FINANCIAL SYSTEM
AND
FINANCIAL MARKET
FINANCIAL SYSTEM
Definition:
The financial system refers to the set of
institutions, markets, instruments, and
regulations that enable the flow of funds
between savers and borrowers. It is the
backbone of any economy, ensuring that capital
is allocated efficiently.
KEY COMPONENTS:
Financial Institutions:
Banks, insurance companies, mutual funds, pension funds, and investment
firms.
They act as intermediaries between savers and borrowers.
Financial Markets:
Platforms where financial instruments are traded. (example: stocks and bonds)
Financial Instruments:
Contracts like stocks, bonds, derivatives and loans that represent claims on assets or
income
a) Stocks – representing ownership in a company and provide shareholders
with voting rights and potential dividends
b) Bonds – debt securities issued by the governments or corporations
paying periodic interest and returning the principal amount at maturity.
c) Derivatives – they derive their value from an underlying asset. They are
sued for hedging and speculations.
Regulatory bodies:
Authorities like central banks (e.g., Federal Reserve, RBI) and
securities regulators ensure stability and fairness of financial
markets and institutions. They aim to protect consumers and
maintain confidence in the financial system.
Payment Systems:
A system that includes payment system that enable the smooth
and efficient exchange of money and goods. This includes
transactions, such as electronic fund transfers and clearinghouses.
FUNCTIONS OF FINANCIAL
SYSTEM:
Mobilizing savings for investment.
Facilitating liquidity in the economy.
Providing mechanisms for risk management.
Enabling efficient allocation of resources.
Supporting economic growth and stability.
FINANCIAL MARKET
Definition:
A financial market is a marketplace where
individuals, businesses, and governments can buy,
sell, and trade financial instruments, such as stocks,
bonds, currencies, and derivatives. Financial markets
provide a venue for investors to trade assets and help
companies and governments raise funds for expansion
and development.
TYPES OF FINANCIAL
MARKETS:
Capital Markets:
Long term funding markets for equities (stocks) and debts
(bonds).
Divided into:
1. Primary Market: Where new securities are issued for the first
time. (ex. Initial Public Offerings)
2. Secondary Market: Where existing securities are traded. (ex.
Stock exchanges)
Money Markets:
Money markets are where short-term borrowing and lending
occur, typically with instruments that mature in one year or less.
Foreign Exchange (Forex) Market:
The foreign exchange market, also known as the Forex or FX
market, is the market for buying and selling currencies. It is the
largest and most liquid financial market in the world, where
participants trade currency pairs, such as USD/EUR, GBP/USD, or
JPY/USD.
Derivative Markets:
Derivative markets deal with financial instruments whose value is
derived from the price of an underlying asset, such as stocks,
bonds, commodities, or interest rates. Derivatives are primarily
used for hedging and speculation.
Commodities Markets:
Commodities markets involve the buying and selling of raw
materials or primary agricultural products. These markets provide
an avenue for price discovery, speculation, and risk management
related to the physical goods being traded.
KEY DIFFERENCES BETWEEN FINANCIAL
MARKETS AND FINANCIAL SYSTEM
Aspect Financial System Financial Market
Definition A broader network of institutions, A marketplace for buying and
markets, and regulations selling financial assets.
facilitating the flow of funds in
the economy.
Purpose To connect savers and borrowers, To allocate capital, provide
maintain financial stability, and liquidity, and manage risk.
support economic growth.
Scope Encompasses financial markets, Focuses on specific transactions
institutions, instruments, and involving financial instruments
regulators. like stocks, bonds, currencies,
etc.
Key Components Financial markets, including Financial institutions (banks,
stock, bond, and Forex markets. insurance companies, pension
funds), financial markets, and
regulatory bodies.
Example The entire financial The Philippines Stock
ecosystem, including the PSE, Exchange (PSE) where stocks
banks, insurance companies, and are traded.
regulatory authorities.
IN CONCLUSION:
Both financial markets and the financial system are vital
for the economy to work smoothly. Financial markets are
places where people buy and sell things like stocks,
bonds, and currencies, and they help manage financial
risks. On the other hand, the financial system is a bigger
structure that includes these markets, the banks and
other institutions that support them, and the rules that
keep everything running fairly and safely. Together, they
help the economy grow, encourage investment, and
make sure financial risks are managed properly.
