Kenneth R. Szulczyk
Subsequently, the business can invest new machines and equipment, boosting its production
level, and creating economic growth.
Savers link to the borrowers through two routes: financial intermediaries and direct finance.
Common financial intermediaries include banks, mutual funds, and insurance companies. For
example, you purchased fire insurance for your home. When you pay your premium, the
insurance company invests your payment into the financial markets by investing in financial
securities. Financial intermediaries only provide this function for one reason – to earn profits.
For instance, banks transfer your funds to borrowers to earn profits. Banks earn profits from the
difference between the interest rate paid by the borrowers and the interest rate the bank pays on
your accounts.
Second route links savers to the borrowers through direct finance. Net savers, like
households, can lend directly to businesses through the financial markets. Two broadly defined
financial instruments are common stock and bonds. If you buy common stock, you own shares
of a corporation that we call equity. We show an example of a stock certificate in Figure 1.
Moreover, stockholders have the right to vote on certain corporate policies and elect the Board
of Directors. Each share of stock entitles the owner to one vote. For example, if you owned 100
shares of stock, and this corporation issued a million shares, your vote would have a small
impact on corporate policy. Finally, the stockholders earn a share of the profits, which we call
dividends.
Second financial instrument is a bond. A bond consists of a standardized loan to a
corporation. A bond is fancy paper giving bondholders legal rights where the corporation
promises to repay a long-term loan plus interest to the bondholders. If a corporation bankrupts
and is liquidated, bondholders have a higher priority and claim on the corporation’s assets, while
the common stockholders come last.
Source: http://www.oldstockresearch.com/faq.htmFigure 1. An example of a stock certificate
Bonds and stocks have two markets: the primary market and second market. A corporation
or government issues brand-new securities in the primary market by selling them directly to
security dealers. Thus, they sell new securities in the primary market, while investors sell and
buy existing securities in the secondary market. Most famous secondary market for stock is the
New York Stock Exchange. This exchange allows investors to buy and to sell existing stock for