Capital Formation, Liquidity, and Risk Management
The three basic functions of securities markets are capital formation, liquidity, and risk management. These markets pair the companies that need capital to function, and the investors with capital that are looking for a return on their investments. It also connects investors together, those that are looking to liquefy and sell their securities, and those who want to buy those same securities.
The liquidity of securities is crucial to the buyer, and it can be the decision-maker on whether or not the buyer will invest. These markets diminish the risk involved with purchasing securities by diversifying and hedging their investments. They can purchase groups of securities to lower the overall risk, despite some of the securities having a higher individual risk. Derivatives are further measures to eliminate risks; they create a maximum loss and secure investment gains. Other options like mutual funds, which allow one to be financially involved without having to deal with investment and voting discretion, and put options, which gives the owner the right, but not the obligation, to sell a certain amount at a specific price within a certain time frame, are other ways that investors can lower the risks of purchasing securities.
This market, of buying, selling, and trading securities, has beneficial repercussions for the economy. This market helps evaluate the price of certain companies, and even the economy as a whole. Securities prices can help judge management performance and can act as a valuation for tax or other purposes. The market is not intended to act as an evaluation of companies and their performance or worth, however, that is a direct result that benefits the economy.
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