Charlee_CH_2 - FIN MKTS: CHAPTER 2 I. Function of Financial...

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FIN MKTS: CHAPTER 2 I. Function of Financial Markets a. Perform essential economic function of channeling funds from households/firms/government that have saved surplus funds to those who have a shortage of funds. b. Essential to promoting economic efficiency i. Without financial markets it is hard to transfer funds from a person who has no investment opportunities (saver) to one who has them 1. People who save are frequently not the same people who have profitable investment opportunities available to them (entrepreneurs) ii. Markets are critical for producing an efficient allocation of capital, which contributes to higher production and efficiency for the overall economy. c. Well-functioning markets directly improve the well-being of consumers by allowing them to time their purchases better i. Provide funds to young people to buy what they need without forcing them to wait until they have saved ii. Efficient markets improve the economic welfare of everyone in society d. Lender/Savers i. Principal lender/savers are households e. Borrowers/Spenders i. Most important borrower/spenders are businesses and government (particularly federal) f. Direct Finance – borrowers borrow funds directly from lenders by selling them securities (financial instruments), which are claims on the borrower’s future income/assets. i. Securities are assets for the person who buys them (lender) and liabilities for the issuer (borrower) ii. EX: GM needs to borrow funds for new factory – borrow funds from saver by selling saver a bond II. Structure of Financial Markets a. Debt and Equity Markets i. Most common way to obtain funds in a financial market is to issue a debt instrument (bond/mortgage) 1. contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until specified date when final payment is made ii. Second method to obtain funds is issuing equities (common stock) 1. claims to share in the net income and assets of a business (dividends) 2. Disadvantage : equity holder is a residual claimant; the corporation must pay all its debt holders before it pays its equity holders 3. Advantage: equity holders benefit directly from any increases in the corporation’s profitability or asset value iii. *Size of debt market greatly exceeds that of the equities market (50% larger) b. Primary and Secondary Markets i. Primary – new issues of a security are sold to initial buyers by the corporation or government agency borrowing the funds (stock/bond) 1. not well known to buyers – selling takes place behind closed doors 2. Investment banks assist in the initial sale of securities by underwriting – guarantees a price and then sells to public ii. Secondary – securities that have been previously issued can be resold 1. New York and American Stock Exchanges 2. Securities brokers and dealers crucial a. Brokers – agents of investors who match buyers with sellers b. Dealers – link buyers and sellers buy buying and selling at stated prices
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This note was uploaded on 02/21/2011 for the course FIN 3403 taught by Professor Duong during the Spring '08 term at The University of Oklahoma.

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Charlee_CH_2 - FIN MKTS: CHAPTER 2 I. Function of Financial...

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