10/17/2008

Stock Markets: Do We Really Need 'Em?

Well with the recent credit crunch spreading from the US to various parts of the world, I can't help but wonder: do we really need stock markets? I'm not educated in economics & I don't have Mum & Dad's flair in this subject *feels dejected* However I came across this article & thought to do a brief summary about it :)

What...
Before we ask what are stock markets, we should know more about the main component: companies. Companies are legal entities that provide services/goods to the market (consumers) & provide job opportunities to many.

Shareholders are owners of the company. The number of shareholders vary from company to company. The amount of shares distributed also varies. Shares are then traded on the stock market to raise funds.

Why...
Next we should understand the concept of limited liability. Limited liability is where the shareholder will lose the amount they paid for their share & not more than that. This isn't applied in partnerships where partners are jointly liable for all the debts incurred. 

Not all companies offer their shares for sale to the public. These companies are known as private companies. However, many companies opted to sell their shares to the public & these shares are traded on an organized stock exchange. These companies are called "quoted companies"; the values of their shares are quoted in the financial press daily.

Selling shares is one of the ways to increase capital for the company. Another method would be to increase debt (by taking loans/issuing bonds). A benefit of trading shares is that one need not hold the share for a fixed period of time; the shares can be sold whenever the owner feels that the market is good.

Share prices are basically determined by predictions of the future gain of that share if it was sold at the time. Hence the share prices are determined by several factors:
  • Big, important news; sudden change of events.
  • Shift in demand of the market; eg. more buyers than sellers.
Sometimes excessive optimism drives share prices up, such as during the dotcom "bubble". When reality hits, the bubbles burst & share prices drop sharply. The recent drop in the share market is due to negative prospects of the survival of many banks & impending economic slowdown.

The current economic crisis is not because of the existence of the stock market; rather, it's because of poor financial judgement: many financial institutions made the mistake of giving loans to risky creditors despite knowing that property prices can fall.

The Effect...
To people who buy shares that are affected by the current economic crisis, drop in share prices will mean financial loss which may not be claimed back soon enough, if ever. This effect is more significant among those retiring/living on pensions as their funding will be reduced. 

There is no straight cure for the problem; it will take time for the economy to stabilize. In Malaysia, the government is optimistic we can weather this storm; meanwhile the KLCI falls to 27-month low. The government says it will be aggressive to attract foreign investors to keep the economy going. 

I certainly hope that we learn from the horrible error made by these foreign banks; too much of a good thing is a bad thing, folks. Moderation is key. The share market is certainly a way to make a quick buck but it's also one of the quickest method to bankruptcy. We don't really need 'em but we've MADE them important. It's time to reevaluate & take charge of your lives. Be cautious when making financial decisions, now we know that the stock market is a fickle creature.

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