The role of financial markets

The role of financial markets

A market is the place where an offer and a demand for a certain good are met. In this case the good in question is money.

On the capital market, the holders of the offer are the agents known as “with capacity for positive savings“, in this case the households essentially (as surprising as it may seem!) And also the companies, although these generally prefer to reincorporate their profits into their own business or distribute dividends to their shareholders. The plaintiffs are, on the one hand, the states, the modern welfare state requiring considerable investment and, on the other hand, of course the companies: these are the agents that we call “in need of financing”.

Far from an abstract entity and often presented as irrational and almighty at the same time, the capital market is actually the engine of the economy , since it is the place where fuel, money, will be used to propel the machine forward, that is, to produce wealth.

This is the principle, but the practical application presents obviously more complex modalities.

The first stumbling block lies in the possibility that an exchange may actually take place between agents with savings capacity and agents with a need for financing. Indeed, for the market to work, it is necessary not only that the good, the supply and the demand exist, but also that the agents want to proceed with the exchange! But agents with savings capacity, the households recall, have a deep aversion to risk. Aversion, moreover, justified by common sense, every textbook of the perfect self-respecting stockbroker begins with a warning that the reader should not place directly on the stock market anything but his superfluity, that is, what he does not need. today and will not need tomorrow. From then on most of thecurrent accounts or savings accounts where the money is immediately available.

Opposite, the agents in need of financing, namely the companies, wish to find long-term financing to plan their development. The horizon of agents with savings capacity is generally from a few weeks (the next pay) to a few months (the next third provisional …). The horizon for agents in need of financing is several years! This difference makes the actual exchange somewhat problematic.

The banks

This is where a third category of economic agents comes in: the banks. Banks are the only agents with the power to transform resources in the very short term: sight deposits (current accounts) into medium or long-term jobs: bank credit. Banks thus establish the necessary bridge between households and businesses; historically they have played and still play a vital role in financing the economy.

Each bank has the right to distribute in the form of credit almost all the money (but not everything, see below) placed on deposit by its customers on current accounts. But this credit distributed by the bank does not cancel the deposit, which remains available to the customer. There is therefore money creation by the bank. These credits, granted in the form of demand deposits, add to the banks’ cash and therefore their ability to distribute new loans, etc. The deposits make the credits, which themselves make the deposits, … etc. This is called the ” credit multiplier “.

The power of money creation of banks is obviously, and fortunately, not infinite. It is limited primarily by the fact that only part of the credit granted will remain in the form of a deposit. The rest will be converted into fiat money (notes) by withdrawals. In fact, it is to guarantee banks’ ability to cope with withdrawals that the central bank requires them to block a percentage of their deposits in the form of minimum reserves, which can not be used to distribute credit. This rate of reserverequirements is one of the instruments of control by the central banks of the quantity of money in circulation.

In addition, a company can not finance itself only by credit: beyond a certain level of indebtedness, the financial costs end up unbearably penalizing the results and at this moment the banks do not accept anymore to lend . Companies also need to find financing for even longer terms, which in fact become payable only in the event of the dissolution of the company: capital, or in the very long term, bonds for example. All capital and long-term debt is called a company’s equity .

Banks, especially merchant banks, are also involved in the long-term financing of companies, but it is not their primary purpose that is to circulate money. To provide companies with equity, economic agents are needed to immobilize large sums over long periods, obviously in order to obtain a profit: investors.

Institutional investors

The main investors in the capital markets today are the so-called “institutional investors” (colloquially “zinzins”), ie insurance companies, asset managers , credit unions retirement and their US equivalent pension funds. They, too, are draining public savings, but these savings are locked in and are not immediately due as deposits on current accounts. On the other hand, the organizations in question generally have a regulatory or contractual or statutory obligation to grow these savings in order to be able to pay indemnities in the case of insurance companies,

Instead of distributing credit like banks, institutional investors buy securities issued by companies in search of financing. These securities are representative of either equity: shares , or long-term debts: bonds . This purchase is made either on the primary market, that is to say from the issue of the title, or on the secondary market, which is more commonly called “the Stock Exchange”.

Between the decision of companies to find financing on the market on the one hand, and the decision of institutional investors to invest the savings they have custody on the other hand, there is clearly this time an offer and a demand that can only meet. It is still necessary that the market is organized to facilitate this meeting; several kinds of actors will contribute to it. At this level, the banks are once again showing their strong presence, because, as organizations that hold cash accounts and provide liquidity, they will play a vital intermediation role.

Issue of securities

The issuer that wants to finance itself in the market turns to a bank, or a group of banks (the “syndicate”) which acts as the agent for this issue. The agent supports all the economic terms of the issue. He undertakes to “take firm”, in other words to buy the securities issued, at his expense to find investors ready to buy them.

After the issue, and once the securities are on the market, the paying agent of the issuer (which may be the same as the financial agent or another institution) will be in charge of the smooth running of all operations involved in the life of the title: payment of coupons for bonds or dividends for shares , repayments, capital increases

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