FINANCIAL MARKETS

To answer the questions of what, how and for whom toproduce we look at three major financial markets: the stock market, the bond market and the futures market (where everything from frozen pork bellies to U.S. Treasury bonds are traded).

Stock markets are one of the institutions that serve as financial intermediaries. Stock markets help channel savings into investment. Although most people immediately think of Wall Street when they hear “stock exchanges” the stock market is highly dispersed. There are 17 different stock exchanges in the United States and over a hundred additional exchanges in other countries.

What people buy and sell on the stock exchanges are ownership shares of corporations. A corporation tends to be the largest type of enterprise, with average asset values measured in millions of dollars.

The ownership of corporation is defined in terms of stock shares. Each share of corporate stock represents partial ownership of the business. People holding shares of corporations hope to realize a financial gain from these assets. As part owners, shareholders are entitled to any profits the corporation makes.

Shareholders do not necessarily receive their share of the company's profit in cash. The corporation may choose to retain earnings or pay them out to shareholders as dividends. There are two motivations for buying and holding stocks — the expectation of dividends and anticipated capital gains.

Stock prices depend upon demand and supply in financial markets. If demand for the stock increases the stock's price will tend to rise. Similarly, an increasing reluctance of owners to sell would push the stock's price higher.

The bond market operates much like the stock market. The major difference is in the kind of paper traded. In the stock market people buy and sell shares of corporate ownership. In the bond market people buy and sell promissory notes («IOUs» — I owe you). A bond is a written promise to repay a loan. The borrower may be a corporation ("corporate bonds"), local governments ("municipal bonds”), the federal government ("treasury bonds”) and other institutions.

A bond is issued when an institution wants to borrow money. The company had great ideas but not enough resources to start production. Previously, the problem was solved by issuing stock. A second alternative for raising necessary funds is to borrow money. The advantage of borrowing funds is that we can keep control of the company. Lenders are not owners. On the other hand, if we borrow, we have to pay the lenders back, with interest.

Thus the bond market also functions as a financial intermediary transferring available savings (wealth) to those who want to acquire more resources (invest). The critical issue here is the “price” of the bond. At low rates of interest no one is willing to lend funds to the company. The increased willingness to lend funds is reflected in an increased demand for bonds. This increased demand will push up the price of the bond. As bond prices rise their implied effective interest rate (yield) falls.

In futures markets people buy and sell things that are to be “delivered” in the future at prices agreed on today. Futures markets make life easier for the farmer and consumer.

To summarize: The central purpose of financial markets is to help channel the savings of consumers and businesses into productive investments.

Vocabulary:

stock market – ринок капіталу, фондова біржа

bond market – ринок облігацій, ринок довго-строкового капіталу

bond – облігація, боргове зобов’язання

futures market – ф’ючерсний ринок

financial intermediary – фінансовий посередник

exchange – обмін; біржа; іноземна валюта

corporation –корпорація, акціонерне товариство

corporate stock – акціонерний капітал

shareholder – акціонер

dividend – дивіденд

capital gain – прибуток від приросту капіталу

yield – прибуток з цінних паперів

Questions:

1. What is the purpose of financial markets?
2. What is a financial intermediary?
3. What does each share of corporate stock represent?
4. What do people buy and sell on the stock exchanges?
5. What is the largest type of enterprise?
6. What does the stock price depend on?
7. When is a bond issued?
8. What is the futures market?

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