What's the Purpose of the Financial Markets and Trading?

Markets play an important role in the economy: they set fair prices, help companies raise funds, offer investment opportunities, manage financial risks, and make transactions easier. This system benefits both individuals and businesses by providing a clear asset value, accessible funding, and smoother financial operations. Let’s break down each one:

Price-Setting

Markets provide price discovery, where an asset’s price is determined by what buyers are willing to pay. This creates a fair, transparent value for assets, making it easier for anyone to understand an asset's worth at a glance. For example, a company can determine its value based on its stock price rather than needing complex, costly assessments.

Price-setting also simplifies valuing personal assets or investments. If you hold a stock or other asset, you can immediately see its worth on the market, saving time and resources that would otherwise go into private appraisals. 

This transparent pricing is one of the market’s fundamental contributions, grounding everything from personal wealth assessments to complex business valuations.

Raising Capital

Companies and governments often need large sums of money for projects or daily operations. Relying on banks or single institutions can be costly or impractical for such sums, as they would demand high-interest payments to account for risk. Instead, organisations can turn to markets to raise funds through bonds or stock offerings.

By issuing bonds, a company or government can spread risk across numerous investors, raising large amounts of capital at a lower cost. Alternatively, companies can offer shares in exchange for investment, giving investors ownership stakes. 

This method provides companies with access to essential funds while distributing ownership and, often, reducing financing costs. It also democratises investment opportunities, allowing people to participate in the success of companies and projects.

Investing

Investing is perhaps the best-known function of the markets. Companies and individuals often have money they don’t immediately need, and rather than letting it sit in a bank and lose value to inflation, they can use it in the markets to earn potential returns. By investing, they provide resources to other businesses or governments that need capital, helping stimulate growth and development.

For individual investors, this provides an accessible way to grow wealth and achieve financial goals. It’s a misconception that markets exist solely for investors’ benefit. Instead, they create a cycle where excess funds can be channelled to productive uses, benefiting both those who invest and those who need investment.

Risk Management

Markets provide tools for managing and sharing risks, especially through derivatives like options and futures. These can protect businesses from unpredictable price swings.

A famous example is McDonald’s in the 1980s, when they wanted to launch Chicken McNuggets. At the time, chicken prices were volatile, and McDonald’s risked losing profits or needing to adjust menu prices frequently. 

With the help of hedge fund founder Ray Dalio, they used futures contracts on corn and soybean, the main components of chicken feed, to stabilise chicken prices. This allowed them to control costs and proceed with their launch, showing how markets can mitigate real-world risks in innovative ways.

Facilitating Transactions

Markets make complex transactions more efficient and accessible. For example, selling shares in a private company involves high costs for brokers, legal fees, and more, whereas public markets offer low-cost transactions that simplify the process. Instead of facing high fees, sellers in public markets pay a modest commission or transaction fee, making it easier for assets to change hands.

Markets also provide liquidity, meaning assets can be converted to cash quickly without needing drastic price cuts. Liquidity benefits everyone by ensuring that buyers and sellers can easily transact, and prices remain fair. 

This accessibility is needed for large transactions, such as currency exchanges for companies investing abroad. While you might easily exchange small sums locally, a company moving hundreds of millions across borders relies on the efficiency of global markets.

By facilitating these transactions, markets shape the global economy and streamline everything from small personal trades to complex multinational investments.

Each of these functions demonstrates the markets’ vital role, and they operate smoothly thanks to the market participants, people like us.