11 May 2020

The role of stock market in economic growth and development

By DICC Institute

The stock exchange provides a platform between investors and companies and provides a strong foundation in proper functioning of the economy. Many feel that stock market is mere a speculative platform and doesn’t have any role to play in economy. They are actually made a huge mistake considering it just a speculative platform. Joining a stock market course in Delhi will make you enable to properly understand the different concepts of stock market.

Also Read: What is stock market and stock exchanges

The Stock Exchange is a market that offers guarantees of transparency, liquidity and security to investors. The notion of stock market liquidity is very important, which is what guarantees investors to be able to recover their savings at any time if they so choose.

In order for the system to work, applicants for capital can pay remuneration to capital providers in the form of a dividend. Investors also have the prospect of making a profit if the market price of the asset appreciates.

The stock market can distinguish as the primary market and the secondary market. The primary market is the place where securities are issued or created for the first time known as IPO (initial public offering) by the investors.  The secondary market is the place where the securities traded by the investors. It is the second-hand market for listed financial assets. These assets generate more or less transaction volumes.

The stock market as a source of finance

Source of Finance For companies  : 

Companies use two tools to finance themselves through the stock market: stocks and bonds. Bonds are a riskier means of financing for the company, which alone bears the risk of the development of its investment projects. Conversely, equities allow the company to finance itself by sharing this risk with other investors (individuals, hedge funds, banks, etc.).

Without the stock market, companies could not finance their investment projects and continue to develop.

Source of Finance For States: 

The stock exchange’s funding role is twofold. On the one hand, it allows direct funding with the issuance of government bonds.  On the other hand, the Stock Exchange also provides indirect financing to States through taxation on income from the stock markets. There is the capital gains tax on securities, the dividend tax and the financial transaction tax. This brings a significant financial windfall to the States.

The stock market as an evaluation tool

 

Business valuation: 

The market capitalization of a company is a method to evaluate companies. The business model or the business valuation of a company can also be judge by the level of confidence of an investor. If a company’s stock price goes up, it’s because investors have confidence is high and they keep investing in the stock of a company. Conversely, a company with a falling share price reflects a lack of investor confidence in the company’s ability to continue to develop.

State Assessment: 

As with companies, the stock market is a tool for assessing investor confidence through interest rates. If a country’s interest rates are high for financing, it is because investors do not trust the future of the country and are not confident in its ability to repay its debt. Investor confidence can also be measured with the rate of subscription of the investors to government bond issues. We can thus compare the interest rates of different countries and can provide a rank to the country.

The stock market as a hedging tool

Companies use many derivatives on the stock market (CFDs, swaps, futures, options, futures, etc.) to protect themselves from many risks:

Risk of change : 

The evolution of the exchange rate between two currencies on the Forex can have serious consequences depending on whether the company is an importer or an exporter abroad. Companies will then use the stock market to hedge against this risk by using a currency swap.

Interest rate risk: 

Changes in interest rates have consequences for not only bank loans but also for bond rates. This can therefore impact the cost of financing the businesses with banks. The banks would start charging higher interest rates and thus it impacts the overall financial markets. The company will then use the stock market to hedge against this risk by using an interest rate swap.

Risk of price variations: 

The price of raw materials is constantly changing on the stock markets. For a company to be able to ensure good management, it needs to stabilize its costs. With the use of futures contracts on the stock market, the company will be able to combat this risk.

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