Assignment1 - Chapter 1 Q4. The financial market helps...

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Chapter 1 Q4. The financial market helps boost the productive capacity of the economy by playing the following roles: Investors in the financial market try to find out as much information as possible before deciding on which company/industry to invest their capital in. This results in the companies with brighter prospects being able to raise capital under easier conditions. This allocation process allows the most efficient and productive components of the economy to flourish while the less efficient and unproductive die. Another role of the financial market is that of channelling capital from ‘net savers’ to ‘net borrowers’. There are some individuals who at any point earn more than they spend, while some will spend more than they earn. The financial market acts as the intermediary to channel these funds so that those who are spending more than their earnings have access to capital at that point, while those who are saving now, get to invest their capital for future gains. The financial markets also allow investors with different risk appetites to invest according to preference. Various types of instruments like stocks, bonds, warrants, options, etc cater to different types of investors. This again brings efficiency to the markets. The financial markets also allow a separation between owners and managers of the company. While it is true that this also brings with it some inherent problems, the benefits of this separation in general outweigh the problems. Finally the financial market mechanism fosters good corporate governance and ethics. Investors demand that the companies they invest in practice high standards of corporate governance and ethics. Again, if companies chose to ignore their responsibilities, then the financial market allows the investors to simply invest in other ventures. This competition for the allocation of resources ensures that in general most companies adhere to a high standard of corporate governance and ethics. The US economy is the perfect example of the above roles of the financial markets. It is a large economy with millions of net savers and net borrowers. The investors range from small household individuals to large institutional investors. The corporations that produce real products depend heavily on the capital and bond markets for their capital requirements. If the financial markets did not exist, then the whole economy would suffer from inefficiencies and the US would definitely not be the financial powerhouse that it is now. Q12
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This note was uploaded on 07/08/2009 for the course FINANCE BMA 5302 taught by Professor Johnputhenpurackal during the Summer '09 term at National University of Singapore.

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Assignment1 - Chapter 1 Q4. The financial market helps...

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