How to Benefit from Financial Market

Financial markets arose out of the need to bring borrowers and lenders of money together. This remains one of the main reasons that they are vital components of the world economy. There are two basic ways for individuals and institutions to lend and borrow money. One way is to use a bank as an intermediary. When you deposit money in a bank, you are, in reality, lending that money to someone else. The bank pays you interest for the privilege of using your money, and then it lends your money out to a borrower, who must pay interest at a higher rate.

When corporations and governments borrow money, however, often they need much more money than a single bank can provide. Financial markets provide a forum for raising large amounts of capital. When a government needs to pay for a war, for example, it may sell bonds. This allows the government to collect money from thousands of different lenders, including not just individuals but institutions such as banks and companies. A government or company sells bonds directly to investors on what is known as the primary bond market. There is also a secondary bond market, which allows investors to sell bonds among themselves. Trading on both the primary and the secondary markets occurs on what is known as the over-the-counter (OTC) market, a variety of organized networks where dealers sell to buyers using the telephone, fax, or computers.

Similarly, a company that has successfully established a niche selling merchandise on the Internet may see the opportunity to develop a worldwide market for its products and services. By going public (that is, selling stock in the company so that it is no longer a private company but a public one owned by stockholders), a company collects money from people all over the world and can expand much more rapidly than it could by other means. There are many stock exchanges in the world. The largest stock exchanges in the United States are the New York Stock Exchange (NYSE) and the NASDAQ. The NYSE occupies a physical location in New York City, where the buyers and sellers of stocks come together through intermediaries known as brokers. Many NYSE trades are also conducted via computer. The NASDAQ, by contrast, is entirely computerized; there is no physical location where trading occurs. Worldwide there are stock exchanges in many national capitals and large cities. Most of these are computerized as well.

Financial markets benefit lenders as well as borrowers, of course, since few people would willingly lend their money to someone else without the promise of a return on their investment. The different financial markets offer different forms of return. The bond market offers a steady, reliable return in the form of a fixed interest rate. Usually a bond must be held for a specific time period, such as 10 years. During this period the bondholder receives annual or semi-annual interest payments from the bond issuer (the government or company), and at the end of that period the bondholder receives his or her initial investment back. Interest rates vary over time depending on the condition of the overall economy and the riskiness of the company or government issuing the bonds. When interest rates are high, buying bonds is naturally a more popular form of investment than when they are low. On the secondary bond market there are additional possibilities for profit. For example, if you buy a bond in January, and then interest rates fall in February, your bond will gain value in the secondary market, and you may be able to sell it at a profit.

The stock market, on the other hand, offers the possibility for higher returns than the bond market, but it is also a riskier way to invest. Companies’ future performance is extremely hard to predict, and the stock market is subject to human error. Stocks can gain value quickly because of investor enthusiasm about a company’s prospects, but they can lose value just as quickly if the reality of a company’s performance does not live up to expectations.

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