Today, we’ll examine a new kind of financial intermediary: stock markets. As an individual, you participate in the stock market when you buy a company’s shares.
Today, we’ll examine a new kind of financial intermediary: stock markets.
As an individual, you participate in the stock market when you buy a company’s shares. This turns you into a part-owner, entitled to some of the company's profits. Sometimes, profits are paid out directly via dividends. Other times, profits are reinvested for company growth. In this case, you benefit by seeing the value of your shares rise in tandem with this growth.
Still, the buying and selling of stock doesn't actually create any new investment. Buying and selling only transfers ownership between stockholders. What actually creates investment is when a company offers stock to the public for the first time (known as an Initial Public Offering or IPO), which is when it issues new shares to raise money for key ventures.
This process of turning savings into investment is what makes the stock market an intermediary.
A key caveat, though—buying stock essentially means betting on a company. As with all gambles, sometimes it pays off, sometimes, it doesn't. For you as a saver, this means some of your stocks will win, and others, not so much.
This volatility makes stock markets more risky than banks. Bank savers typically don't have to worry about fluctuations in the value of their deposits.
As for the entrepreneurial side, the stock market is a key institution encouraging new businesses. For a founder, the payoff typically comes during the IPO. An IPO allows founders to sell some of their ownership (in a now more-valuable company) so they can diversify their own holdings.
Next time, we'll look at the third kind of intermediary: bond markets.