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The History of Capital Markets

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  • 0:03 Overview of Financial Markets
  • 1:06 Early Moneylending
  • 2:26 Stock: Risk vs. Reward
  • 3:31 Learning Through Trial…
  • 4:19 Stop, Rethink, and Try Again
  • 5:05 Lesson Summary
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Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

Wall Street has been a hub for financial markets since the 1700s, but other financial markets existed long before that. This lesson discusses the history of financial markets and how they have developed into the intricate systems they are today.

Overview of Financial Markets

Broadly defined, financial markets are the systems through which financial transactions occur. They don't have to be in a specific location, although some - like the New York Stock Exchange - partially are. All that is required for a financial market to exist is a buyer, a seller, and a financial asset, such as a bond, stock, or contract, that the buyer and seller want to exchange. When most people think of stocks and financial markets, the picture of Wall Street and electronic tickers probably comes to mind. A few might know that Wall Street has been a central location for many financial markets since the 1700s.

The earliest example of a financial market were the banks and lenders in early 14th century Europe. These markets operated before the idea of stock, the partial ownership of a company obtained by buying shares. For early banks and moneylenders, the financial markets were all debt-based. They would give loans to governments and individuals, then they would buy, sell, and trade the repayment of the loan.

Early Money Lending

How did money lending work long ago? Consider this example: if a moneylender loaned a merchant in Venice 1,000 lira, the agreement might be for the merchant to pay the moneylender back 1,100 lira. The terms might be 50 lira a month for the next 22 months. After collecting 650 lira over thirteen months, maybe that moneylender needed some cash and couldn't wait the remaining nine months for the other 450 lira. In the financial markets of the day, another moneylender or bank might buy those future payments at a discount. Let's say 420 lira.

The first moneylender loaned 1,000 lira and got back 1,070 (650 from the merchant and 420 from the new moneylender). That's a profit of 70 lira for him. The second moneylender will receive the remaining 450 lira. He only paid 420 lira for the right to receive those payments, giving him a profit of 30 lira. When it's all over, the merchant got the cash they needed, when they needed it.

Imagine thousands of transactions like this going on constantly with many buyers, sellers, and borrowers. That is what the first financial market looked like. These early transactions were based on debt. They fundamentally set the structure for numerous market participants to help each other out and make money while doing so.

Stock: Risk vs. Reward

In the 15th century, global exploration and advances in nautical travel led to an increase in the number of explorers hopping on a ship and setting out to seek fortune. While the fortunes did exist, they were neither easy nor cheap to obtain. Rarely could a single individual finance the cost of a ship, a crew, and everything else it took to make a risky venture that could potentially result in a lost or wrecked ship. The potential reward was enormous, but so was the risk.

Nothing spurs people to innovate like money. It didn't take long for trading companies to gather groups of individuals together, have them fund a voyage, and then share the bounty when - and if - it returned. With that, the idea of partial ownership and shared risk/reward, established the practice of issuing stock. As more companies issued stock, it became necessary to have a centralized, physical location where shares could be bought and sold, and dividends collected. Dividends are the payments from profit paid out to shareholders, proportionate to their percentage of ownership.

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