price in the secondary market, the higher will be the price that the issuing firm will receive for a new security in the primary market and hence the greater the amount of capital it can raise. Conditions in the secondary market are therefore the most relevant to organizations issuing securities. Secondary markets can be organized in two ways. One is to organize exchanges, where buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trades. The other method of organizing a secondary market is to have an over-the-counter (OTC) market, in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities "over the counter" to anyone who comes to them and is willing to accept their prices. Because over-the-counter dealers are in computer contact and know the prices set by one another, the OTC market is very competitive and not very different from a market with an organized exchange.
24 Money and Capital Markets Another way of distinguishing between markets is on the basis of the maturity of the securities traded in each market. The money market is a financial market in which only short-term instruments (maturity of less one year) are traded; the capital market is the market in which longer-term debt (maturity of one year or greater) and equity Instruments are traded. Money market securities are usually more widely traded than longer-term securities and so tend to be more liquid. In addition short-term securities have smaller fluctuations in prices than long-term securities, making them safer investments. As a result, corporations and banks actively use this market to earn interest surplus funds that they expect to have only temporarily. Capital market securities such as stocks and long-term bonds are often held by financial intermediaries such as insurance companies and pension funds, which have little uncertainty about the amount of funds they will have-available in the future. 2.3. FUNCTION OF FINANCIAL INTERMEDIARIES As shown in Figure 2.1, funds can move from lenders to borrowers by a second route, called indirect finance because it involves a financial intermediary that stands between the lender-savers and the borrower-spenders and helps transfer funds from one to the other. A financial intermediary does this by borrowing funds from the lender-savers and then uses these funds to make loans to borrower-spenders. For example, a bank might acquire funds by issuing a liability to the public in the form of savings deposits. It will then use the funds to acquire an asset by making a loan to a business firm or investor who needs fund. The ultimate result is that funds have been transferred from the public (the lender-savers) to the business firm or the investor (the borrower-spender) with the help of the financial intermediary (the bank).
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- Summer '17