Financial Markets and Capital Allocation

This assignment examines the role of financial markets in allocating capital resources effectively. It explores how financial markets channel funds to profitable investment projects, both domestically and internationally. The discussion includes key concepts like Tobin's Q ratio and the impact of factors such as interest rates and foreign direct investment on capital allocation. The limitations of relying solely on financial markets for efficient resource allocation are also addressed.

Running head: INTERNATIONAL TRADE, FINANCE AND INVESTMENT
International Trade, Finance and Investment
Name of the Student
Name of the University
Author Note

1INTERNATIONAL TRADE, FINANCE AND INVESTMENT
Table of Contents
Introduction......................................................................................................................................2
Financial markets and allocation of capital resources.....................................................................2
Limitation........................................................................................................................................3
References........................................................................................................................................4

2INTERNATIONAL TRADE, FINANCE AND INVESTMENT
Introduction
The term “market” in economics, means the place of interaction between the buyers and
the sellers of different goods and services. In this context, financial market refers to the forum
where the buyers and sellers exchange monetary assets which includes stocks, exchanges (both
domestic and foreign), bonds and other monetary assets. The market deals with risks and returns
in commercial activities and plays a huge role in allocation of capital resources, in both domestic
as well as international market, with the help of the different components and tools present at
their disposal, which will be discussed in the following assignment (Grinblatt and Titman 2016).
Financial markets and allocation of capital resources
A lot of the profitability of the businesses operating in a country as well as the economic
health of the country itself depends on how appropriately the capital resources present in the
economy is used. For the same proper allocation of these scarce resources are also required,
which is expected to be facilitated by the financial market.
The primary role played by the financial market in this aspect is the channeling of funds
to those investment projects, both in the domestic as well as international domains, which brings
back maximum returns for the investors in particular and economy as a whole. For this often-
economic tools like Tobin’s Q and others are used (Gopinath, Helpman and Rogoff 2014). The
Tobin’s Q is the ratio of the market value of the asset of a company and the replacement cost of
the same asset of the company. The higher is the value of this index the more lucrative is the
company for the investors to invest their money (Bond, Edmans and Goldstein 2012).

3INTERNATIONAL TRADE, FINANCE AND INVESTMENT
There are sectors in the financial market, which play important role in capital allocations.
This includes the stock market, the bond market, the derivatives and others. The above-discussed
method of operation falls under the stock market operations, which deals with the share trading
of the ownership of different enterprises. Through this mechanism, also the financial market
facilitates both domestic and international allocation of capital resourced efficiently as people
tend to buy shares of those companies, which seem to be profitable.
Another component of the financial system is the bond market. Bonds are a monetary
tool used to build up assets as well as regulate money supply in the economy. Bonds include
treasury, corporate, municipal and other bonds, which are bought by people to build up assets.
This operation of the financial market is regulated with the help of rate of interest, which is
decided by the monetary institution of the country, which in turn regulates the liquidity in the
economy. The Foreign Direct Investment coming from other countries to an economy and from
an economy to other countries also depend on the investment prospects in different sectors of the
economy. This is again determined by the operations in the financial market (Soumaré and
Tchana Tchana 2015).
Limitation
Financial market, do have significant roles in allocating the capital resources, as can be
seen from the above discussion. Therefore, for efficient allocation and utilization of resources a
robust framework in the financial market is required. There are however, many exogenous
factors, other than financial market, which also affect the allocation of the capital resources. This
includes the overall performance of the economy, the policy frameworks of the government and
other socio political aspects in the domestic as well as global economic scenario.

4INTERNATIONAL TRADE, FINANCE AND INVESTMENT
References
Bond, P., Edmans, A. and Goldstein, I., 2012. The real effects of financial markets. Annu. Rev.
Financ. Econ., 4(1), pp.339-360.
Gopinath, G., Helpman, E. and Rogoff, K. eds., 2014. Handbook of international
economics (Vol. 4). Elsevier.
Grinblatt, M. and Titman, S., 2016. Financial markets & corporate strategy.
Soumaré, I. and Tchana Tchana, F., 2015. Causality between FDI and financial market
development: evidence from emerging markets. The World Bank Economic Review, 29(suppl_1),
pp.S205-S216.