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Lecture 2 - Financial Markets (Finance Types (Direct (Transfer of funds…
Lecture 2 - Financial Markets
Finance Types
Direct
Transfer of funds from surplus units to deficit units via financial markets
Indirect
Transfer of funds does not occur directly between parties, financial intermediaries interpose the transaction
The needs of different economic agents
Surplus agents
Expenditure is less than income
More risk-avoiding
Desire highest rate of returns for the lowest possible risk
Prefer short term securities
Deficit Agents
Expenditure greater than income
Generally risk takers
Prefer longer-term securities
Desire lowest possible cost at the highest possible investment
Roles played by Financial Markets
Pricing Function
Markets provide buyers/sellers with a fair estimation for the price of their goods/services
Discipline Function
Due to fear of adverse selection, governments and large companies are fearful of introducing policies too radical - this fear is provided by financial markets and the competition between suppliers
Primary and Secondary Markets
Primary markets
Deal in the issue of new securities
securities must be underwritten and distributted
Issuer receives proceeds from sale
Primary Market information
Examples of organisaitons that operate in primary markets: Governments, Corporations, Local Authorities
Securities underwritten by banks and financial institutions, who distribute them about the economy
Secondary markets
Deals in second hand securities
Issuer receives nothing from the sale, all proceeds go to the party who sold the security
Secondary Market Information
Once a security has been allocated to investors, it can be bought or sold on the stock market
Despite receiving no proceeds from the secondary market, it is useful to the issuer because:
Gives an estimation of the value of the company
Liquidity provided in the secondary market decreases the cost of capital of the issuers