Final answer:
Financial markets require high liquidity for operational efficiency, with the primary market offering less liquid assets compared to the more liquid secondary market. Operational efficiency is characterized by the ease of converting assets to cash without significant loss in value.
Step-by-step explanation:
The financial system is considered to be operationally efficient when the markets provide a high degree of liquidity. However, it seems there is a misconception in the statement that suggests financial markets are operationally efficient when they are illiquid, which is not the case. Generally, liquid markets are desired more than illiquid markets for operational efficiency. In the context of the financial markets, liquidity means the ease with which an asset can be converted into cash without significantly affecting its value. The primary market and secondary market both play crucial roles in the financial system.
In a primary market, assets such as government bonds or Individual Retirement Accounts (IRAs) are initially issued. Assets in this market are typically less liquid because they are non-transferable or can only be redeemed by the original issuer. In contrast, the secondary market provides an avenue for the existing securities to be traded among investors, thus offering much higher liquidity. Examples of assets in the secondary market include stocks and bonds that are traded on stock exchanges. The liquidity of these markets is what generally facilitates the ease of buying and selling without a significant penalty for liquidation.
Furthermore, financial markets could be described in terms of money markets or capital markets, depending on the length of the maturity of the assets traded. Money markets deal with short-term debt instruments, whereas capital markets are for long-term securities. The liquidity in these markets, especially the secondary market, is very important because it allows for assets to be sold quickly and efficiently which is a key aspect of an operationally efficient financial system.
Agents operating in financial markets include households and firms, with households typically being suppliers of capital and firms being demanders of capital. Changes in the market, such as a rise in the supply of loans, can lead to an increase in the quantity of loans made and received, directly affecting the financial market's dynamics.