Financial Markets and The Economy| Investment Management
The financial asset represents claims on real assets. Real assets determine the wealth of an economy. However, financial assets and the markets in which they trade play crucial roles in the economy. Financial assets allow the use of most of the economy’s real assets. Because of the divisibility, marketability, and availability of information, financial investment is gaining much more popularity nowadays. The financial markets play the following role in an economy.
THE INFORMATIONAL ROLE:
Securities prices reflect several pieces of information- good or bad that are disseminated in the financial market. For instance, if a corporation seeks to have good prospects for future profitability, investors will certainly bid up its stock price. As a result, the corporation’s management will find it easier to issue new shares or borrow funds for further expansion. On the other hand, the reverse situation is also true. For instance, if a company’s performance seems poor, investors will certainly bid down its stock price. As a result, a Company will have to downsize its operation and a day may come when the company eventually disappears. Thus, the financial market encourages the allocation of capital to those firms that appear to have the best prospects and discourages the allocation of capital to those firms whose performance is deteriorating. The development of personal computers and the dissemination of information on the internet has increased an individual’s ability to track investment and to perform -investment analysis. Such informational role of financial markets has assisted the economy to grow.
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ADJUSTMENT IN CONSUMPTION TIMING:
The earning power of an individual does not remain constant throughout her/his lifetime. Further, all individuals do not have the same earnings and the consumption pattern. Some individuals may be earning more than they currently wish to spend. On the other hand, some other individuals, such as retirees, spend more than they currently earn. This disequilibrium can be balanced by shifting the purchasing power from high-earning periods to low-earning periods of life.
An individual can store her/his wealth in financial assets. In other words, one can invest the savings of a high earnings period in financial assets. In return, an individual’s consumption needs can be met by selling these financial assets during a low earnings period. In this way, the financial market allows individuals to shift their consumption over the course of a lifetime.
ALLOCATION OF RISK:
Every investment imposes some degree of risk on investors. They can choose different assets in financial markets depending on their risk-bearing capacity. Financial markets, with diverse financial instruments traded in those markets, allow investors with the greatest taste for risk to bear. Less risk-tolerant investors can choose less risky assets. In this way, capital markets allow the allocation of risk inherent to all investments that the investors. most willing to bear. As a result, such allocation of risk also benefits the firm that needs to raise capital to finance their investments. The process of building the economy’s stock of real assets is also facilitated as investors are able to select security types with the risk-return characteristics that best suit their performance.
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EASY SEPARATION OF OWNERSHIP AND MANAGEMENT:
In a closely held small company, owners and managers are the same. However, a large company, generally, has the owners and managers separate. As a firm grows in number of owners, it is not possible for all owners to participate in the management. As a result, they appoint their representative to look after the management and operation of firms. However, in a firm with separate ownership and management, conflict between these two aspects is more likely. Therefore, the group of owners who are dissatisfied with an existing team of management can leave the firm simply by selling their ownership to other investors. Financial markets allow this possibility for owners with no impact on the management of the firm. Thus, financial markets allow for easy separation of ownership and management.
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