Chapter 2, Lesson 3: Financial Organizations

It’s been a while since I made my last post, from school to family and everything in between, life got in the way and the blog found itself on the backburner. I could make excuses for days, but what I really want to get to is the content itself. The hiatus is over, let’s learn about the organizations and entities, the key players, that run the financial markets.

Stock exchanges

In order for any sort of trade to take place, there needs to be a physical place for it to occur. At least, this was the case in the beginning, like most things. Nowadays, with the internet, this can be done from anywhere with an internet connection. In fact, only a fraction of all financial transactions occur physically anymore, most are conducted virtually. The organizations that provide the medium for this trade to occur are the stock exchanges. These are corporations like the New York Stock Exchange and the NASDAQ in New York, or the Euronext in, you guessed it, a number of cities in Europe. These corporations oversee the trading of assets. It is important to note that exchanges are not brokers, they don’t place the trade for you, they simply provide the place and mechanisms which allow what is being traded to do just that.

Brokerage firms

Brokerage firms are corporate entities which facilitate investors’ financial transactions. If you’ve ever seen The Wolf of Wall Street, (which is, by the way, a crude and hyperbolized yet real reflection of the financial industry, or at least a niche of it) at the beginning, DiCaprio’s character’s first job was at a brokerage firm and ended on Black Friday (see Chapter One, Lesson One for information on Black Friday, which, by the way, I think is a terrible name for it given the losses that manifested that day, it would be more appropriate to call it Red Friday).  These corporations are made up of brokers who place clients’ trades and advise them on trades (often with ulterior motives). They also take a cut, a percentage of the value of the trade, for themselves as revenue. Online brokerage, meanwhile, tend to charge a flat rate for this service at an amount which increases with level of the broker’s involvement.

Market makers

Market makers make the market by ensuring all the trades that take place in it are able to be conducted. Market makers have large stockpiles of cash and often, when you place a trade, it’s bought by the market maker, a corporation with whom it sits until it is sold again. Thus, when you sell a commodity future, it rarely ends up in the hands of another individual like yourself or a large institution like a bank or private equity firm until later when the market maker sells it to them. This allows for slightly more complex trades like short-selling.

Governments

Central Banks

            Central banks are the main agencies of the government’s involvement in the financial market. They can manipulate the price of their currency by buying and selling it or printing more or less of it, they also set the interest rate at which the government provides loans to large institutions. You’ve probably heard things like “the Fed raised rates, oh no!” The speaker here is referring to the Federal Reserve Bank of the United States, the U.S.’s central bank. When it raises rates, it increases the cost of borrowing and this slows the growth of the economy. Conversely, when the economy slows too much, such as when markets fail, central banks will lower rates in order to promote borrowing which then puts money back into the economy with the idea that the growth created will pay the loan back with whatever interest it incurred. Recently, the central bank of Japan, a country who’s economy has long been stagnating, has issued negative interest rates, meaning they are actually paying borrowers to take out a loan in an effort to further engender growth. Will it work? Only time can tell for sure. 

Regulatory agencies

Regulatory agencies are the departments of judicial branches of government which oversee the lawful operation of the market’s participants. These agencies ensure that the laws set by the government concerning the legal restrictions on the market are followed and any individuals who break these laws are held accountable and pay their debt to society for their actions. You’ve probably heard of a few sorts of financial crimes, such insider trading. This is when a financial professional with access – given their profession – to information that isn’t publicly available uses this knowledge to make a profit.

Banks

The roles of banks are pretty well known. They keep the value of your money for you, provide loans, investment services (investment banks), transfer money for you, and essentially cater to all your financial needs. What you may not known is what banks do with your money. It doesn’t sit in some box somewhere carefully labelled with your name and account information; once your money is put into the bank, it’s gone, it’s out there. You shouldn’t worry, banks are required to have cash on hand to provide to you when you want to take all or a portion of the money you put in back out, but you aren’t getting the exact cash you initially deposited. Banks also engage in trading activities, allowing them to use the money they’ve made, i.e. a lot, to grow their wealth. They also make money off of the loans they provide in the form of interest. Banks aren’t limited to the aforementioned standard operations either, they can provide insurance, move the assets of large corporate clients to make them money (from which they take a cut), and they even act as the market makers previously mentioned.

Private equity firms

Private equity firms are companies which take clients’ money, invest it in any number of ways with the general intention of making more money from it, and then take a cut for their hard work. Clients put money into private equity firms’ funds, and can withdraw it, although usually with some restrictions to prevent the firm from collapsing in times of crisis or other volatile scenarios. Private equity firms can range from boutique firms which cater to small neighbourhoods, to massive mutual funds and asset management corporations which manage multiples funds worth hundreds of billions of dollars and have combined assets in the trillions of dollars. There are some funds which aren’t necessarily “private,” and instead manage the assets of governments or the money that is going towards employees’ pensions.

Private investors

Private investors are individuals like you and I who make use of the aforementioned entities, in one way or another, to grow our personal wealth in the market. It is our job to evaluate who we trust and our decisions carefully and in our best interest, which believe me, is not always easy.

 

This lesson was a short one, I wrote it in one sitting in, one hour, mainly because I want to get to the next chapter, Capitalizing on Capitalism. Check back soon to start learning how investors make money in the market.

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