Financial Markets & Institutions
Financial markets are an important contributor to the economy and provide an environment for investors to make decisions and act on investment opportunities. Various financial institutions are a part of financial markets and offer not only opportunity for buyers and sellers but play a role as major employers of finance professionals. Success in investing requires having an understanding of the financial markets and the products that are available for investing. These products can include stocks, bonds, mutual funds and international securities. Investors must weigh the risk and reward of these products and compare them to investing in other items or choosing to do nothing. Participation in financial markets and working with financial institutions requires understanding how they work and the process of investing. While this knowledge doesn't guarantee success, it can prevent investors from making avoidable mistakes.
Keywords Bond; Equity; Financial Industry; Financial Institutions; Financial Market; Mutual Funds; Security; Stock
Finance: Financial Markets
Successful investors become educated about the environment in which they operate. Part of that success is in understanding financial markets and institutions, to understand what investments are available, and to understand how and where to invest and the basic rules of investing. According to the Bureau of Labor Statistics (www.bls.gov) the financial services industry includes banking, insurance and securities and commodities trading. The industry also includes the real estate and rental and leasing sector. The finance and insurance institutions engage in financial transactions that create financial instruments, dispose of them or change ownership. The Bureau of Labor Statistics has identified three activities related to financial transactions including:
- "Raising funds by taking deposits and/or issuing securities and, in the process, incurring liabilities.
- Pooling of risk by underwriting insurance and annuities.
- Providing specialized services, facilitating or supporting financial intermediation, insurance, and employee benefit programs."
Real estate, rental and leasing transactions have to do with the "use, sale or rental" of "tangible or intangible assets." Simply put, financial markets are a place where the buying and selling of financial instruments is facilitated and where access to market demand is provided.
Knowledge Necessary for Savvy Investing
Groz (1999) suggested ten categories of knowledge one needs to become a "savvy" investor. These categories are:
- The Products
- The Players
- The Procedures
- The Rules
- The Regulators
- Risk And Performance
This list is an overwhelming one and it could take an investor a lifetime to master many of these subjects. Groz's last point, jargon, is an important concept. Every industry has its own language and shorthand. The financial industry is no different, other than its jargon can be very complex and difficult to understand. Some financial terms come from very old concepts and have survived over time and may not have a meaning similar to a current situation or item. The complexity of the language of finance frightens many would-be investors and may cause novice investors to rely heavily on advisors to assist in understanding and navigating the financial system.
Financial Stock Markets
There are two major financial markets for stocks in the United States. The New York Stock Exchange and the Nasdaq Stock Market are the places where public companies list their stock. The oldest is the New York Stock Exchange which began in 1792 (Kansas, 2005). At this point in history, brokers who served as mediators between buyers and sellers, offered to trade securities and stock for a commission. The New York Stock Exchange started with only five securities but now lists stocks that value over $20 trillion (Kansas, 2005). There are many famous companies, old and new, that have stock listed on the New York Stock Exchange. Large corporations like Exxon Mobil, General Electric and IBM are listed and have long, established histories as companies. Others like Verizon Communications are more recent entries that resulted from mergers in their industries. The NASDAQ has been home to companies that are in technology or newer companies. While the New York Stock Exchange (NYSE) relies on specialists who trade stocks, the NASDAQ uses market traders who specialize in a grouping of similar stocks (Kansas, 2005). An individual investor deals with a broker to invest in stocks on the NYSE who interact with floor brokers and post specialists or "referees" (Kansas, 2005).
There are international markets for stocks and bonds and there are exchanges that govern those financial markets. Some large international exchanges include the London Stock Exchange, the Deutsche Borse Exchange in Franfurt, the Tokyo Stock Exchange and the Hong Kong Stock Exchange (Kansas, 2005). Globalization is increasing the connection of economies that were previously separated. As a result, the financial markets in one part of the world can have a powerful effect on markets in another part of the world.
Electronic Communications Networks
A new trend in financial markets trading stocks are ECNs or electronic communications networks which allow large buyers and sellers a convenient way to find each other (Kansas, 2005). Investors like to know the general direction of financial markets. Certain types of information can provide an average of how major stocks in major industries are faring. One such index is the Dow Jones Industrial Average. The Dow Jones Industrial Average (DJIA) gives investors an idea of how things are going in a market and can be used in concert with other information. Other indexes include the Standard & Poor's 500 stock index of blue chip companies (Kansas, 2005).
Investors realize that things change with financial instruments and are always looking for growth stocks. These are stocks that tend to perform well or grow, even when the economy is not very good (Kansas, 2005). Two symbols of the rising and falling fortunes of financial markets are the bear and the bull. The bull symbolizes a time when the market is going higher while the bear signifies a "downward trend" in stocks (Kansas, 2005). The common anecdotal reason for these symbols is that bulls move their horns in an upward motion when going for the kill and bearskin traders would sell the skins before they were caught hoping that they would be able to deliver them later. When the DJIA declines 20% or more it is considered to be a bear market. Similarly, if the market were to increase 20% or more it would be considered a bull market.
Kansas (2005) notes several characteristics of bull and bear markets. A bull market is characterized by rising stock prices, an increase in earnings, low inflation and interest rates. Meanwhile, a bear market is characterized by falling stock prices and earning, rising inflation and high or rising interest rates. Rapid changes in the financial markets make the action dynamic and exciting for those involved. However, at the same time, financial markets can be difficult to follow and even scary. In one moment, an investor can make a fortune and lose it in the next moment. Many say that is why there are brokers and traders. These professionals may enjoy gambling with someone else's money but can't take a chance on their own.
How Financial Markets Work
Groz (1999) defines the basic products in financial markets to be stocks, mutual funds, bonds, options, and futures. These products are typically managed and affected by a number of players including the investor as well as brokers, money managers, financial planners and information providers. All players can be adversely impacted on returns except information providers who are likely to disclaim or explain away any results that aren't entirely favorable. Some players assume multiple roles. Investors have to look carefully for conflicts of interest when taking the advice of an entity that plays multiple roles. In fact, there is a sales opportunity for entities that play multiple roles. Most financial services products require gathering personal information from the consumer and that information may be shared amongst all of the entities that a company owns regardless of what they sell. Investors should read privacy statements from companies and act decisively to ensure that information is not shared without their consent and to minimize additional sales prospecting that is unwanted.
Part of being a smart investor is to be an educated investor. Groz (1999) feels that it is difficult for the average investor to get good information about financial markets and investing. However, Groz recommended what he called "financial information...
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