What are the advantages and disadvantages of financial markets?

Answer 1

The existence of financial markets allows for the ability of a company to raise funds for a new product, or for the ability of a partnership of individuals to raise funds to begin a new company. Financial markets provide the liquidity and the forum in which to trade either stocks and bonds or commodities. The existence of financial markets is part and parcel of a free market economy. And, in some cases, even highly regulated, or government owned companies, will allow for a sector of publicly owned companies to have their stocks and bonds bought and sold. Thus for example, a nation may own and operate the nation's defense industry, but allow for companies that supply parts for that industry to be publicly owned corporations who operate for profit.

The disadvantage of financial markets is if they are not operated honestly, or find ways to get around sound and legal methods of operation. Happily, such markets will not exist as "rogue" operations for too long. As individuals, news media and government regulatory bodies will find out about these types of problems and apply corrective measures.

Answer 2

Basing financial statements on fair value is claimed to provide users with more relevant information.

It is notoriously less reliable. Unless an asset is exchanged in an arm's length transaction fair value has to be based on an estimate. Some assets and liabilities, such as quoted shares, can be valued quite accurately because they are traded frequently on an arm's length basis and the value is publicly available. Other elements in the balance sheet may be rarely traded and/or more or less unique. For example, how would you place a fair value on the original Declaration of Independence document? Brands are a classic example of this. Every brand is unique (there is only one Coca Cola) and the values assigned are sometimes huge. Reputable valuers use scientific methods to produce the values, but they are poorly understood by the community at large and no matter how scientific, all methods involve judgments that can have an enormous effect on the final sum. Auditors generally hate fair value accounting because of this lack of reliability and the fear that in a company failure the value will turn out to have been unduly optimistic. Basing accounting values on historic cost means they are founded on a certain figure.

The second major disadvantage is that fair values can fluctuate significantly over a short time and thus produce major swings in reported results. Historical cost accounting generally produces smoother patterns of profit over time. For example, a forest may be harvested 50 to 100 years after it is planted. In that time the price for logs may go through several cycles of peaks and troughs. How should the growing trees be valued? Using the current price will see the forestry company report big profits as the price rises and then big losses as it declines. Using a long-term average price will dampen this effect and using historical cost will mean no profit is reported until the trees are felled two generations later. No method is entirely satisfactory.

Answer 3

advantages of fair value