The purpose of financial markets

Financial markets help to finance the economy

Financial markets allow companies and individuals to finance themselves by raising capital, either by issuing bonds (debt securities) or shares (titles of property). This allows them to finance business growth and their projects, by having access to long-term finance, rather than short term finance such as bank loans. For investors (whether individual savers, institutions, banks, etc.), financial markets offer the opportunity to invest capital in exchange for a return called a “dividend”, and the prospect of added value if their assets appreciate. In summary, financial markets put companies that need money in contact with players who have funds to invest.

NB: Financial markets are thus a real means of financing the economy. There are two types of markets: the primary market, which is the part that deals with issuing and listing shares. It is also referred to as using the term, initial public offering (IPO). This is where financial markets enable companies to finance themselves. Once these shares are in circulation, they can be negotiated on a daily basis on the “secondary” market. This is how several billion-dollar worths of exchanges take place daily on the financial markets, some investors sell shares and others buy them.

Financial markets help to finance States

States tax investors on the revenues obtained from their investments in financial markets, either through a tax on financial transactions (FTTs) or tax on dividends and capital gains. Although some investments offer tax benefits, investors using simple securities accounts are taxed at a relatively high level on their profits, namely at their income tax rate.

Financial markets help to provide liquidity

Financial markets are places where supply meets demand, and therefore they offer a significant level of liquidity. They are the reference markets for international investors to invest their capital: each day buyers and sellers throughout the world carry out their transactions. It is this high level of liquidity which benefits both companies and States, because it is an indispensable means of funding, offering extensive output.

Financial markets, a protective instrument

Financial markets allow all investors in the market to protect themselves against a multitude of risks (currency risk, interest rate risk, risk of price reductions, etc.), in particular through derivatives. For example, businesses use currency SWAPs to protect themselves against exchange risks, or interest rate SWAPs to protect themselves against the interest rate risk. Other derivatives such as futures, options or forward contracts are used as part of risk management, whether it is banks managing their exposure or companies protecting themselves against the price variations in the raw materials they need for their business (oil for an airline for example).

Financial markets, a communication tool

Multinationals now use financial markets as a communication tool, especially through advertising effects. Although the majority of market players use financial markets for the traditional function of raising funds, large global companies such as Google and Facebook use them to impress the competition. Indeed, Facebook’s initial public entry offering created a lot of talks, a story that certainly made even the most hesitant about new communication techniques aware of this company’s strength. The respective takeovers of Tumblr and Instagram by Yahoo and Facebook, for overvalued prices, was primarily a communication strategy to impress market players and spread their financial power.

Financial markets may also enable medium-sized companies to make themselves known internationally through IPOs. In addition, a publicly-traded company is subject to a number of tax obligations, regulations, etc. which reassure investors and customers by making the company more trustworthy.

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