Financial markets play an important role in the economy. They enable individuals to find a better balance between current and future use. For example, entrepreneurs with good investment projects may need funding while people who want to provide for retirement may look for ways to invest gratefully. Financial markets bring borrowers to contact lenders and in this process have made both better. Financial markets also allow for effective risk sharing between investors. As we will see later, the dangers are of two kinds: varied and irreversible.
Separate risk can be eliminated by holding back non-returnable goods. Financial markets not only assist investors in classifying certain risks, but also offer a wide range of financial instruments with very different risk recovery relationships. This allows people to choose the investment risk profile based on their risk tolerance levels. Investors who are less prone to risk, for example, may choose to invest most of their wealth in risk-free securities (such as gilts), while risk-conscious investors may choose to invest in unpredictable stocks.
In addition, the existence of exit markets means that people can choose which indiscriminate risks they want to bear and which ones they want to eliminate using futures or options markets. Indiscriminate risk, by definition, cannot be eliminated by diversity. However, the existence of futures markets and options allows for the transfer of risk from people who are less sensitive to risk and from those who are less likely to manage risk. Thus, financial markets enable effective risk sharing between investors.
Financial markets also make possible the separation of ownership and management that is a real necessity for managing large corporations. Many companies have hundreds of thousands of shareholders with very different interests, wealth, risk tolerance and personal investment opportunities. However, as Irving Fisher pointed out in 1930, all can agree on one thing that they should continue to invest in real assets as long as the minimum return on investment equals the return rate on the same investment in large markets.
As shareholders agree unanimously on investment terms, they can delegate business activities to a professional management team. Managers do not need to know anything about their shareholders’ preferences; nor do they have to ask what they like. Managers need to pursue only one goal: to invest in high-profit projects compared to those that are equally invested in large markets (capital cost). Put another way, the goal of management is to invest in projects that in terms of current value cost less than the benefits they bring, i.e. investing in current value projects. This goal increases the market value of individual shareholders to what concerns it therefore turns out to be the best benefit for all shareholders.
Separation of ownership and control is essential to the successful operation of the capitalist economy. It means that people can decide how much to spend now and how much to invest in the future. Once they have decided how much to invest, using a wide range of financial instruments available in the financial markets, they can choose the timing of the operating system and the risk factor of the associated operating systems.
On the other hand, executives of large private companies can borrow money from large markets to buy real assets. Real assets may be intangible, such as machinery, industry and offices, or they may be intangible, such as patents, trademarks and patents. When managers increase the current total value they make everyone better. Therefore, efficient financial markets ensure that individual growth leads to a positive impact on society.
Financial markets lead to the efficient allocation of resources with information transferred through market prices. Consider the case of a farmer who has land that could be used to grow wheat, corn, or oatmeal. He is reasonable about how much it will cost to grow any of these crops and how much his land will produce. However, there is great uncertainty about the price the crop will receive after harvest. This price volatility depends not only on factors such as weather conditions but also on levels of demand and potential supply in the future.
However, the farmer can look at the future prices of wheat, corn and oatmeal and, knowing his cost structure, determine which crop is most beneficial to him. He can also use future markets to secure a guaranteed crop and continue to plant crops. In this way the financial markets ensure that the land is used efficiently and effectively.
The stock market combines the different perspectives of market participants and conveys how well a company equity is under current management. Suppose Company A shares are traded at a certain price and suppose another company, Company B, can use Company A assets more efficiently. Then Company B may decide to acquire Company A. If it does, Company A assets will be used more efficiently and productively under the management of Company B. If there were no stock market, it would be difficult for Company. B to realize that Company A assets could not be used in the best possible way. Even if Company B sees this, it may not be possible to find Company A and transfer the goods. Thus, the existence of an efficient stock market leads to the efficient use of assets and enables mismanagement of disciplinary action through the business management market.
If a company announces a plan for future actions, such as starting a new project or taking over another company, the stock price may respond positively or negatively. Company executives can see the stock price response and learn what market participants think collectively about its proposed system. If the stock price reaction is negative, managers may wish to re-evaluate their statistics and reconsider their decision. Thus, the stock market helps managers get a second perspective on their investment decisions. In addition, as stock prices reflect the value of assets under current management, the market provides an estimate of how well management performs their function and therefore assists in the process of evaluating the performance of management.
Banks play an important role in the economy as well. In addition to merging lenders and lenders, banks also serve as corporate security guards. When funds are fully funded by the various owners of the shareholders, no one alone has the motivation to use the resources to monitor the management and ensure that they act in a way that benefits those shareholders.
Conclusion
Financial markets serve many useful purposes. This includes merging lenders and lenders; risk sharing between investors; separation of ownership and management; achieving a better balance between individuals between current and future use; efficient allocation of resources, efficient use of assets, and assisting in the process of evaluating management performance with signals contained in market prices.
Reference.
https://www.business-standard.com/article/specials/the-role-of-financial-markets-196110101118_1.html
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