E305 Chapter 2_Word

E305 Chapter 2_Word - E305 Chapter 2 Function of Financial Markets Lender Savers and Borrower Spenders In direct finance borrowers borrow fund

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E305 Chapter 2 Function of Financial Markets Lender Savers and Borrower Spenders In direct finance, borrowers borrow fund directly from lenders in financial markets by selling them securities Securities = claims on borrower’s future income or assets Securities are assets for person who buys them but liabilities (IOU) for person who sell (issue) them. e.g. bond (debt securities); e.g. stock ( a security that entitles the owner to a share of company’s profit) Financial markets are essential to promoting economic efficiency Makes both lender (earn interest) and borrower (extra productivity/ enjoyment) better off Financial Markets are critical for producing efficient allocation of capital, results in higher production and efficiency Improve well being of consumer by allowing them to time their purchase better Structure of Financial Markets Debt and Equity Market • Individual can obtain funds in financial market in 2 ways • Issue Debt or Equity Debt such as bond or mortgage short term debt -- less than a year long term debt -- more than 10 years intermediate term -- in between Equity such as common stock claims to share in the net income and the assets of a business Equities often make periodic payments (dividends) to their holders Are considered long term securities because they have no maturity date * Main disadvantage of owning corp equities rather than debt is that equity holder is a residual claimant, that is, the corp must pay all its debt holders benefit directly from any increase in profit because equities confer ownership rights on the equity holders. Debt holders do not share this benefit (their dollar pmt is fixed) Primary and Secondary Markets
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E305 Chapter 2 Primary market is financial market in which new issues of a security are sold to initial buyers by the corp or govt borrowing the funds Primary market for securities are not well known to the public because selling of securities to initial buyers often take place behind closed doors Investment bank assist the initial sale of securities in primary market, they underwrite securities (guarantees a price for corp securities and then sells them to public) Secondary market is a financial market in which securities that have been previously issued can be resold e.g. New York Stock Exchange , NASDAQ Securities brokers and dealers are crucial to secondary market Brokers are agents of investors who match buyers with sellers of securities Dealers link buyers and sellers by buying and selling securities at stated prices Secondary markets serve 2 important functions 1. They make it easier and quicker to sell these instruments to raise cash (make instruments more liquid). The liquidity makes them more desirable and easier for firm to sell in primary market 2. They determine the price of the security that the issuing firm sells in primary market Investor who buy securities in primary market will only pay the price they think the
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This note was uploaded on 12/12/2011 for the course BUS 345 taught by Professor Reiben during the Spring '11 term at Indiana.

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E305 Chapter 2_Word - E305 Chapter 2 Function of Financial Markets Lender Savers and Borrower Spenders In direct finance borrowers borrow fund

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