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Functions of Financial Market Video Lecture | Business Studies (BST) Class 12 - Commerce

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FAQs on Functions of Financial Market Video Lecture - Business Studies (BST) Class 12 - Commerce

1. What are the functions of financial market commerce?
Ans. Financial market commerce serves several important functions, including: - Facilitating capital formation: Financial markets provide a platform for individuals, businesses, and governments to raise funds by issuing and trading financial instruments such as stocks and bonds. This capital formation process helps to channel savings into productive investments, which can stimulate economic growth. - Price determination: Financial markets enable the interaction of buyers and sellers, resulting in the determination of prices for various financial assets. These prices reflect market participants' expectations, supply and demand dynamics, and other factors that influence the value of these assets. - Risk management: Financial markets provide individuals and businesses with tools to manage financial risks. For example, derivatives such as futures and options allow market participants to hedge against price fluctuations, reducing their exposure to potential losses. - Liquidity provision: Financial markets offer a platform for buying and selling financial assets, providing liquidity to investors. This liquidity allows market participants to easily convert their investments into cash, enhancing market efficiency. - Information dissemination: Financial markets play a crucial role in disseminating information to market participants. Through various channels such as financial news, company reports, and regulatory filings, investors can access relevant information to make informed investment decisions.
2. How do financial markets facilitate capital formation?
Ans. Financial markets facilitate capital formation by providing a platform for individuals, businesses, and governments to raise funds. Here's how the process typically works: 1. Issuance of financial instruments: Entities in need of capital, such as companies or governments, issue financial instruments like stocks or bonds. These instruments represent claims on future cash flows or ownership stakes in the issuing entity. 2. Primary market transactions: The initial sale of these financial instruments takes place in the primary market. Investors, including individuals and institutional investors, purchase these instruments directly from the issuer. The proceeds from these sales provide the issuer with the necessary capital. 3. Secondary market trading: Once issued, these financial instruments can be traded on secondary markets, such as stock exchanges or bond markets. Investors can buy or sell these instruments among themselves, providing liquidity and allowing the issuer to access additional capital or for investors to exit their positions. 4. Capital allocation: The funds raised through primary and secondary market transactions are then allocated to various investment opportunities, such as funding business expansions, infrastructure projects, or government expenditures. This allocation of capital helps stimulate economic growth and development. Overall, financial markets play a crucial role in connecting those in need of capital with those willing to invest, facilitating the flow of funds towards productive investments.
3. What is the role of price determination in financial markets?
Ans. Price determination is a fundamental function of financial markets. Here's why it is important: - Efficient allocation of resources: Price determination allows market participants to assess the value of financial assets based on various factors, such as market sentiment, supply and demand dynamics, and fundamental analysis. This information helps in the efficient allocation of resources by directing funds towards investments that are expected to generate the highest returns. - Risk assessment: Prices in financial markets reflect market participants' expectations about the future performance of assets. By observing price movements, investors can evaluate the risk associated with different investments. Higher prices may indicate increased demand and positive expectations, while lower prices may suggest negative sentiment and potential risks. - Market transparency: Financial markets provide a transparent platform where prices are publicly available. This transparency promotes fair competition and reduces information asymmetry among market participants. It allows investors to make informed decisions based on market prices, ensuring a level playing field. - Market efficiency: Price determination is crucial for market efficiency. As buyers and sellers interact and adjust their bids and offers, prices reach equilibrium, reflecting the true value of assets. Efficient markets help ensure that financial assets are fairly priced, reducing the potential for arbitrage opportunities and enhancing overall market integrity. In summary, price determination in financial markets plays a vital role in allocating resources efficiently, assessing risk, promoting transparency, and enhancing market efficiency.
4. How do financial markets provide liquidity?
Ans. Financial markets provide liquidity by offering a platform for buying and selling financial assets. Here's how they achieve this: - Centralized trading venues: Financial markets, such as stock exchanges or bond markets, provide centralized trading venues where buyers and sellers can come together to execute transactions. These venues facilitate the exchange of financial assets, ensuring liquidity by connecting those seeking to sell with potential buyers. - Market participants: Financial markets attract a diverse range of participants, including individual investors, institutional investors, market makers, and brokers. The presence of multiple participants increases the likelihood of finding willing buyers or sellers, enhancing liquidity. - Market depth: The depth of a financial market refers to the volume of buy and sell orders available for a particular asset. Deep markets with a high number of orders at various price levels provide greater liquidity. Market depth is typically influenced by the number of participants, the size of their orders, and the overall trading activity in the market. - Market hours: Financial markets often have designated trading hours during which investors can buy or sell assets. These predefined hours allow market participants to transact at a time that suits them, ensuring continuous liquidity throughout the trading day. - Market makers and liquidity providers: Market makers are entities that provide liquidity by continuously quoting bid and ask prices for specific assets. They stand ready to buy or sell the asset, ensuring that there is always a counterparty available for a trade. Market makers play a crucial role in enhancing liquidity, especially for less actively traded assets. Overall, financial markets provide liquidity by creating a platform for trading, attracting a diverse range of participants, maintaining deep markets, and facilitating continuous trading throughout designated market hours.
5. How do financial markets contribute to risk management?
Ans. Financial markets contribute to risk management by providing tools and instruments that allow market participants to mitigate and manage financial risks. Here's how they do it: - Derivatives: Financial markets offer a wide range of derivative instruments, such as futures, options, and swaps. These derivatives allow investors to hedge against price fluctuations, interest rate changes, currency movements, and other types of risks. By entering into derivative contracts, market participants can offset potential losses in their existing positions, reducing their overall risk exposure. - Diversification: Financial markets provide opportunities for investors to diversify their portfolios. By investing in a variety of assets, such as stocks, bonds, commodities, or real estate, investors can spread their risks across different sectors and asset classes. Diversification helps reduce the impact of any single investment's poor performance on the overall portfolio. - Risk assessment tools: Financial markets provide access to various risk assessment tools, such as credit ratings, market indices, and volatility indicators. These tools help investors evaluate the creditworthiness of borrowers, assess the overall market sentiment, and gauge the level of risk associated with different investments. By using these tools, market participants can make more informed decisions and manage their risks effectively. - Insurance products: Financial markets facilitate the trading of insurance products, such as insurance policies and reinsurance contracts. These products allow individuals and businesses to transfer the risk of potential losses to insurance companies. Insurance markets help protect against unforeseen events, such as accidents, natural disasters, or business disruptions, providing a mechanism for risk management. In summary, financial markets contribute to risk management by offering derivative instruments, facilitating diversification, providing risk assessment tools, and enabling the trading of insurance products. These mechanisms allow market participants to hedge against risks, reduce exposure, and protect against potential losses.
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