Chapter 2 notes * Everyday individuals, businesses, and the government, have direct and indirect contact with financial markets (institutions and procedures for bringing buyers and sellers of financial instruments together) * Without financial markets, firms could not finance their investment in assets to support their business, most individuals could not purchase their new car or home, some students could not pay their college tuition and government could not provide benefits that improve the quality of our lives.
Purpose of Financial Markets * Financial markets exist because businesses, individuals and the government are not self-sufficient in regards to paying for their investments in real and financial assets. * Real assets * Physical things * Such as * Cars * Houses * Equipment * Inventory * Petroleum * Financial assets * Derive their value based on their claim on real assets * Such as * Stocks * Bonds * Mortgages * Some individuals and businesses have surplus funds because incomes > expenditures => money available for investment * While other economic units are deficient in their funds, which leads to the need to acquire money * Financial markets bring these suppliers and demanders of funds together to accomplish their goals * Without financial markets * Rate of capital formation would not be as high * Creation of inventory, productive factories, establishment of communities would be considerably lower * Overall wealth of a nation would be less * Financial markets serve an important function in an economy because they facilitate efficient, convenient and inexpensive allocation of funds from those who have a saving surplus to those who have a savings deficit * In summary financial market provide benefits to both corporations and investors by: 1. Providing a continuous, liquid marketplace where price fluctuations from transaction to transaction are smaller than in the absence of such an arena. All transactions occur quickly on large sales quantities, which helps to reduce the spread between the price asked and offered on any security. 2. Determining and publicizing fair prices that reflect the competitive environment of the exchanges. All transactions occur openly, in an auction style and not through private negotiations, creating a fair price that reflects the underlying value of the security. Final sale prices are well publicized and easily obtained at any time during and after trading hours. 3. Assisting businesses to obtain new financing. Since a ready and competitive secondary market exists, it is easier for companies to offer new securities because investors know that at any time, these securities are liquid. The competitive environment supports the pricing process and inspires companies to continuously add value to their company
Description of financial markets * Each market focuses on a different kind of instrument in terms of maturity and the assets backing it, but all have a role in channeling funds through the economy. It is broadly divided into money and capital markets.
Money Markets * Focus on buying and selling government and corporate debt that matures within one year of its issuance. A firm’s marketable securities portfolio manager usually restricts its purchases to these types of investment because of their liquidity and generally low risk.
United States Treasury bills (T-bills) * Sold to finance short-term federal government expenditures and are direct obligations of the federal government. * Sold on discount basis, therefore investor does not receive an actual interest payment but earns a return by paying less than the maturity value received. * These securities are very popular because there is a large, active secondary market and are the safest investment available * Risk-free and