FINMAN 8

Financial markets meeting place for

people, corporations and institutions that
either need money or have money to lend or
invest.
-participants in the financial markets also
include national, state and local governments
that are primarily borrowers of funds for public
activities; markets are referred to as public
financial markets.
-large corporations raise funds in the
corporate financial markets
-when a corporation uses financial
market to raise new funds, sale of
securities is said to be in the primary
market by way of a new issue. After
securities are sold to the public
(institutions and individuals), they are
traded in the secondary market between
investors
STRUCTURE AND FUNCTIONS OF
FINANCIAL MARKETS
Types of markets
1. Physical asset markets versus
financial asset markets
-physical asset markets (also
tangible or real asset markets) are for
products such as wheat, autos, real
estate, computers and machinery,
-financial asset markets, deal with
stocks, bonds, notes and mortgages
also derivative securities whose values
are derived from changes in the prices
of other assets.
2.
Spot market vs. future markets
-spot markets are markets in which assets
are bought for or sold for on the spot
delivery
-future markets are markets in which
participants agree today to buy or sell an
asset at some future date.
3.
Money markets vs. capital markets
-money markets are financial markets in
which funds are borrowed or loaned for short
periods
-capital markets are financial markets for
stocks and for intermediate or long term debt
4.
Primary markets vs. secondary
markets
-primary markets are markets in which
corporations raise capital by issuing new
securities.

-secondary markets are markets in

which securities and other financial assets are
traded among investors after they have been
issued by the corporations.
5.
Private markets vs. public markets
-private markets are markets in which
transactions are worked out directly between
two parties.
-public markets are markets in which
standardized contracts are traded on
organized exchanges.
FINANCIAL INSTITUTIONS
Categories of financial institutions
1. Investment banks an organization
that underwrites and distributes new
investment securities and helps
business obtain financing.
2. Commercial banks traditional
department store of finance serving a
variety of savers and borrowers
3. Financial services corporations
firm that offers wide range of financial
services, including investment banking,
brokerage operations, insurance and
commercial banking
4. Credit unions cooperative
associations whose members are
supposed to have a common bond,
such as being employees of the same
firm. Credit unions are often the
cheapest source of funds available to
individual borrowers.
5. Pension funds retirement plans
funded by corporations or government
agencies for their workers and
administered primarily by the trust
departments of commercial banks or by
life insurance companies
6. Life insurance companies savings
in the form of annual premiums; invest
these funds in stock, bonds, real estate
and mortgages and make payments to
the beneficiaries of insured parties
7. Mutual funds organizations that pool
investor funds to purchase financial
instruments and thus reduce risks
through diversification. Money market
funds are mutual funds that invest in
short term, low risk securities and allow
investors to write checks against their
accounts.
8. Exchange Trade funds similar to
regular mutual funds and are often
operated by mutual fund companies.
ETF buy a portfolio of stocks of a certain
type and then sell their own shares to
the public

9. Hedge funds similar to mutual funds

information about a particular
because they accept money and use
security than other market
the funds to buy various securities, but
participants. This info leads them to
there are differences
believe that the security is not being
10.
Private equity companies
correctly priced by the market.
organizations that operate much like
2. Liquidity Motivated reasons
- Transact in the secondary market
hedge funds but rather than purchasing
because they are currently in a
some of the stock of firm, private equity
position of either excess or
players buy and then manage entire
insufficient
liquidity. Investors with
firms.
surplus cash holdings will buy
STOCK MARKET
securities; where as investors with
*the price of money is the rate of interest paid
insufficient
cash will sell securities.
for use. If the demand for investment
MEANING OF STOCK EXCHANGE
funds is greater than the funds offered
Stock exchange an organized secondary
for investment by savers, rate of interest
market where securities like shares,
will rise until people in the economy will
debentures of public companies, government
be induced to forgo consumption and
securities and bonds issued by municipalities,
make their savings available for
etc.
investment.
-an entity which is in the business of bringing
The new issues of securities are made
buyers and sellers of stocks and securities
available in the primary market. The
together.
securities that are already outstanding and
-its purpose is to facilitate exchange of
owned by the investors are usually bought
securities between buyers and sellers thus
and sold through the secondary market which
providing a market place, virtual or real.
is the stock market.
The securities of government are traded in the Outcry method share brokers assembled in a
place called trading ring and bought and sold
stock market as a separate component called
shares
gilt edged market. Government securities
Listing agreement ensures that the
are traded outside the trading wing in the
company provides all the information
form of over the counter sales or purchases.
pertaining
to its working from time to time,
The proceeds from sale in the stock market do
including events that affect its valuation.
not go to the issuing organization but to the
current owner of the security. Once new issues *stock market is known as barometer of the
companys economy.
have been purchased by the investors, they
LISTING OF SECURITIES ON STOCK
change hands in the stock market. The
EXCHANGE
primary middlemen in the stock market
Listing

admission
of securities to dealings
are the brokers and dealers.
on a recognized stock exchange of any
*brokers act as an agent whereas dealers
incorporated company, central and state
act as a principal in the transaction.
governments, quasi governmental, etc.
*stock markets are said to reflect the
The principal objective of listing is to
health of the countrys economy.
provide liquidity and marketability to listed
*individuals who wish to avoid or reduce risk
securities
and ensure effective monitoring of
can deal with others who are willing to accept
the risk for a price the place where this takes trading for the benefit of all participants in the
market
place is the derivative market.
Recognized
stock
exchange a stock
KINDS OF STOCK MARKET
exchange being recognized by the national
1. Organized stock exchange stock
government through the SEC. Securities are
exchanges will have a physical location
bought and sold in recognized stock
where stocks buying and selling
exchanges
through members who are known
transactions take place in the stock
as brokers.
exchange floor
2. Over the counter exchange where
The price at which the securities are bought
shares, bonds, and money market
and sold on a recognized stock exchange is
instruments are traded using a system
known as official quotation.
of computer screens and telephones.
THE SECURITIES OF AN ENTITY MAY BE
Reasons for transactions in stock market
ISTED AT ANY OF THE FOLLOWING
1. Information motivated reasons
STAGES:
- Information motivated investors
*at the time of public issue of shares or
believe that they have superior
debentures

*at the time of rights issue of shares or

debentures
*at the time of bonus issue of shares
*shares issued on amalgamation or
merger
*a person who wishes to sell his security
is called a seller, a person who is willing
to buy is called buyers.

-global market is bigger than any

single national market including that
of the United states.
4. Access to New Ideas
- when countries trade, they not only
exchange goods and services but
they also trade ideas and ways of
doing things thus accelerating
development of new products
Absolute advantage if a country
has absolute advantage in the
production of a particular good,
there is an incentive for that country
to produce more than its citizens
need to export the good to countries
with higher production costs.
Comparative advantage country
has no alternate uses of its
resources that would involve a
higher return
*by exploiting its comparative
advantage and exporting goods
and services, a nation can
import the goods for which it
has a comparative
disadvantage. In this manner, all
nations are better off.
OBSTACLES TO FREE TRADE
Import tariff a tax on an
imported product.
Import quota a restriction on the
amount of a good that may be
imported during a period.
Arguments in favor of trade
restrictions
To protect domestic labor against
inexpensive foreign labor
To reduce domestic
unemployment
To protect young or infant
industries
To protect industries important to
the nations defense

Chapter 9
Mercantilists emphasized the power
of national economy favoring state
intervention to maximize wealth by
building huge export surpluses.
Classical economists condemned
mercantilism as inefficient. Classical
school favored free trade between
nations based on comparative
advantage and w/o government
interference
FOREIGN EXCHANGE RATES
GATT was the first framework to
establish worldwide free trade based on
Exchange rates relationships among the
a commitment by 23 nations
value of currencies
In 1995, GATT converted to WTO
with 150 members and a better
FACTORS INFLUENCING EXCHANGE RATES
procedure for resolving disputes.
GAINS FROM TRADE
*factors that tend to increase supply or
1. Lower prices of goods and
decrease demand schedule for a given
services
currency will bring down the value of
-products are less expensive than
that currency in foreign exchange
comparable domestic products.
markets. (happens the other way around
2. Access to Natural resources
as well)
- too expensive to be produced
domestically or insufficient in
Major reasons for exchange rates
quantity
movements include:
3. Access to Global markets

*Inflation tends to deflate the value of a

currency because holding the currency results
in reduced purchase power

*Government intervention central bank of

a country may support or depress the value of
its currency

*Interest Rates if interest returns in a

particular country are higher relative to other
countries, individuals, companies, etc will be
enticed to invest in that country. (increase in
demand for the countrys currency)

*Other factors political and economic

stability, extended stock market rallies and
significant declines in the demand for major
exports.

*balance of payments system of accounts

that catalogs the flow of goods between the
residents of two countries.