The essay will focus on the potential role of the financial institutions and financial markets in the economy. Further, possible differences between primary and secondary markets will also be analyzed, and lastly, the essay will focus on the analysis of differences between money and capital markets.
The Role of the Financial Institutions and Financial Markets in the Economy
Financial institutions and financial markets play a critical role in the economy. In most instances, within the financial system, funds tend to flow specifically from those sources that are believed to have surplus funds towards those with shortages in funds. In a more general view, financial institutions and financial markets can be considered as the stomach of the economy, from where the other economic organizations derive their tone. Well established and highly developed financial markets and institutions contribute increasingly towards a healthy economy and additionally, contribute towards the efficiency of economy operations (Mishkin, 2007). It is worth noting that there exists a strong relationship between a well-established financial market and economic growth. Therefore, financial institutions play a vital role towards economic growth. Further, it is important to note that an effective financial system will help enhance the efficiency of economic, financial decision-making and that this leads to better resource allocation, which in turn leads to economic growth. The financial system and market further play the role of reallocating capital within the economy, and as a result of this, they offer the basis for enhanced economic restructuring in order for economic growth to be attained.
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The financial markets further help to direct the flows in terms of savings and investments in a manner that’s economically effective, and as a result of this; they facilitate capital accumulation, thus, enhance productivity. According to Mishkin (2007), the lack of well-developed financial and stock market is considered a disadvantage for any economy. Therefore, financial markets are essential because they help to enhance and maintain economic competitiveness, giving the economy increased global competitiveness, access to technological advancement and increased innovation and invention, seeing as these are critical for economic growth. In addition to this, an efficient financial market and institutions also play a critical role in relation to lowering the economic costs of transactions in that together; they offer an array of financial services and products to the economy while at the same time directing effective credit allocation within the economy.
Difference between Primary and Secondary Markets
Both primary and secondary markets tend to describe two distinct markets where potential investors and companies trade in securities. There exist two major capital markets in which potential investors can trade in securities. There is a clear difference between primary and secondary markets, and this has been established by economists. First, with respect to the primary market, all of the potential investors within the market, often purchase securities directly from various existing firms which issue them while on the other hand, within the secondary market, the potential investors in most instances exchange and trade securities more closely among themselves implying that exchange security firms rarely participate within these trading (Kakarot-Handtke, 2011).
In situations where a firm sells their stocks or bonds in the market for the first time, then this will take place within the primary market while in the secondary market, the securities are often exchanged after a firm has sold its stocks and bonds, all of which were initially offered within the primary market. In most occasions, it has been established that small investors within the secondary market tend to have a higher chance in regard to trading in securities, seeing as they are often not excluded from IPOs courtesy of the little cash interests that they represent. Further, focusing on the secondary market, there is the need for a potential investor to have a broker in order for this broker to effectively and efficiency buy securities on their behalf, mainly because security prices tend to fluctuate rapidly hence posting a great financial risk.
The primary market tends to deal with new securities that have been added to the market so as to be exchanged, and the type of purchasing is direct, whereas, secondary market exchanges of securities that were formerly issued to the potential investors and companies alongside the associated type of buying, is often indirect. Within the primary market, an investor may possibly sell any number of securities only once while in the secondary market; security may be sold multiple times. The trading of securities in the primary market takes place between a company and investors, and the price is fixed while on the other hand, in the secondary market this takes place between investors and prices fluctuate significantly based on demand and supply (Kakarot-Handtke, 2011).
Difference between Money and capital Markets
A financial market often brings buyers and sellers together to conduct transactions in financial assets including bonds and stocks. Two major components of the financial markets are money and capital markets. There exists a clear difference between the two types of markets. First, the money market is often utilized on a short time basis, especially on assets, and this takes a period of one year while on the other hand, the capital market is often utilized for long term assets and entails any assets that only attain maturity in more than a year (Mishkin, 2007). The capital market is believed to be the market where bonds and stocks are often closely followed. Within this market, investors trade on bonds and stocks. However, this is a highly risky market, and for this reason, investors avoid it when dealing with shorter-term funds. The capital market is normally accessed with the intention to save for education or even, for retirement.
On the contrary, the money market is generally accessed alongside the general capital market. In the money markets, investors have the opportunity to park their funds, most especially those funds that are required in the short-term, for instance, for periods of less than a year. Within the capital market, the most commonly used financial instruments include stocks and bonds, and this is different from the money markets, where the most commonly used instruments include the bill of exchange, and collateral loans in addition to deposits (Mishkin, 2007). Additionally, in the money market, the returns are in most instances very low, but at the same time, very steady while in the capital market, the returns offered are very high. Further, focusing on the money market, the nature of this market is informal, and the returns on investment are low while in the capital market, the nature of the market is formal and the investment return is high.
Conclusion
In conclusion, the essay has critically analyzed three areas. It has been established that the financial institutions and financial markets play a critical role in the economy and these often result in increased economic growth. Further, it has been shown that there exist clear differences between primary and secondary markets and between money and capital markets
References
Kakarot-Handtke, E. (2011). Primary and secondary markets. Available at SSRN 1917012 .
Mishkin, F. S. (2007). The economics of money, banking, and financial markets . Pearson education.
