Lecture 1 - Functions of Financial Markets

Question 1

Primary Markets

Answer 1

Firms raise finance by selling shares (or other securities) to investors

Question 2

Secondary Markets

Answer 2

• Existing securities are sold between investors
• Encourage investment by improving market liquidity
• Offers a solution to the often conflicting investment horizons of lenders and borrowers - thus sustaining economic growth

Question 3

Why is compensation required to induce people to save?

Answer 3

Impatience to consume - people prefer consumption now rather than later
Risk - the pay-out may not take place or the future amount may be less than expected
Inflation - there may be a loss of purchasing power in the future

Question 4

Retail Banks

Answer 4

• Take small deposits from public or borrow from financial markets
• This money is lent to businesses and households through loans/overdrafts /mortgages
• Generally high-volume and low-value business

Question 5

Investment Banks

Answer 5

• Deal in large sums of money; high value and low volume business
• Undertake some lending
• Main focus is generating commission or trading income by providing advice and facilitating deals

Question 6

5 Main areas of Activity - Investment Banks

Answer 6

• Raising external finance for companies
• Broking and dealing
• Fund management
• Assistance in corporate restructuring
• Assisting risk management using derivatives

Question 7

Benefits of Organised Markets

Answer 7

• Efficiency in gathering information
• Intermediaries are able to spread funds across a large number of borrowers and thereby reduce risk
• Search, agreement, and monitoring costs involved in a direct transaction are reduced

Question 8

Types of financial securities

Answer 8

• Derivatives (Futures/Options)
• Equities
• Corporate Bonds
• Ordinary shares

Question 9

Difference between bonds and shares

Answer 9

• Shareholders own part of a company whereas bondholders are owed money by a company

Question 10

Main features of financial markets

Answer 10

• Lenders (Individuals/Companies)
• Intermediaries (Banks/Insurance Companies)
• Markets (Foreign exchange/bond market)
• Borrowers (Individuals, companies)

Question 11

Exchange-Traded and OTC Transactions

Answer 11

Exchange-traded securities have a standardized financial contract that trades on a regulated exchange
OTC deals are struck between two parties without any regulation or supervision

Question 12

Advantages of Pooled Investments

Answer 12

• Access to a diversified portfolio at lower transaction costs
• Managed by professional fund managers