The Financial Markets
By elmads
Every government in the world has a duty to protect, fulfil justice, ensure stability and growth of the country, and its citizens that it serves. In order for the government to do it, they will need sufficient money and funding like anyone else. All the actions that needs to be taken to supply the necessities of the people and make sure that the economy is moving its feet are directly related to money.
Job employment, building infrastructures like roads, airports, and trade to other countries will not be possible without the money and liquidity for it. This is where the importance of the financial markets come into place, they provide liquidity and support for the allocation of resources within the economy and provide both company and government entities access to capital. Plus, it gives wealth to individuals, only if done right with discipline, proper mindset and strategy.
What are the benefits of the financial markets?
Financial market just like any other market is a place where people meet looking in to trade financial products and services such as stocks, bonds, and money market funds. Below are the benefits of financial markets:
1.) Gives funding and liquidity for the companies and governments to spur growth – Companies are made to improve lives of the people by innovating new technological products and services, but with this endeavour comes the need to raise money, which they can access through the financial markets.
- When companies are successful in making products or services that has demand and brings value to its consumers, this results to a increasing profitability in a year to year basis, when done consistently.
- With more money comes more opportunities for the company, as they have the option to continue to invest it back in their company for further growth and expansion.
- With growth and expansion comes the need for more employees (increase demand for employment, which will improve the lives of the people and at the same time will increase the activity in the economy.)
To give you context, in the Philippines, SM corporation (publicly listed company) owned by the late Henry Sy only had one shoe store in 1958 with just few employees. Fast forward today 2021, they now have 72, not stores anymore but malls nationwide with around 100,000 employees. SM corporation contributed significant growth in the Philippine economy throughout the years.
- Also, while the company is growing, they can invest some of their money to other companies outside their country or acquire another smaller company. This will give them significant capital returns (more money again) in the long run, which increases the companies wealth several folds. This is a simple narrative how a company and economy grows with the help of the financial market, as it supplies initial liquidity and can boost capital to businesses.
2.) Gives capital growth for investors – Individual investors like us, place our hard-earned money in the financial markets in the expectation to receive a good return from it in the future. The money that we gave either in government bonds, stocks of a company or other financial products will be used by these institutions to finance their growth. When these institutions grow so as our capital invested in them. This also applies for large institutional investors who have vast amount of capital that they invest into companies needing capital for growth. That’s how the financial markets are related to one another.
Types of Financial Markets
1.) Stock market – This is where the ownership of a company (known as a shares) is being sold to the primary markets first before going into stock exchanges to trade into the secondary markets. I have discussed this in details on my blog titled “How shares are made and how the stock market works” and “Stocks and Shares”. Companies will be able to raise money by making their company public and giving parts of its ownership to the public. In short, a share of a company equals a corresponding amount of money.
2.) Bond market – known as a debt instrument, in which investors give money to institutions as a loan, with the expectation to receive a fixed amount of income with a specific time and interval per year. The whole loan amount lent by investors will be returned by the institutions who owe the money. These bond contracts are also traded within investors through the bond markets. I have discussed this in details on my blog titled “Bonds Asset Class”. See infographics below as well.
3.) Money Market – This is a market that trades financial products that can be categorized to as cash due to the nature of very high liquidity. Money markets have very high degree of safety in terms of capital stability compared to bonds. Nevertheless, the returns on this market investments are measly in amount. The financial instruments used in money markets have short term maturities (less than 1 year maturity), which is the reason for the very low interest rate of return that it gives. The popular money market funds are certificate of deposits, government bills and government notes.
4.) Commodities Market – This is also called the futures markets as investors trade contract of commodities for the future amount with a specific future date. Common commodities that are traded in this space are oil, gold, corn and wheat. The fact that investors try to forecast the price in the future makes it a very high risk investment. Meaning the chances for us to lose our capital is very high, not unless we have a crystal ball to see what will happen in the future, which no one has.
Just like what George Soros quoted “The markets generally are unpredictable, so that one has to have different scenarios. The idea that you can actually predict what’s going to happen contradicts my way of looking at the market.”
George Soros
On the other hand, commodities market will always be a vital piece of our world. This is due to the fact that all of the thing things we utilize like for eating, drinking, living, and wearing are all by products of the collected raw materials, which gives value to all of us. This is the reason why it has been commoditized since time immemorial.
Commodities can be highly volatile in terms of prices as they are driven by factors such as macroeconomics, geopolitics, socioeconomics, and supply and demand. These are events that most people cannot accurately predict.
5.) Derivatives Market – This is almost the same with commodities markets because of predicting the future price outcome of a financial asset. In here, instead of commodities it will be financial assets, the popular asset used for derivative trading are stocks and index funds. In here investors and traders will borrow an asset and sell it at the current market price to gain cash, in the expectation that the asset price will either go up or down in a later date. Then the trader will buy the asset price as per his/her projected speculated price, only if it actually happened. The difference between the initial selling of the asset and the future repurchased price of the asset will be the money gains for the trader. The problem here is the high uncertainty because we speculate of what will happen in the price. I’ll just repeat what I just said in my commodities markets entry previously, the fact that investors are trying to predict what will happen in the future price is a very high risk investment. In the bright side, investors will get high returns in venturing in such risks. Below is an infographic example of one of the most famous derivatives strategy in the financial markets, the short-selling. Instead of me using a stock as an example, I used a real world item, in this case the Michael Jordan Vintage NBA Card.
6.) Forex Market – Forex is a short term for Foreign Exchange, traders trade currencies and speculate if the prices will go up or down. Currencies are very volatile in nature because politics plays a major role in it. In particular, when the UK announced in 2016, that they will be leaving the European Union, which is called BREXIT (British Exit). Because of this the pound compared to US dollars, significantly dropped in price and has never regained yet its pre BREXIT price levels. See the GBP to USD price chart below.
The chart below shows the various types of financial markets.
To sum it up
The purpose of the financial markets for us individual/retail investors is to give options to which market instrument will be applicable to our investment strategy and financial goals.
We do not need to have deep knowledge of each instruments, we only need to focus into the one or two that we understand.
The financial market is not a greedy market unlike what other’s perceive. It is only a vehicle to attain what is essential and important in our lives, based on each and our own goals and objectives.
What matters is we invest our money with the proper mindset, strategy and patience. Making our money work for us.
To give you more context, Money is a car (a tool to bring us from point A to point B) while the financial markets are the roads ahead of us. There are a lot of paths to take, a lot of probabilities that can happen, but knowing the route that is applicable to our needs makes all the difference for us.
Knowledge is my Sword and Patience is my Shield,
elmads
This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.
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