Learning Objectives:

  • Understand the role and functions of financial markets in the economy 

  • Distinguish between primary and secondary markets and their respective participants 

  • Identify the key segments of financial markets: money markets, capital markets, and derivatives markets 

1.1 The Role of Financial Markets

Financial markets are the platforms where financial assets are created, priced, and traded. As the University of York module states, students should be able to “explain and critically discuss the role of financial markets and financial intermediaries in the global economy” . The University of Warsaw’s Financial Market course similarly emphasises “determining the place of the financial market in the economy” as a fundamental learning outcome .

Core Functions of Financial Markets:

  • Capital Allocation: Financial markets channel funds from savers to borrowers, enabling investment and economic growth. This is the fundamental economic function of financial intermediation .

  • Price Discovery: Markets determine the prices of financial assets through the interaction of supply and demand. This price information guides resource allocation decisions throughout the economy .

  • Liquidity Provision: Markets enable investors to buy and sell assets quickly and efficiently, reducing the cost of trading and allowing investors to adjust their portfolios .

  • Risk Management: Markets provide instruments (derivatives, insurance products) that allow investors to hedge and diversify risk .

1.2 Primary vs. Secondary Markets

Primary Markets: These are markets where new securities are issued and sold for the first time . The University of Warsaw syllabus covers “Primary market. Features and participants” as a core topic, including “The company’s path to the stock exchange (documentation and admission conditions)” and “Issuance of shares, distribution channels of new issues” .

  • Initial Public Offerings (IPOs): The first sale of a company’s shares to the public.

  • Follow-on Offerings: Additional issuances of securities by an already-public company.

  • Private Placements: The sale of securities to a select group of institutional investors without a public offering.

  • Role of Investment Banks: Investment banks underwrite new issues, providing advisory services, due diligence, and distribution capabilities .

Secondary Markets: These are markets where existing securities are traded between investors . The issuer does not receive proceeds from secondary market transactions.

  • Exchanges: Organised markets where securities are traded (e.g., NYSE, NASDAQ, LSE). The University of Warsaw syllabus covers “Stock exchange” as a core topic, including “Trading systems,” “Exchange orders,” and “Stock exchange session” .

  • Over-the-Counter (OTC) Markets: Decentralised markets where trades are negotiated directly between parties.

  • Electronic Trading Platforms: Modern market structures increasingly rely on electronic trading systems.

1.3 Market Participants

Financial markets are composed of various participants :

  • Issuers: Companies, governments, and other entities that raise capital by issuing securities.

  • Investors: Institutional investors (pension funds, insurance companies, mutual funds), retail investors, and other market participants seeking returns.

  • Intermediaries: Investment banks, brokers, dealers, and exchanges that facilitate transactions .

  • Regulators: Government bodies that oversee market integrity and investor protection.

  • Market Makers: Dealers who provide liquidity by standing ready to buy and sell securities.

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