Financial markets provide participants with favorable conditions for buying and selling financial instruments. The main functions of these markets are to ensure liquidity, determine asset prices based on supply and demand, and reduce the operational costs for market participants.
The financial market consists of various instruments, and its functioning depends on the instruments available. It can be classified by the type of financial instruments or the terms of their payoff. Based on the types of instruments, the market can be divided into promissory notes and securities (stock market). Promissory notes offer fixed payments to owners in the future, while securities provide returns based on profit, such as stocks.
Another classification of financial markets is based on the term of instruments. There is the money market for short-term assets (up to 12 months) and the capital market for long-term assets (over 12 months). This classification applies to the bond market, as bonds have fixed expiry dates, whereas stocks generally do not.
The stock market involves purchasing shares to invest in a company and become part-owner. The influence of shareholders in company decisions depends on the number of shares they own. Based on the company’s financial performance and market position, shares can be categorized as follows:
- Blue Chips: Shares of large companies with a history of profit growth, annual revenue exceeding $4 billion, high market capitalization, and regular dividend payments.
- Growth Stocks: Shares of companies that focus on reinvesting revenue into their growth. These companies rarely pay dividends, instead focusing on future development.
- Income Stocks: Shares of companies with stable earnings that pay high dividends. These are popular in mutual funds for middle-aged and elderly investors.
- Defensive Stocks: Shares that remain stable during market declines and do well in recessions, minimizing risk during economic downturns.
Companies can issue shares domestically or internationally. When issuing shares abroad, companies can use American Depositary Receipts (ADRs), issued by American banks to represent shares of foreign companies.
Shareholders can receive quarterly dividends based on the type of share, company financials, and other factors. Ordinary shares do not guarantee dividend payments—they depend on company profitability and cash reserves. Dividends vary over time and may not be paid if a company reinvests income into development or faces financial distress.
The value of an ordinary share depends on three factors: annual dividend rate, dividend growth rate, and discount rate (required rate of return). The greater the risk associated with a company, the higher the required rate of return. Cash flow also directly affects share price.
Before buying shares, it is essential to analyze the company’s financial statements, cash flow, profit distribution, and executive compensation. Being informed ensures better decision-making in purchasing or selling shares. If unsure of the company’s status, it is advisable to avoid holding shares long-term, especially before financial reports are published.
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