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The stock market is one of the most important
sources for companies to raise money. This allows businesses to go public, or
raise additional capital for expansion. The liquidity that an exchange provides
affords investors the ability to quickly and easily sell securities. This is an
attractive feature of investing in stocks, compared to other less liquid
investments such as real estate.
History has shown that the price of shares and
other assets is an important part of the dynamics of economic activity, and can
influence or be an indicator of social mood. Rising share prices, for instance,
tend to be associated with increased business investment and vice versa. Share
prices also affect the wealth of households and their consumption. Therefore,
central banks tend to keep an eye on the control and behavior of the stock
market and, in general, on the smooth operation of financial system functions.
Financial stability is the raison d'être of central banks.
Exchanges also act as the clearinghouse for each
transaction, meaning that they collect and deliver the shares, and guarantee
payment to the seller of a security. This eliminates the risk to an individual
buyer or seller that the counterparty could default on the transaction.
The smooth functioning of all these activities
facilitates economic growth in that lower costs and enterprise risks promote the
production of goods and services as well as employment. In this way the
financial system contributes to increased prosperity.
Relation of the stock market to the modern
financial system
The financial system in most western countries has
undergone a remarkable transformation. One feature of this development is
disintermediation. A portion of the funds involved in saving and financing flows
directly to the financial markets instead of being routed via banks' traditional
lending and deposit operations. The general public's heightened interest in
investing in the stock market, either directly or through mutual funds, has been
an important component of this process. Statistics show that in recent decades
shares have made up an increasingly large proportion of households' financial
assets in many countries. In the 1970s, in Sweden, deposit accounts and other
very liquid assets with little risk made up almost 60 per cent of households'
financial wealth, compared to less than 20 per cent in the 2000s. The major part
of this adjustment in financial portfolios has gone directly to shares but a
good deal now takes the form of various kinds of institutional investment for
groups of individuals, e.g., pension funds, mutual funds, hedge funds, insurance
investment of premiums, etc. The trend towards forms of saving with a higher
risk has been accentuated by new rules for most funds and insurance, permitting
a higher proportion of shares to bonds. Similar tendencies are to be found in
other industrialized countries. In all developed economic systems, such as the
European Union, the United States, Japan and other developed nations, the trend
has been the same: saving has moved away from traditional (government insured)
bank deposits to more risky securities of one sort or another.
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