What is the economic role of the financial market?
The financial market is based on the activity of two compartments whose functions are different and complementary: the primary market and the secondary market.
- The primary market is the “new” market, that of securities issues. Savers can acquire securities at the time of their creation through banks or brokerage firms.
- The secondary market is the "second-hand market," the one where transactions take place between those who wish to sell securities already issued and those who want to acquire them. It is on this market that old securities are listed. It is organized in the form of Stock Exchanges. The exchanges that take place there do not concern the issuers of securities and do not directly contribute to their financing.
What is the role of the primary financial market in the Economy?
The primary market performs two essential functions in an economy: the financing of economic agents and the allocation of resources:
Agent financing: the primary market fulfills a function of financing the economy. It balances the needs of lenders and borrowers. Three categories of securities issuers (borrowers) operate on the primary market: companies, the state, and local authorities, as well as financial institutions:
the primary market allows companies to obtain the capital they lack to finance an investment. In return for the capital raised, companies issue securities using three methods: IPO, capital increase and bond issuance.
- The IPO
the operation consists of a company wishing to access the stock market, selling investors part of the shares making up the share capital. The introduction takes place via a public sale offer (OPV) and is accompanied by an opening of the company's capital to the public.
- The capital increase
is an operation that consists of a company, in increasing the amount of its share capital by new contributions. For this, the company issues new shares sold to investors.
- Bond issuance:
only large companies can issue bonds on the stock exchange. They have to offer higher rates than the states. The higher the rates, the lower the "rating" given by the rating agencies.
- The State and local authorities
States issue long-term bonds (beyond five years) to make up for their budget deficits. These are the assimilable treasury bonds (OAT). In addition, governments issue short bonds, treasury bills, to finance their cash requirements due to the mismatch between their revenues and their expenses. Government bonds are considered to be the safest securities on the market.
- Financial intermediaries: to obtain resources, financial intermediaries have recourse to the capital markets. They can issue bonds, stocks, or hybrid securities on the financial market (a mixture of stocks and bonds). To do this, they use the same methods as companies.
The meeting point between supply and demand for capital, the primary market, allows the allocation of resources between activities and between regional and national spaces. It makes it easier to mobilize the national and foreign savings of agents with financing capacity. It facilitates the financing of investments and innovation necessary for economic growth.
What is the role of the secondary financial market in the economy?
The secondary market performs three essential functions: fixing the price of securities, liquidity of securities, and capital restructuring of listed companies:
- Fixing the price of the securities
on the secondary market, transactions are carried out after a large number of offers and requests are confronted with establishing the price of the securities. It is fixed according to the law of the offer and demand. If the title is more in demand than offered, its price rises. If it is more offered than requested, its course regresses. By setting the price, the financial market helps to determine the value of companies, that is to say, their market capitalization (market capitalization = share price x number of shares).
- The price reflects investors' expectations for the future and the results of listed companies
If investors anticipate an increase in a company's profit, they buy its shares, which increases demand and push up the price. Conversely, if investors anticipate a decline in the results of a company, they proceed to sell their shares, which increase the supply and lower the price. However, investors' expectations are sometimes irrational, which generates speculative bubbles and disconnection between prices and corporate results.
- Securities liquidity
liquidity is the characteristic of security that can be bought and sold quickly, without high costs and without a capital discount. The ability for investors to easily sell their securities is a decisive factor in encouraging them to subscribe when new securities are issued. It is the secondary market that ensures the liquidity of securities, stocks, and bonds. A market is considered all the more liquid as it welcomes a large number of transactions and operators.
- Capital restructuring of listed companies
the secondary market allows the external growth of companies by acquiring share packages, to acquire stakes in other firms or to merge with them. The secondary market offers to any investor who wishes to take control of a listed company, three instruments: stock market picking, takeover bid, and takeover bid.
- Stock picking
stock market transactions being free, it is enough to take control of a listed company, to buy half of the shares plus one. This method is long and expensive. It is visible, which gives the managers of the target company time to organize themselves.
- The public takeover offer (OPA)
is a financial transaction allowing a company to take control of another, with or without the agreement of its managers. It is done by proposing to the shareholders of the target company to buy their shares from a price higher than the price observed on the market. This procedure is severely regulated by the Financial Markets Authority (AMF).
- The public exchange offer (OPE)
is close to the takeover bid, but shareholders are offered a settlement in the form of securities, generally those of the company carrying out the transaction. In addition to these three economic functions, the secondary market provides operators with transparency and security of transactions.
Author: Vicki Lezama