Economics: The Stock Markets

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From our previous discussions of economic concepts, specifically in Economics: The economic cycle part 1, we looked at a simplified version of the economic cycle. The economic agents in our discussion were a household (the consumer), a farmer (the producer), and the Fruit and Veg (the market). We will be using this simplified model of the economic cycle to illustrate how investment markets work. The specific market we will be looking at is the stock market.

But, what is the stock market?

The stock market, according to the Oxford dictionary, is defined as a market in which securities such as shares and bonds are bought and sold. Other names you may find commonly used to refer to the stock market are equity market or the stock exchange.

The stock market is like any other simplified market you may know of where goods are sold or services are rendered to the public. The difference between the stock market with any of the other kinds of markets that sell goods or render services to the public are the types of services offered as well as the regulation governing how the stakeholders (investors, companies, governments, stock brokers) should conduct themselves. In essence, every stakeholder must play by the legal rules associated with the stock market when the buy and sell shares and bonds. These rules and regulations, of course, are put in place to make the market fair and more transparent for everyone, including ordinary investors like you and me. One of the other factors that differentiates the stock market from any of the other types of market is the level of technological utilisation that has made it easier to transact in the market.

How does the stock market work?

Suppose a newly formed company, say ABC Ltd, requires money to grow and start with new types of operations. Now, in order to raise this money, the people who run ABC can either ask for money from private investors or they can ask for money from the public. In this case, let’s say they decide to raise the money from the public. Having decided this, the people who run ABC will then sell off a percentage of their company, or stake of their company, in the form of shares, to potential investors. They sell these shares in exchange for money from investors. Now, in order to allow for the public to buy the shares of ABC, the people who run company ABC will then notify the Johannesburg Stock Exchange (JSE) of their intentions to sell shares on the stock market to the public so that they can raise the money needed to start with the new operations. Potential investors who want to buy and own a percentage of ABC in the form of shares will then line up to make their purchase. After offering its shares to the public on the JSE, company ABC will be known as a “listing company”, and after purchasing shares in company ABC from the JSE, the person owning the shares will now be known as the “shareholders” of the company.

It is worth noting that when we refer to “the public” or “potential investors” we are not just talking about retail investors (ordinary people like you and me). Potential investors also include other entities such as institutional investors like pension funds, banks, governments, and many other types of financial institutions. So, in essence, the stock market is open to a diverse range of people and institutions.

Also, note that the JSE comes into the picture as a platform or market that allows investors to purchase the shares that companies want to sell to the public, thus, allowing company ABC to sell its shares to investors and receive the funds from the purchase. As a result of this flow of money and services, a link has been established between investors (the public), the stock market (JSE) and Companies (listing companies), thus portraying another very simplified version of the economic cycle.

figure 1

Other types of investment markets (The credit market)

A similar cycle can be seen in other markets, where the economic cycle operates as a tool and mechanism to bring consumers and producers together with the aim of satisfying their needs and wants through spending and receiving compensation for goods sold and services rendered.

Another of these types of investment market where the economic cycle can be seen, which is different from the stock market, is the credit market. This is a market where consumers tend to go seeking immediate funds to address their current needs and wants with the aim of paying the money borrowed later. An example of the credit market is the mortgage bond market where banks will act as market by bringing investors and debt-holders together.

The credit market in action

Suppose a family relocating to Cape Town from Johannesburg requires R4,5 million to buy their new home in Camp’s Bay. The family will then approach a financial institution, like a bank, to apply for a loan to finance the purchase of the house. After receiving this loan request, the bank will then look on their list of investment liabilities (the people who the bank owes money to) and they may discover that they have one such client, say the Durban man, who has invested R4,5 million for twenty years with the bank. The bank will then grant the family the loan they require for the house purchase, and will require the family’s loan, with interest, to be repaid back over a period of 20 years to ensure that they fulfill their obligation to the Durban man, and also make a profit on the interest charged. This process, of matching investments and loans is known as asset-liability matching. We shall discuss it in a later article.

Figure 2

Conclusion

As you have seen from the discussion we’ve had above about the stock market and the credit market, there are different markets that make use of the economic cycle. In fact, there are millions and millions of markets in the world that make use of the economic cycle to ensure that there is a continuous flow of goods and services in exchange for money (or credit). So, the next time you are making a purchase in any outlet or market, think about how the whole purchase process may be linked with the economic cycle.

This article was written by Realeboha Molaba.

You can contact Realeboha Molaba by clicking on the social media buttons below, or by emailing him on: relebz.quinton@gmail.com

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