4.4.1 Role of financial markets

• The Dodd-Frank Act was introduced to strengthen financial stability post-2008.
• What is the primary function of financial markets?

  Trade financial instruments
• Financial markets serve as a platform where buyers and sellers trade various financial instruments
• Financial markets connect savers to borrowers, facilitating investment in productive projects.
• How do financial markets facilitate international trade?

  Through foreign exchange markets
• Financial markets provide real-time price discovery for assets, enhancing market transparency
• Stock markets are where shares of publicly traded companies are bought and sold.
• What instruments are traded in bond markets?

  Debt securities
• Money markets trade short-term debt instruments
• Match the financial market with its primary instrument:

  Foreign Exchange Markets ↔️ Currencies

  Derivatives Markets ↔️ Futures

  Commodities Markets ↔️ Oil
• Financial markets direct funds to their most productive uses through capital allocation and risk sharing.
• What is the role of financial markets in savings mobilization?

  Collect savings from households and firms
• Investment funding in financial markets provides capital for businesses to expand and innovate
• Financial markets allow investors to diversify their portfolios and spread risk across different assets.
• How does diversification reduce portfolio volatility?

  Spreads risk across assets
• Financial markets enhance economic growth and stability through efficient capital allocation and risk sharing.
• Financial markets channel savings into investment, ensuring capital flows to projects with the highest potential returns
• Investment funding in financial markets stimulates productivity and economic development.
• What is the primary benefit of risk transfer in financial markets?

  Reduces business vulnerability
• Financial markets promote financial stability, which leads to economic resilience
• What two forces determine asset prices in financial markets during price discovery?

  Supply and demand
• In price discovery, supply refers to the amount of assets available for sale
• In price discovery, the equilibrium price is where supply equals demand.
• What is the definition of demand in financial markets?

  Willingness to buy assets
• The equilibrium price in financial markets is where supply equals demand.
• What is the role of financial markets in price discovery?

  Determining asset prices
• Financial markets enhance market transparency and efficiency
• Financial markets facilitate risk management through diversification and transfer of risk.
• What is diversification in risk management?

  Spreading investments across assets
• Hedging protects against adverse price movements by taking offsetting positions
• Insurance premiums are calculated based on the probability of loss and the loss amount.
• Match the financial instrument with its purpose in risk management:

  Derivatives ↔️ Hedging

  Insurance policies ↔️ Protection against losses
• What are the key functions of financial markets?

  Channel savings into investment
• Price discovery in financial markets is driven by the interaction of supply and demand
• What is the purpose of a stock market?

  Trade shares of companies
• Match the financial market with its primary instrument:

  Bond Markets ↔️ Bonds

  Money Markets ↔️ Treasury bills
• Foreign exchange markets enable cross-border transactions through currency trading.
• What is the primary purpose of a derivative market?

  Trade contracts based on assets
• Real estate markets involve the trading of properties such as residential, commercial, and industrial land.
• Financial markets enhance resource allocation by directing funds to productive uses.