Below is an except of a presentation I made teaching non-finacial managers of an engineering entity about the basics of Financial Markets...
Financial Markets are the system through which companies, governments, and other entities are able to raise and exchange capital. Financial markets are important because they provide an efficient and cost-effective way to raise capital, which is essential for investments in production, innovation, and economic growth. Financial markets also provide the means for individuals and institutions to diversify their portfolios, manage their risk exposure, and create investment opportunities.
Furthermore, financial markets provide the necessary liquidity for investments, allowing for efficient and cost-effective transactions. In short, financial markets are important for the functioning of the global economy, as they enable companies, governments, and other entities to raise capital, manage risk, and create investment opportunities.
Simply put, financial markets are where people can buy, sell, loan, lend, save, insure or invest. Thus, they match buyers and sellers to set a price for financial assets, helping the price setting dynamics of market forces.
What are the financial instruments exchanged in the financial markets?
Financial markets are the primary venue for the exchange of financial instruments, such as stocks, bonds, derivatives, and commodities, to site but a few examples.
> Shares - You own a portion of a firm if you hold shares in it. Companies issue shares to raise funds for investment and growth.
> Bonds - Bonds can be issued by governments or major corporations to raise funds. These are basically future 'IOUs' that can be purchased and traded in financial markets. Government bonds, commonly referred to as "gilts," are a type of government debt.
> Currencies - Foreign exchange markets allow people to exchange a currency which is legal tender in one country for another legal tender in another (for mainly purposes of transacting in that other country, but also quite often for speculative purposes with hopes of off-loading at a higher profit).
These instruments are the assets that are traded in the financial markets to facilitate the flow of capital and manage risk exposure.
So to expand, stocks represent ownership in a company and can provide investors with a stream of dividend payments. Bonds are debt instruments issued by governments or corporations and provide investors with a regular stream of income. Derivatives are contracts that derive their value from underlying assets, such as stocks or commodities, and are used to hedge risk exposure. Commodities are physical assets, such as gold, oil, or agricultural products, that are exchanged in the market to provide investors with exposure to price movements in these assets. All of these instruments are traded in the financial markets to facilitate the flow of capital, manage risk exposure, and create investment opportunities.
What are the benefits of investing in financial markets?
Financial markets might provide you with the option to invest money in shares (also known as equities) to save for the future.
Over time, this can frequently yield a greater return than opening a savings account at your bank. However, purchasing stock might be dangerous. This link will open in a new window. It's crucial to remember that the value of any investment can go down as well as up, and that previous performance does not automatically imply future success.
People can also get insurance through financial markets. Insurance firms must use financial markets to ensure that you will be compensated if you have an accident, such as losing or damage your phone.
Lenders, such as banks, can provide money through financial markets. They give loans to those who wish to borrow, whether it's to go to college with a student loan or to purchase a house through a mortgage.
What is the Importance of Financial Markets?
Financial markets are an essential component of the global economy, providing the necessary capital to fund investments in production, innovation, and economic growth.
Additionally, financial markets provide individuals and institutions with the opportunity to diversify their portfolios, manage risk, and create investment opportunities. By investing in financial markets, investors can access a wide range of asset classes, allowing them to create a diversified portfolio that is tailored to their own risk profile and investment objectives.
Furthermore, financial markets provide investors with the ability to manage their risk exposure through the use of derivatives, such as options and futures contracts. Finally, financial markets provide investors with the ability to create investment opportunities by taking advantage of market inefficiencies and opportunities for arbitrage.
By providing these benefits, financial markets help to ensure the efficient functioning of the global economy and provide individuals and institutions with the necessary tools to build and protect their wealth.
What is the role of a Central/Reserve Bank, pertaining to financial markets?
As the Global Financial Crisis of 2007 showed, when markets go wrong, they may do significant damage.
Markets were quite volatile at the time. This vulnerability extends to the broader economy. Banks were less willing and able to make loans to individuals and businesses. This meant less economic activity and businesses had to cut employment to alight with reduced economic activity and also to conserve whatever little money they were making. This in turn means less demand for business goods and services and fewer and fewer people can afford them. A vicious cycle.
That is why it is critical that financial markets operate in a secure and confident manner.
Central Banks accomplish this in a variety of ways. They gather information about financial markets. It's critical that they talk to those who work in financial markets so that they understand, in real time, what's going on, what the dangers are, and how they can all work together to solve them.
Sometimes Central Banks have to intervene by making adjustments, like making banks hold more cash in reserve or adjusting their lending interest rates to encourage or discourage borrowing, whatever the desired effect is. This is called Open Market Operations, but we will leave it at that as this is beyond the scope of our discussion today.
Now lets discuss all I have presented, before I move to the next topic...