2 Financial Markets and Instruments
Learn how financial markets connect fund providers and borrowers, how key institutions support trading, and how stocks and bonds differ in their rights, payments, and risks.
How financial markets work
Financial markets bring together people and organizations that supply funds with firms and governments that need them. They help issuers raise money, provide investment opportunities, and direct funds toward their uses. Trading also helps establish market prices and can make financial assets easier to buy or sell.
A market need not be a single physical place. exchanges bring buyers and sellers together, while other securities—including many bonds—may trade through networks of broker-dealers. Much trading takes place through electronic systems.
New issues and investor trading
In a , an issuer sells a new security to investors and receives the proceeds, less any associated costs. A company might issue new shares or bonds to raise funds.
In a , investors trade securities that have already been issued. When one investor sells a share to another, the issuing company generally does not receive the sale proceeds. Secondary trading can still benefit issuers: making securities easier to buy and sell can support demand for new issues.
Participants and their roles
Several participants have distinct but connected roles in moving funds and completing securities transactions:
Firms and other issuers raise funds by issuing securities. Businesses may use funds for equipment, research, expansion, or other purposes. Governments and municipalities issue securities to finance public spending.
Investors provide funds in exchange for a possible return. They include individuals and institutions such as pension funds, mutual funds, insurers, and banks. Their goals, time horizons, and willingness to take risk differ.
help move funds and arrange transactions. Banks take deposits and make loans. Investment banks may help issuers structure, underwrite, and sell new securities. Broker-dealers execute trades for customers or trade for their own accounts. Some firms perform more than one of these roles.
Exchanges and other trading venues provide systems and rules for matching or arranging trades. Not all securities trade on an exchange.
Clearing and settlement institutions help confirm trade details and transfer securities and money so that a transaction is completed.
Regulators establish and enforce rules intended to support fair, orderly markets and investor protection. In the United States, the Securities and Exchange Commission (SEC) regulates securities markets and many securities firms. FINRA oversees member broker-dealers under SEC supervision.
For example, a company seeking funds for a new factory might sell bonds to investors in a primary offering, with an investment bank helping arrange the sale. Later, an investor wishing to sell one of those bonds may use a broker-dealer to find a buyer in the . That resale transfers ownership between investors; it does not provide the company with new factory funding.
Stocks and ownership
A represents an ownership interest in a company. may provide voting rights and may entitle its owner to dividends if the company declares them. Neither dividends nor an increase in share price is guaranteed. Investors may earn a return if the ’s value rises or dividends are paid, but they can also lose some or all of their investment.
Some companies also issue . It commonly has priority over for dividends and claims on assets, but usually has limited or no voting rights. The exact rights depend on the terms of the issue.
prices change as investors reassess a company’s expected prospects and risks, as well as broader market conditions. If a company goes bankrupt, creditors—including bondholders—generally have claims ahead of shareholders. Common shareholders are residual owners and may receive nothing if the company’s assets are insufficient to satisfy prior claims.
Bonds and promised payments
A is a debt security: the issuer borrows from investors and promises to pay interest according to the ’s terms and repay its at , unless it defaults or the terms provide otherwise. is also called face value or par value. Governments, municipalities, and corporations issue bonds.
A ’s is the stated interest rate applied to its face value. For example, a with a face value of and an annual of pays per year in interest, according to its payment schedule. The ’s market price can differ from its face value. Its reflects the return implied by its price and expected payments.
When market interest rates rise, existing fixed-rate bonds generally become less attractive and their prices tend to fall. When market interest rates fall, those prices generally tend to rise. These are general tendencies, not guarantees about a particular ’s price.
Comparing stocks and bonds
Stocks and bonds give investors different roles and potential payments. A stockholder is a part-owner of a company and may receive dividends if declared, as well as possible gains if the share price rises. A bondholder is a lender to the issuer and may receive contractual interest and , subject to the issuer’s ability to pay and the ’s terms.
Ordinary shares usually have no , whereas bonds usually have a stated date. If an issuer fails, bondholders and other creditors generally have claims ahead of shareholders, subject to the law and the security or priority terms. Stockholders may be exposed to price declines and loss of their investment; bondholders face risks including default, interest-rate, and .
Neither stocks nor bonds are risk-free. A security’s specific rights and risks depend on its terms and issuer.