Chap. 14 Questions 14-1, 14-3, 14-4
Chap. 15 Questions 15-12A, 15-13A
What are financial markets? What function do they perform? How would an economy be worse off without them?
Financial markets report price for each good; they are institutions and procedures that facilitate transactions in all types of financial claims (securities). They exist in order to allocate the supply of savings from those economic units with a surplus to those with a deficit.
Each financial market has a different function that they perform. For example, the stock markets primary function is to provide a platform for investors to buy shares of ownership of a public corporation which are sold to investors to allow the companies to raise a lot of cash at once. The investors profit when the companies increase their earnings which keeps the United States economy growing.
With mutual funds give you the ability to buy a lot of stocks at once. In a way this makes them an easier tool to invest in than individual stocks. By reducing stock market volatility, they have also had a calming effect on the United States economy.
In commodities, such as oil, the price is determined in the commodities futures market. The futures market are a way to pay for something today that is delivered tomorrow, which helps to remove some of the volatility in the United States economy. However, futures also increase the trader’s leverage by allowing him to borrow the money to purchase the commodity.
Hedge funds are supposed have higher returns for high-end investors. Since hedge funds invest heavily in futures, some argue that they have decreased the volatility of the stock market and the United States economy.
Bonds also provide some of the liquidity that helps keep the United States economy lubricated. However, when stock prices go up the bond prices go down.
The economy would suffer without a developed financial market system because the wealth of the economy would be less without them. Rate of capital formation would not be as high, followed by the slowed rate of stock contribution to (1) dwellings, (2) productive plant and equipment, (3) inventory, and (4) consumer durables. Normal business activities would be funded slowly or not at all.
Business firms in the aggregate usually spend more during a specific period than they earn. Households in the aggregate spend less on current consumption than they earn. As a result, some mechanism is needed to facilitate the transfer of savings from those economic units with a surplus to those with a deficit. That is precisely the function of financial markets. Financial markets exist in order to allocate the supply of savings in the economy to the demanders of those savings. The central characteristic of a financial market is that it acts as the vehicle through which the forces of demand and supply for a specific type of financial claim are brought together. If, specifically, the United States did not have a financial market then there would not be a way for the economy to move money around to facilitate progress and profit.
Distinguish between the money and capital markets.
Money Markets facilitates transactions using short-term financial instruments; whereas, Capital Markets facilitates transactions using long-term financial instruments.
A money market is a market for short term debt securities such as banker’s acceptances, commercial paper, repos, negotiable certificates of deposit, and Treasury Bills with a maturity of one year or less and often 30 days or less. Money market securities are generally very safe investment which returns a relatively low interest rate that is most appropriate for temporary cash storage or short-term time horizons. A capital market is where debt or equity securities are traded.
What major benefits do corporations and investors enjoy because of the existence of organized...