soybeans, wheat, oil and iron. Intangible assets are valuable assets that aren’t tangible. These assets include patents, trademarks and intellectual property, to name a few.

What is Financial Markets?

Financial markets, which include the stock market, bond market, currency market and derivatives market, among others, are any market- place where trading in securities takes place. The efficient running of capitalist economies depends on the financial markets.

By allocating resources and generating liquidity for firms and entrepreneurs, financial markets play a crucial role in supporting the smooth running of capitalist economies. Trading financial assets are made simple by the markets for buyers and sellers. Financial markets design securities as a way to reward investors and lenders who have extra money while also making that money accessible to those who need it (borrowers).

One form of financial market is the stock exchange. Buying and selling different kinds of financial assets, such as shares, bonds, currencies and derivatives, create the financial markets. To guarantee that the markets establish prices that are effective and reasonable, financial markets primarily depend on informational openness. Due to macroeconomic factors like taxation, the market prices of securities may not reflect their true worth.

Other financial markets, like the New York Stock Exchange (NYSE), exchange billions of dollars’ worth of assets every day whereas other financial markets are tiny and inactive. Investors may purchase and sell shares of publicly listed corporations on the equities (stock) market, which is a financial market.

Initial public offerings or IPOs, are new stock issues that are offered on the main stock market. The secondary market is where investors purchase and sell securities that they already hold and here is where any additional trading of equities takes place.

Types of Financial Markets

Stock Markets

The stock market is perhaps the financial market that is most prevalent. These are places where investors and traders may buy and sell shares that are listed by corporations. Companies utilise stock markets, also known as equities markets, to obtain cash via an initial public offering (IPO), after which shares are exchanged between different buyers and sellers in what is referred to as a secondary market.

Stocks may be traded over the counter or on public platforms like the New York Stock Exchange (NYSE) or Nasdaq (OTC). The majority of stock trading takes place on regulated exchanges, which are crucial to the economy because they serve as a gauge of the economy’s overall health as well as a source of capital gains and dividend income for investors, including those with retirement accounts like IRAs and 401(k) plans.

Market makers (MMs) and experts who maintain liquidity and offer two-sided markets are typical stock market players, together with investors and traders (both retail and institutional). Brokers are impartial middlemen that help buyers and sellers complete transactions but do not have any real positions in stocks.

Over-the-Counter Markets

An over-the-counter (OTC) market is a decentralised market in which players transact securities without the need of a broker, trading taking place online rather than at physical locations. The majority of stock trading is conducted via exchanges, while OTC markets may handle trade in certain equities (for example, smaller or riskier businesses that do not fulfil the listing standards of exchanges).

But certain OTC-only derivatives markets account for a significant portion of the financial markets. In general, OTC markets are far less regulated, less liquid and more opaque, as are the transactions that take place there.

Bond Markets

A bond is a kind of asset where an investor lends money for a certain amount of time at a fixed interest rate. A bond may be seen as an agreement outlining the terms of the loan and the payments between the lender and borrower.

Corporations, as well as cities, states and other sovereign entities, issue bonds to fund operations and projects. Securities like notes and bills issued by the US Treasury, for instance, are sold on the bond market. The debt, credit or fixed-income markets are other names for the bond market.

Money Markets

The money markets typically deal in highly liquid, short-term securities with maturities of less than a year. They are distinguished by a high level of safety and a relatively modest rate of interest return. Large-volume transactions between institutions and dealers take place in the money markets at the wholesale level.

They include money market accounts created by bank clients and money market mutual funds purchased by retail investors. Purchases of short-term certificates of deposit (CDs), municipal securities or U.S. Treasury bills are just a few examples of how individuals might invest in the money markets.

Derivatives Markets

A derivative is a contract between two or more parties, the value of which is determined by an accepted underlying financial asset (such as securities) or collection of assets (like an index). The value of derivatives, which are secondary securities, is wholly based on the value of the original security to which they are tied.

A derivative has no value by itself. A derivatives market trades complex financial products like futures and options contracts, which derive their value from underlying securities like bonds, commodities, currencies, interest rates, market indices and stocks, as opposed to trading equities directly. Futures contracts are posted and sold on futures exchanges.

The futures markets, which employ standardised contract specifications, are well-regulated and use clearinghouses to settle and confirm transactions, in contrast to OTC forward markets. Similar to stock exchanges, options markets like the Chicago Board Options Exchange (CBOE) lists and oversee options transactions. Contracts on a variety of asset types, including stocks, fixed-income instruments, commodities and so forth, may be listed on futures and options markets.

Forex Market

The market where players may purchase, sell, hedge and speculate on the exchange rates between currency pairings is known as the forex (foreign exchange) market. Since cash is the most liquid asset, the FX market is the most liquid market in the whole globe. Daily transactions on the currency market exceed $6.6 trillion, which is more than on the futures and stock markets put together.

The forex market is decentralised and made up of a worldwide network of computers and brokers from all over the globe, much like the OTC markets. Banks, commercial enterprises, central banks, asset management businesses, hedge funds, as well as small-scale currency dealers and investors, make up the forex market.

Commodities Markets

Producers and consumers trade physical commodities such as agricultural items (such as maize, cattle and soybeans), energy products (such as oil, gas and carbon cred- its), precious metals (such as gold, silver and platinum) or “soft” commodities in commodities markets (such as cotton, coffee and sugar). These places, where tangible products are traded for cash, are referred to as spot commodities markets.

However, the majority of these commodities’ trading occurs on derivatives markets, which use spot commodities as the underlying assets. Commodity forwards, futures and options are traded both over-the-counter (OTC) and on publicly traded markets like the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE).

Cryptocurrency Markets

Cryptocurrencies like Bitcoin and Ethe- reum, which are decentralised digital assets based on block chain technology, have been introduced and have grown significantly over the last few years. Today, a variety of independent online cryptocurrency exchanges provide hundreds of cryptocurrency tokens for trading. These exchanges provide traders with access to digital wallets where they may exchange one cryptocurrency for another or fiat money like dollars or euros.

Users are vulnerable to fraud or hacking since the bulk of cryptocurrency exchanges are centralised systems. There are also decentralised exchanges that function without a central authority. Without the assistance of a real exchange body, these exchanges enable peer-to-peer (P2P) trading of digital currencies directly. Major cryptocurrencies may also be traded in futures and options.

Financial Market Return

In its most basic form, a return, often known as a financial return, is the amount of money gained or lost on an investment over time. The change in cash worth of an investment over time may be stated formally as a return. A percentage determined from the profit-to-in-vestment ratio may also be used to calculate a return.

Prudent investors understand that a precise definition of return is situational and based on the financial facts used to calculate it. Profit, for example, can be defined as gross, operational, net, before tax or after tax. Investment can refer to specific, average or total assets.

The return on investment over the time it has been owned by a certain investor is referred to as a holding period return. The return on a holding period can be stated as a percentage or as a nominal amount. The word ‘rate of return (RoR)’ is commonly used when expressing a percentage (RoR).

Returns spanning various length periodic intervals may only be compared once they’ve been converted to the same interval length. Returns gained over a year are often compared. The term “annualization” refers to the process of transforming shorter or longer return periods into annual returns.

Financial Intermediaries

A commercial bank, investment bank, mutual fund or pension fund is an example of a financial intermediary. Consumers profit from financial intermediaries because of their safety, liquidity and economies of scale in banking and asset management. Although technological advancements threaten to eliminate the financial middleman in certain sectors, such as investing, disintermediation poses a far lower risk in other areas of finance, such as banking and insurance.

The general public cannot deposit money with a non-bank financial intermediary. Factoring, leasing, insurance policies and other financial services are some of the services that the middleman may offer. Many intermediaries participate in stock exchanges and manage and develop their money using long-term strategies. The actions of financial intermediaries and the expansion of the financial services industry can provide insight into a country’s overall economic stability.

Financial intermediaries transfer money from those with surplus capital to others who require it. The approach results in more efficient marketplaces and cheaper corporate costs. A financial adviser, for example, connects with customers by helping them buy insurance, stocks, bonds, real estate and other assets.

Types of Financial Intermediaries

Active management of shareholder-collected cash is provided by mutual funds. By investing in firms whose stock he believes will beat the market, the fund manager establishes a connection with shareholders. In doing so, the management offers assets to shareholders, money to businesses and liquidity to the market.

Role of Financial Intermediary

Financial middlemen essentially link a party with surplus money to a party with a deficit fund. They facilitate the movement of money across the economy and promote expansion. The intricacy of the intermediaries’ duties varies depending on the services and goods they provide. They manifest themselves as channels that provide loans, mortgages, investment vehicles, leases, insurances, etc.

Intermediaries play a variety of important responsibilities, such as:

  • Connecting consumers to the financial sector

  • They protect their clients’ valuable cash

  • Financial advising services, the dissemination of financial data and credit rating

  • Enabling company owners’ economies of scale to lower the cost of doing business

  • By attaining the right balance of stock and debt, it aids firms in optimising their capital structures.

  • Encourage economic growth

Financial Intermediaries Advantages

Savers can combine their assets through a financial intermediary, allowing them to make big investments that benefit the organisation in which they are investing. Financial intermediaries, on the other hand, pool risk by distributing funds over a variety of assets and loans. Households and governments profit from loans because they allow them to spend more money than they now have.

Financial intermediaries can also help you save money on a number of fronts. For example, they can use economies of scale to properly assess potential borrowers’ credit profiles and maintain records and profiles at a low cost. Finally, they lower the expenses of the numerous financial transactions that an individual investor would have to perform if the financial intermediary did not exist.

Example of a Financial Intermediary

Two new financial instruments were approved by the European Commission in July 2016 for use in ESI fund investments. The objective was to make it simpler for entrepreneurs and others in charge of urban development projects to get finance. In contrast to obtaining grants, loans, stocks, guarantees and other financial instruments attract more public and private financing sources that may be reinvested across several cycles.

One of the tools, a co-investment facility, was designed to provide money to startups so they could build out their business models and attract more finance through a collective investment plan run by one primary financial intermediary. According to the European Commission, each small- and medium-sized business would need to spend around €15 million (or $17.75 million) in public and private resources.

Growth and Trends in the Indian Financial System

India’s financial industry is now growing rapidly. The increase in the growth rate indicates that the economy is expanding. Financial and monetary policies are capable of maintaining a steady growth rate. Over the last several years, monetary and macroeconomic policy reforms have had a profound impact on the Indian economy.

The repeal of laws impeding the expansion of India’s financial industry was a crucial step toward further opening up the financial market. In order to maintain such long-term growth, inflation must be reduced further. The expansion of industries in India contributed to the growth of the financial industry.

India’s Banking Industry is Expanding

India has the largest financial system in the world. In 2020, the banking sector in India had a total asset value of roughly US$ 2.5 trillion.

The overall amount of deposits is close to US$ 2.175909 trillion.

India’s banking system has undergone a thorough transformation. Internet banking and Core banking are two recent additions that have made banking procedures more user-friendly and simpler.

India’s Capital Market is Expanding

  • With the share ratio and deposit system, the transaction ratio was raised.

  • The flexible but underutilised forward trading system is being phased out.

  • The National Stock Exchange (NSE) has implemented information technology solutions to cater to a variety of investors in diverse places.

  • Stock markets are becoming privatised.

India’s Insurance Industry is Expanding

  • Foreign and private Indian firms are eager to turn untapped market potential into possibilities by supplying tailor-made items now that the market has opened.

  • New companies have entered the insurance sector, resulting in the creation of various novel insurance-based products, value add-ons and services. Tokio Marine, Aviva, Allianz, Lombard General, AMP, New York Life, Standard Life, AIG and Sun Life are just a few of the international businesses that have joined the market.

  • The corporations’ competitiveness has resulted in aggressive marketing and distribution strategies.

  • As a regulatory organisation, the Insurance Regulatory and Development Authority (IRDA) has played an important role in the sector’s development.

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