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Question 1
Part A
Financial markets are markets where various types of financial assets are traded. ... Though the creation/ exchange of financial assets can be done over the counter financial markets enable better transaction efficiency.
In the UK, financial markets can be divided into money markets and capital markets. The money markets match borrowers and lenders of short term funds and are largely regulated by the Bank of England. Most players in these markets are institutions. Capital markets match borrowers and lenders investors of medium and long-term funds.
(Source: Fabozzi, Modigliani and Ferri, Foundations of Financial Markets and Institutions)
The function of financial markets is to perform economic functions of channelling funds from those who have saved surplus funds, to those who have a shortage of funds.
Figure1: Flows of funds through the financial system
Indirect finance
Key:
= Funds
Direct finance
(Source: Financial Markets, institutions, and money, Mishkin)
Those who have saved are at the left and those who must borrow funds to finance their spending are at the right. In direct finance borrowers borrow funds directly from lenders in financial markets by selling them securities, which are claims on the borrower’s future income or assets. Financial markets intermediate between borrowers and lenders to facilitate the process.
(Source: Financial Markets, institutions, and money, Mishkin)
Investment objectives of lenders and borrowers are different: Firstly often borrowers want large amounts but lenders wish to invest small sums to spread risk. ... (Source: Boakes, Kevin, International Financial markets lecture slides)
Financial markets serve many functions in any economy. Some of these roles include
Mechanisms to sell financial assets: Financial markets provide liquidity that motivates both buyers and sellers of financial assets to buy/sell respectively. The degree of liquidity differs in various markets, yet all markets provide some degree of liquidity.
Transparency of pricing and efficient price discovery: Financial markets allow efficient/effective interaction between buyers and sellers and thus enable an efficient pricing mechanism. ...
Lowering transaction costs: Financial markets lower search and information costs by providing both borrowers and lenders with mechanisms to search better and process information better (the role of brokers; market makers).
Approximate Word count = 1745
Approximate Pages = 7
(250 words per page double spaced)
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