Financial Markets can be tricky to understand, but, since they play such a huge role in most of the western, developed worlds, it’s imperative that you understand what they are. People can either become extremely wealthy through them or they can lose everything they have, including the shirt off their backs.
It’s not difficult to understand why Financial Markets confuse people. There are 2 definitions that are quite different, though they sound similar.
Definition 1: A Financial Market is an ORGANIZATION that takes part in trading, such as banks, the stock exchange, etc….
Definition 2: A Financial Market is the ACT of trading, between buyers and sellers.
Do you see the difference? On the one hand, a Financial Market is an organization, while on the other hand a Financial Market is a type of action. Both definitions revolve around “Trading”, which is an action performed by buyers and sellers.
For instance, you want to buy a house so you ask for a loan from a bank. The bank says “Ok, here is the $250,000 you need right now, but you have to PROMISE to pay us a little bit of money every month for a number of years and, in the end, you will be paying us more than $250,000.” Congratulations, you just made a trade. You got $250K from a bank; they got a promise from you to pay more than that – later. So you made a trade and the both of you were participating in the Financial Market.
Why do Financial Markets Exist?
Financial Markets exist for a lot of reasons, but the main reason is exemplified above. They exist so people who need money (Borrowers) can find the people who have the money and are willing to lend it to them (Lenders). It’s an absolute necessity in a free market economy where money equals freedom. The more money you have, the freer you are to be, do and have what you want.
Thanks to the Financial Markets, people are able to support themselves and others. People can support their family by purchasing a $250,000 home for a fraction of the price. Usually, you just pay a small up-front fee and then a small monthly payment. Financial Markets also allow people to support businesses and make some money themselves. Say you want to buy stock in a company. In effect you’re saying: “Hey, I like your company and I think that you will take the money I give you and use it to make even more money for your company. Oh, and then you’ll give me my money back plus a bonus, right?” That ‘bonus’ is usually called a Dividend.
The Financial Market is like AIR for our economy. Without it, the economy would surely die.
Who are Lenders and Buyers?
To put it simply, Lenders and Buyers can be people, companies or organizations. Whether they’re a Lender or Buyer depends on their role in the “Trading” process.
If you’re asking for money, you’re a Borrower. You borrow money from a bank, right? A company borrows money from you when you buy their stock. Did you realize that? Governments borrow money from people by selling Bonds. It’s like an IOU from the Government.
If you are handing the money out, expecting to get it back later, with extra – then you’re a Lender. That ‘extra’ part is called Interest. “Sure, I’ll lend you $10 today, if you give me $12 tomorrow.” You charged $2 worth of Interest. When you bought stock in the company – you were the Lender in that case. You’re also a Lender when you put money in a savings account or Money Market account in a Bank. You don’t have to put it there, but when you do, they use your money to try to make more and you get paid Interest.
Financial Markets make our developed world turn. You now have a strong grasp of the basic concepts. You probably know more than the majority of people. Don’t stop here, though, because the more you know, the more you can EARN.