Quite simply, that is what the financial markets are - any type of financial transaction that you can think of that helps businesses grow and investors make money. Here is an overview of the financial markets, from the simple to the complex.
Stocks and Stock Investing
Stocks are shares of ownership of a public corporation that are sold to investors to allow the companies to raise a lot of cash at once. The investors profit when the companies increase their earnings, which keeps the U.S. economy growing. It's easy to buy stocks, but takes a lot of knowledge to buy stocks in the right company.What Are the Components of the Stock Market?
To a lot of people, the Dow is the stock market. However, the Dow, which is the nickname for the Dow Jones Industrial Average, is just one component among many. There is also the Dow Jones Transportation Average and the Dow Jones Utilities Average. Many investors ignore the Dow, and instead focus on the S&P 500 or other indices to track the progress of the stock market. The stocks that make up these averages are traded on the world's stock exchanges, two of which include the New York Stock Exchange and the NASDAQ.What Are Mutual Funds?
Mutual funds give you the ability to buy a lot of stocks at once. In a way, this makes them an easier tool to invest in than individual stocks. By reducing stock market volatility, they have also had a calming effect on the U.S. economy. Despite their benefits, you still need to learn how to select a good mutual fund.What Is the Bond Market?
Generally, when stock prices go up, bond prices go down. However, there are many different types of bonds, including Treasury Bonds, corporate bonds, and municipal bonds. Bonds also provide some of the liquidity that keeps the U.S. economy functioning smoothly.It's important to understand the relationship between Treasury bonds and Treasury bond yields. Basically, when Treasury bond values go down, the yields go up to compensate. When Treasury yields rise, so do mortgage interest rates. Even worse, when Treasury values decline, so does the value of the dollar. This makes import prices rise, which can trigger inflation. Treasury yields can also predict the future -- an inverted yield curve usually heralds a recession.
What Are Commodities?
Oil is the most important commodity in the U.S. economy. It is used for transportation, industrial products, plastics, heating and electricity generation. When oil prices rise, you'll see the effect in gas prices about a week later. If oil and gas prices stay high, you'll see the impact on food prices in about six weeks.The price of oil is determined in the commodities futures market. What are futures? They are a way to pay for something today that is delivered tomorrow. This helps to remove some of the volatility in the U.S. economy by allowing businesses to control future costs of the critical commodities they use every day.
However, futures also increase a trader's leverage by allowing him or her to borrow the money to purchase the commodity. This leverage can create outsize gains, if traders guess right. It also magnifies the losses if traders guess wrong. If enough traders guess wrong, it can have a huge impact on the U.S. economy, actually increasing overall volatility. Commodities trading was responsible for record-high oil prices in 2008 and 2011, which resulted in food riots and even the Arab Spring.
Another important commodity is gold. It's bought as a hedge against inflation. Gold prices also go up when there is a lot of economic uncertainty in the world. In the past, every dollar could be traded in for its value in gold. However, once the U.S. went off the gold standard, it lost this relationship to money. Nevertheless, this history means that many people still look at gold as safer alternative to cash or currency.
What Are Hedge Funds?
By 2007, hedge funds increased in popularity due to their supposed higher returns for high-end investors. Since hedge funds invest heavily in futures, some argued they decreased the volatility of the stock market and therefore the U.S. economy. However, hedge fund investments in subprime mortgages and derivatives caused the 2008 global financial crisis.Even before this, hedge funds had demonstrated their risky nature. In 1997, the world's largest hedge fund at the time, Long Term Capital Management, practically brought down the U.S. economy. (Article updated April 11, 2012)
