Role and Functions of Capital Market in Business

Capital Market

The Capital Market plays a very vital role in the country. Following are the three important functions of the capital market or exchange that must be in your mind before analyzing any capital market.

1. Economic Function
2. Continuous Price Function
3. Fair Pricing Function

Functions 

Economic Function

From the most important functions of the capital market are the economic functions. In this function, money is effectively transferred from savers to borrowers.

Example

In the secondary market for home mortgages in the USA. There are many middle class residents that have modest levels of savings. The houses are very expensive and almost everyone needs to borrow money to purchase a house. The residents of the town normally have bank relationships. Since because of the offerings of savings account and convenience checking. People also consider banks for the purpose of home mortgages. For example a person contacts a local bank and obtains a loan of $100,000. There are three further families who do the same proceedings. In a short period of time, the entire savings of the town one further can buy a house in the town. In other regions of the USA there may be certain investors who want to lend money instead of borrowing it. The main point is to match up the available savers with the would-be borrowers.

So, the mortgage certificates held by the local banks are sold to someone else on a routine basis. There are government agencies like Government National Mortgage Association and Federal National Mortgage Association assist in the continuity of these sales effectively. When a mortgage is sold by a local bank, an inflow of money is received by the bank. Specifically that is employed to finance the home mortgage of someone else. In this manner these mortgages are sold and the cycle continues. This is the example of the economic function of the capital market. Though in which the flow of capital is made between borrowers and lenders of money.

Continuous Price Function

Continuous price function is also one of the important functions of the capital market. This function indicates that the prices in the market are moment by moment which offers potential benefit to the security investors. The market participants get up-to-date and accurate price information with the continuous price function of the capital market.  

Example

In case of alternative investments like what is the worth of antique grandfather clock. Moreover, worth of 50 acres of southern pine timberland or value of Chinese porcelain. It is not easy and quick to find the price of these items. In the first step the appraiser evaluates the condition and authenticity of these items. Then the current sales of comparable items are analyzed. Hence, this analysis contains researching auction reports, catalogs or making a number of calls on telephone. Much time and effort is consumed in conducting these activities.

The financial assets like stocks and bonds do not bear such problems. Mostly any individual can assess the price of different financial assets during the business day instantly. By making calls to brokers one can get information about the prevailing price of a particular stock. Moreover, through reading wall street journals etc.   

Fair Pricing Function

Fair pricing is also from one of the utmost important functions of the capital market. Many people think that this function is the most important one which corresponds to the trust on the system. An investor can tell his broker to sell his stock of a particular company at the going price. However, he is confident about getting the fair price. The fear of buying and selling at rip off price is removed by the fair pricing function. As the number of participants increases in a more formal marketplace. So the likelihood of getting fair price is resultantly enhanced. For example if someone searches the classified advertisement of automobiles in the newspaper. Then pays automatically the demanded price of the interested car. In such a case that person pays more than the standard rate or price of the car.

The high number of players in the game is the main reason for the fair pricing of the capital market. There are a number of people who compete for the same business. If a particular investor has stock to sell. Then there are thousands of people who are ready to buy it with their bid prices. It is ensured through the market that the investor sells the stock at highest bidding price. On the other hand a buyer faces a number of potential sellers of the stock of a particular company. Actually, that depends on the system to match the best price with his order. That price is the lowest price from the perspective of the buyer.

More From Business Study Notes:- Capital Market 

Example

A person possesses an old coin which is value able. One method of selling that coin is by going to the regional coin show. Then showing it to different dealers’ tables to get individual offers for it. The alternative method is to sell it in the coin auction. Therefore, the higher price is obtained in the second method of auction. This highlights that when a number of dealers consider the certain coin. Simultaneously, the market becomes more efficient as compared to the dealer looking at the coin individually.

There is an academic joke which is related to a business professor who is asked about his consulting on a daily basis. He replied that his fee is $2,500 per day. Then he is further asked about how much consulting he performed. He replied that he did not perform single consulting but $2,500 is his rate. This joke clears the point that when a person sets a particular price for his service (product). So there are also competitive service providers in the market. Then the buyer is not willing to deal with that service provider who has the highest price.