Which of the following statements about financial markets is correct?

Answer & explanation

Correct answer: option 2

The correct answer is Option (2) → Financial markets provide liquidity to financial assets by facilitating their easy purchase and sale.

Option (1) Financial markets provide liquidity to financial assets by facilitating their creation through an initial issue. — False. An initial issue creates a financial asset. Liquidity is about selling an asset that already exists.

Option (2) Financial markets provide liquidity to financial assets by facilitating their easy purchase and sale. — True. Liquidity means an asset can be easily converted into cash. The market makes buying and selling easy, so holders can sell whenever they need cash.

Option (3) Financial markets provide liquidity to financial assets by keeping them in electronic form. — False. Holding securities in electronic form is dematerialisation. It makes holding and transfer convenient, but it is not how the market gives liquidity.

Option (4) Financial markets provide liquidity to financial assets by establishing their price through demand and supply. — False. Setting the price through demand and supply is price discovery, a separate function.

NCERT (Pre-rationalised Edition): “2. Facilitating Price Discovery: You all know that the forces of demand and supply help to establish a price for a commodity or service in the market. In the financial market, the households are suppliers of funds and business firms represent the demand. The interaction between them helps to establish a price for the financial asset which is being traded in that particular market.”

“3. Providing Liquidity to Financial Assets: Financial markets facilitate easy purchase and sale of financial assets. In doing so they provide liquidity to financial assets, so that they can be easily converted into cash whenever required. Holders of assets can readily sell their financial assets through the mechanism of the financial market.”