Lecture 1 Flashcards
What are Financial Markets?
Structures through which funds flow. Provide financial mediation between surplus units and deficit units.
Role of Financial Markets
- Transfer funds from surplus units to deficit units
- Accommodating corporate finance needs
- Accommodating Investment needs
Surplus Units
Participants who receive more money then they spend - Investors
Deficit Units
Participants who spend more money than they receive
What are Corporate Finance needs?
Corporations can obtain funds from investors
What are Investment needs?
Investors can invest in corporations
Functions of Financial Markets
- Spread information - promote price discovery
- Provide trading/liquidity
- Enable agreements
- Reduce transaction costs
- Enable risk sharing
- Enable capital formation
Primary Market
Facilitate the issuance of new securities
Secondary Market
Facilitate the trading of existing securities, allowing for a change in the ownership of the securities
Money Market
- Short term, <1 year
- High Quality Issuers
- Debt only
- Primary market focus
- Liquidity Market - Low returns
Capital Market
- Long term, >1 year
- Range of Quality Issuers
- Debt and equity
- Secondary market focus
- Financing Investment - Higher returns
Organised
- Visible Marketplace
- Members Trade
- Securities Listed
OTC
- Wired Network of Dealers
- No central, physical location
- All securities trade off the exchanges
Foreign Bond
Targeted at a foreign country’s market and denominated in that country’s currency
Eurobonds
Denominated in one currency, but sold in a different market
- Larger than US corporate bond market
- Over 80% of new bonds are Eurobonds
Transactions costs
- Financial intermediaries make profit by reducing transaction costs
- Reduce TC’s by developing expertise and taking advantage of economies of scale
Liquidity
Low transaction costs means increased liquidity making it easier for customers to conduct transactions
1. Banks provide depositors with checking accounts so they can pay their bills easily
2. Depositors can earn interest in checking/savings accounts and can still convert them into goods and services whenever necessary
Risk Sharing
- Financial intermediaries create and sell assets with lesser risk to one party in order to buy assets with greater risk from another party
- Asset transformation: Risky assets turned into safer assets for investors
Asymmetric Information
One party lacks crucial information about another party, impacting decision making
