The Functions Of Securities Markets

Question 1

Money markets vs capital markets

Answer 1

1. Money markets have securities with maturity < 1 yr
2. Capital markets have securities with maturity > 1 yr

Question 2

What are the 4 main functions of securities markets?

Answer 2

1. Raising capital (in the capital markets)
2. Transferring risk (in the derivatives market)
3. Price discovery
4. Creating liquidity

Question 3

One of the main functions of securities markets is “raising capital”. Explain this further

Answer 3

1. Can raise capital by issuing equities/ shares or bonds (corporate bonds)
2. Funds raised can be used to purchase new machinery/ resources that enable firm growth
3. Mobilisation of savings (more liquidity)

Question 4

One of the main functions of securities markets is “transferring risk”. Explain this further

Answer 4

1. Use derivatives to hedge the risk by using index futures contracts
2. Fund manager obtains protection against the risk but, risk itself is not disappeared
3. Risk transferred to the counterparty of the derivative contract e.g trader

Question 5

One of the main functions of securities markets is “price discovery”. Explain this further

Answer 5

1. Determining price of a financial asset e.g stocks/ bonds based on supply and demand
2. Happens when buyers and sellers interact in the market and agree to trade - agreed price reflects the asset’s value
3. Buyers will place a bid (max they are willing to buy the stock for) and sellers place offers (min they are willing to sell the stock for)

Question 6

One of the main functions of securities markets is “creating liquidity”. Explain this further

Answer 6

1. Allow investors to liquidate/ sell their investments
2. Ability to sell investments quickly makes them more attractive to hold and encourages investors to buy them in the first place

Question 7

Define Liquidity in a financial market

Answer 7

The ability to sell a security without causing a significant movement in its price and with minimum loss of value

Question 8

Define what “liquid” market means

Answer 8

A market in which there are many buyers and sellers

Seller is more likely to sell at a price they wish to sell at if there are many buyers willing to trade at the same time.

Question 9

What is a primary market with regards to securities markets?

Answer 9

1. New securities are issued and initially sold to investors for the first time
2. E.g company can issue new shares to raise capital
3. When this is a FIRST ISSUE into the markets - we say that the company is making an INITIAL PUBLIC OFFERING (IPO)

Question 10

Explain IPO in terms of primary markets

Answer 10

IPO - initial public offering

When a company sells its shares to the public for the first time to become publicly traded

Question 11

What is a secondary market with regards to securities markets?

Answer 11

1. Where the subsequent trading of the shares takes place (i.e. after they’re initially issued in primary market)
2. Provides liquidity to investors
3. Funds go to the investors involved in the trade

Question 12

Explain sell-side vs buy-side briefly

Answer 12

Sell side firms e.g. banks/ brokers/ dealers - provide transaction services and investment products

Buy/side firms e.g. investment managers - purchase these services and products