Finance is an industry focused on the buying and selling of financial assets.
The buying and selling of these assets take place through trading rooms or exchanges. A financial market is an exchange where people trade derivative and financial securities at very low transaction prices. Some of these securities include bonds and stocks, precious metals and other physical commodities, which are called commodities in the financial markets. The major components of finance include credit, capital goods, accounts receivable, unsecured liabilities, equity, retained earnings, retained capital and gross value.
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There are many factors that determine the movement of these marketplaces.
Some of these are: external financing, economic, banking system and governmental support. The following discussion highlights some of the main reasons for financial market failures: over-valuation of a firm level, market failure, venture capital, portfolio management failures, lack of investment in growth markets, etc.
There are also some unusual events that may lead to financial market failures.
Overvaluation of a firm level: During the financial crisis, when banks are experiencing difficulties in loan making, they look for buyers, who can absorb the losses. In this situation, they will often purchase undervalued firms, which will become difficult for banks to liquidate. In the long run, even large banks will have to sell some of their holdings. Therefore, over valuation of the firms may result in failure of market operations.
Venture capital: Venture capital represents the third largest sector of the financial markets. Venture capitalists usually provide capital to start-ups or to firms that demonstrate potential growth. In this scenario, the failure of a firm could lead to financial loss for its investors. Venture capital is not limited to private firms; any organization can invest and become a part of the venture capital market.
The three finance markets all have another thing in common.
They are highly leveraged: at the same time they are highly volatile. The volatility of finance markets stems from the fact that no one can accurately predict how prices for the underlying assets will evolve. Varying prices imply varying risks for the investors. Leverage makes the risk bearable for the investors and traders.
Leveraging makes possible the ability to trade using smaller quantities of money, at higher rates of speed.
This advantage enables small traders or companies to deal with large quantities of financial products and market failures easier than trading with large amounts of money. Traders use leverage to exploit price differences between instruments in financial markets. For instance, if there is an easy way to trade a security that is yielding a discount, then it is worthwhile to use that method instead of waiting for an established, reliable instrument to pay off.
Financial market failures also bring forth consequences for those who are directly involved.
When markets fail, there are usually people who suffer financial loss. Professional institutions are often the ones who bear the brunt of these failures. They are the ones who have the power to influence regulatory agencies to take action against market participants who fail to appropriately respond to market failures.
Financial markets play a vital role in our society.
They are used to allow ordinary people to become more economically self-sufficient. Without the markets, many would not be able to afford even the most basic necessities. By providing a platform for the financial industry, markets help in bypassing some of the restrictions placed on normal citizens so that they can participate in financial growth. While this is not the only reason why markets fail, it is one of the most influential factors.
However, the market does not appear to be able to overcome its inadequacies.
It has been experiencing a number of market failures in the recent years. These include the subprime mortgage crisis, the global credit crunch, and the Great Recession. All these events led to a series of market setbacks, including stock losses, investment decline, and the economic slowdown. All these events played a role in weakening the confidence of financial markets around the world. This has affected the global economy, creating instability in international trade and finance.
Even though this might seem to be the end of the line for the financial market, there are different ways through which it can survive such a crisis.
The first thing to do is acknowledge the fact that the market may not be able to recover in its entirety right away. The current setbacks should act as a wake-up call to the market watchers and investors so that they should find ways to keep the failing markets from becoming too much of a setback. In other words, investors should realize that they will have to continue making their money-making decisions in the financial markets despite the fact that everything might look bad now.
For investors who want to make more money in finance markets, it would be important to understand that the market will not crash because of one particular incident or problem.
This is because market crashes usually last only for a matter of months or even just weeks. What investors should watch out for is a longer period of market decline followed by a resurgence of the market in the following few months. If this happens, the market is said to be in the danger zone. The key to surviving a market fall or failure is to keep your cash in the market during its initial stages of decline, and once the stage is past, add more cash into the market so as to take advantage of its renewed upswing.