2.5. Characteristics of a Healthy Financial Marketplace
Finance and the financial markets play a critical role in the market economy by allocating capital to productive investment, creating a virtuous circle of wealth which drives economic growth. Beyond pooling savings into capital and allocating that as investment, a well-functioning and sophisticated financial marketplace also does the following:
- Provides liquidity, i.e. the ability to rapidly access cash: Many businesses have seasonal changes in their cash needs, for example, retail during major holidays, or agriculture during harvesting season. Liquidity also provides investors confidence that they can sell their financial asset for cash if needed or desired.
- Facilitates price discovery, i.e. the act of determining the proper price of a security, commodity, or good or service through the competitive market forces of supply and demand: This allows prices to efficiently signal the most productive use of financial resources.
- Allows for the sharing and management of risk via the diversification of investments as well as by matching the risk appetite of individual investors to the risk profile of different investments.