As a business grows from a sole proprietorship to a partnership and later to an even bigger firm, its needs for financing also grow. Frequently, a company needs financing beyond what its sales and revinvested profits can supply. Most companies have a line of credit from a bank, but sometimes managers realize the company could grow even faster with additional funding.
When that happens, companies often turn to the public markets. They can do that in two ways: Borrowing from the public by issuing debt, or selling ownership stakes in the company by issuing stock.
Within the debt market, there are many ways companies can secure financing.Short-term debt, which includes instruments that mature in less than a year, can include elements such as commercial paper. For longer-term debt financing, companies can turn to the bond market. A bondholder receives an interest payment instead of a dividend and has no voting rights. The company promises to repay him the full value of the note upon maturity.
Stock works differently. Here, investors take ownership of a piece of the company, often receiving dividends, or a small piece of the net profit. Stock enables companies to exchange a share of ownership for cash. When a company has its initial public offering, it's making stock available to the public for the first time. It's a means of raising money so the company can expand.
Individual investors can buy individual shares of stocks, as well as mutual funds, exchange traded funds and other more sophisticated instruments. ETFs have become increasingly popular in recent years. These are funds that trade like stocks, so they are easy for investors to buy and sell.
For the investor who wants to participate in the bond market, there are numerous bond funds available through major brokerages, such as Scottrade, TD Ameritrade or e*Trade.
There are many different methodologies for trading in the stock market. Some have adopted a buy-and-hold system, popularized by Warren Buffett. In this method, an investor buys a stock and holds it for a long period of time, weathering ups and downs in the market. The idea is that the investor will realize gains by being patient.
At the other end of the spectrum is day trading. This method, which became popular in the late 1990s with the advent of the Internet, which allowed investors to make fast trades, focuses on buying a stock quickly, holding it for a short period of time (hours or even minutes) then selling. While this holds appeal for people wanting to make money quickly, it's also a very risky endeavor.
Other widespread methodologies include growth investing and value investing. Growth investors seek out companies whose earnings appear poised to increase at a faster rate than the general market. Often, the prices of these stocks have a corresponding increase. Value investors focus on companies with strong income statements and balance sheets, but whose stock price appears undervalued. These investors look for healthy companies whose shares seem to be trading too low, relative to their earnings. If the market changes its opinion on the valuation of these shares, and sends the price higher, value investors can make good money.
As you see, the financial markets have a great many components. For investors, there are many ways to become involved, depending on a person's interests and risk tolerance.