Financial Markets

Choices

Our opportunities for accumulating personal wealth include banking, investing, and gambling of disposable income.  Millions of people seek these opportunities and generally receive one of the following rewards:

  1. Savers receive about one cent per year for every dollar deposited in their bank account, and their account is insured against loss 1,2,3.  Unfortunately, the purchasing power of a dollar declines by about two cents per year due to inflation 4.
  2. Investors receive an average four cents per year for every dollar spent on an investment-grade bond 5 and nine cents per year for every dollar spent on a stock 6.  U.S. Government Bonds are considered to be risk-free investments.
  3. Gamblers’ returns are less certain.  One online casino reports a loss of one cent, or more, for every dollar wagered in any of dozens of different games 7.

You can quibble about the accuracy of these numbers but their relationship suggests that investing is the best opportunity for accumulating wealth. Investing takes place in financial markets where the trading of assets generates investment returns.  This article describes the investor’s choices for trading assets.

Markets

Markets are places where buyers and sellers make transactions.  Financial markets facilitate transactions involving securities, commodities, derivatives, money, and other financial assets.  Capital markets specialize in trading securities of debt (e.g., bonds) and equity (e.g., stocks).  Capital is the cash or goods used by businesses to generate income 8.

There’s considerable academic interest in factors that determine the flow of capital in and out of markets.  Aside from that, market size depends on the net flow of capital at any point time.  The year-end closing value of transactions in 2010 illustrates the huge SIZE of the global financial market at one point time 9.

The bank deposits signify non-invested capital and the other categories are investment opportunities.  The year-end closing value of all transactions in 2010 also illustrates the great DEPTH of the global financial market 9,10.

Financial markets compete on the basis of participants’ needs, regulatory barriers, and asset classes. Regulators control the spigot of capital flow between participants.  Access to fair and liquid markets is crucial to the investor’s success.  The advantages of global capital markets over domestic markets include the following 11:

  • For businesses,
    • a larger supply of funds from investors
    • a lower cost of capital due to the larger supply of funds
  • For investors,
    • a bigger selection of investment opportunities
    • global portfolio diversification lowers the total risk of the investment portfolio

Celebrities

The famous investor, Benjamin Graham 11, introduced two market participants who possess quite different temperaments.  The one named “intelligent investor” is discriminant and deliberately makes trades that run contrary to the advice of “Mr. Market”.  The other named “Mr. Market” is moody and finds comfort in duplicating the trading behavior of other participants.  Mr. Market is quick to sell securities when feeling pessimistic and quick to buy securities when filled with optimism.  Mr Market’s potential profits and losses are illustrated in the following chart of annual returns from the global stock market 10.

The value investor seeks to do better by buying Mr. Market’s securities at bargain prices and reselling them at premium prices.

Copyright © 2012 Douglas R. Knight

References

1.           Personal savings.  © 2012 American Express Company. All rights reserved  http://personalsavings.americanexpress.com/savings-product.html?extlink=ps-us-PersonalSavings-PS000SA.

2.           FDIC National Survey of Unbanked and Underbanked Households.  Executive Summary.  Federal Deposit Insurance Corporation.  December, 2009, http://www.fdic.gov/householdsurvey/executive_summary.pdf

3.           MoneyRates.com.  Copyright © 1999-2012 by MoneyRates.com. All Rights Reserved. http://www.money-rates.com/savings.htm

4.           CPI Inflation calculator.  United States Department of Labor.  Bureau of Labor Statistics.   http://www.bls.gov/data/inflation_calculator.htm/

5.           Kellie Geressy-Nilsen.  Investment-Grade Bond Yields Near Record Lows.  Credit Markets.  The Wall Street Journal.  August 3, 2011.  Copyright ©2012 Dow Jones & Company, Inc. All Rights Reserved http://online.wsj.com/article/SB10001424053111903454504576486153913336380.html.

6.           Matt Krantz.  Which investment asset class returns 20% on average a year? USA TODAY Updated 6/14/2011 1:54 PM.   © 2012 USA TODAY, a division of Gannett Co. Inc.  http://www.usatoday.com/money/perfi/columnist/krantz/2011-06-13-big-investment-returns_n.htm.

7.           Return To Player (RTP) information.  Dublinbet.com.  http://www.dublinbet.com/getting-started/guides/?guide=return-to-player-information.

8.           Investorwords.com.  ©2011 by WebFinance Inc.  www.investorwords.com

9.           Charles Roxburgh, Susan Lund, and John Piotrowski.  Mapping global capital markets 2011.  The McKinsey Global Institute.  Updated Research, August, 2011.  Copyright © McKinsey & Company 2011.

10.         John Nestor, Sion Cole, David Buckle, et al.  Charity Compendium 2011. A long-term perspective on charity fund investment.  UBS Wealth Management.  © UBS 2011. All rights reserved. October 2011.

11.         Benjamin Graham.  The Intelligent Investor, revised edition.  HarperCollins, New York, 1973

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