Notes inclass 22/01

The roles of financial markets are the same role as any market, that is to transfer funds from borrowers to lenders and to allocate funds between alternative uses.

Surplus funds

Deficit and surplus units- level of savings defined as Income – Consumption = the income must be greater then the consumption function. We aren’t worried about the classification.

Definition: a surplus (deficit) unit saves more (less) than it invests. Investments don’t need to can be capital can be (a home, without borrowing not producing cash but can have a opportunity cost)

Some terms

‘Investment’ refers to the acquisition of new physical assets. financial securities, life style investment.

‘Saving’ means the change in a unit or sectors net worth. (Net worth = assets- liabilities)

‘Dissaving’ occurs when consumption exceeds income.

Implications

Surplus units- lend to other, increase their net assets, issue financial claims. (equity doesn’t have a set value, rights to the money, risk, no guarantees in equity)

Deficit units- borrow from others, run down their net assets, take financial obligations.

Intermediation

Also called indirect financing

Stands inbetween the borrowers and lenders. Involves the transfer of funds between ultimate savers and ultimate borrowers via deposit-taking institutions. Could be a shady person on the street or a bank. Lender of last resort borrowing from the reserve bank. The bank takes the money because they know they can lend for a higher amount.

Advantages of intermediation

Pooling of funds and lend out.

Multiplier effect

Aggregation

Economies of scale

Liquidity

Spreading risk- diversification.

Direct financing

-the transfer of funds from ultimate savers to ultimate borrowers without an intermediary.

Advantages of direct financing

-better returns. (cut out the middle man, earn more)

- cost savings (lower transaction costs)

Financial markets

‘primary market’ is where investors purchase financial securities from the original issuer

Secondary market’ is where investors trade their securities with other investors.

Issuing financial securities

IPO- initial public offering

Public offering: the issuance of securities to the general public

Private placement: the issuance of securities to a single investor or group.

Liquidity of financial markets

-refers to the ease of buying and selling without undue price fluctuations.

-related to volume of turnover

-depends on: depth, breadth, resilience

-dealers and brokers help create liquidity.

Trading financial securties

-Exchage-traded is a market where securtieis are dealty via a centralised exchange facility

-over the counter is when securities are issued and exchange through a dealer or bank.

Securities markets

-a securities market is a market in which a particular type of seucirty is issued and traded

Liquidity: a desirable quality of securities market. Liquidity means that market participants can easily buy or sell parcels of the security without causing changes in the price.

Participants who add liquidity

Market-makers: traders who quote prices at which they are willing to buy or sell any time. Take the position, who need moneys, vultures.

Speculaters: players who take an open position in the market, hoping to profit but also risking a loss. even if they don’t own the shares,

Arbitragers: take offsetting positions in twin markets for profit without risk.

Stability of securities markets

Benefit of liquidy and confidence

Other qualities of securities market

Negotiability:

Low risk: