CHAPTER 2 FINANCIAL MARKETS AND INSTITUTIONS LN 9 1 2015 CAPITAL ALLOCATION PROCESS In a well functioning economy capital flows from those who supply demand Suppliers of capital individuals institutions with excess funds Demanders of capital need for funding willing to pay ROR How is capital transferred Saving money looking for rate of return ROR on investment Direct transfers Financial intermediaries Indirect transfers CAPITAL TRANSFER PROCESS Business Intermediary investment banks financial interm Savers Securities stock or bond flow to right from B to S Dollars flow to left from S to B Investment banking house Paid commission to help you see where your investments are going dashed lines into intermediary visible Financial intermediary You don t see where your money goes solid lines into intermediary Ex Deposit into Bank of America you have no idea where they use the MARKET a venue where goods and services are exchanged money Money vs Capital Money financial instruments with maturity of less than 1 year Capital long term with maturity of more than 1 year Primary vs Secondary Primary new issues of security sold Secondary outstanding shares are traded Public vs Private Spot vs Futures Private not open market for security trade Spot on the spot product delivered and payment made immediately Futures lock in a rate contract for later date Product delivered in future IMPORTANCE OF FINANCIAL MARKETS Provide returns to savers give money to users to finance their projects CHAPTER 2 FINANCIAL MARKETS AND INSTITUTIONS LN Ex Deposit into Bank of America you have no idea where they use the Private not open market for security trade Spot vs Futures Spot on the spot product delivered and payment made immediately Futures lock in a rate contract for later date Product delivered in future IMPORTANCE OF FINANCIAL MARKETS Provide returns to savers give money to users to finance their projects DERIVATIVE a derivative s security value is derived from the price of another security ex PHYSICAL VS ELECTRONIC STOCK MKT Options futures Dealer vs auction market Dealer takes ownership Auciton just facilitates the process doesn t take ownership STOCK MARKET TRANSACTION Apple wants to issue additional stock newly issued with the help of its investment banker This would be an example of Primary market transaction b c stock is being issued for first time STOCK MARKET EFFICIENCY IPO initial public offering Securities are normally in equilibrium and are fairly priced b c stock prices reflect information quickly Investors can t beat the market except through good luck or better information Efficiency continuum Highly inefficient Highly efficient Inef small companies not followed by many analysts Not much contact with investors Eff large companies followed by many analysts good communication with investors Ex Medical research received FDA approval If market is highly efficient can you expect to take advantage by purchasing sock No b c that info should already be reflected in the price by the time you act on that information stock prices reflect information quickly DERIVATIVE a derivative s security value is derived from the price of another security ex Apple wants to issue additional stock newly issued with the help of its investment Ex Medical research received FDA approval If market is highly efficient can No b c that info should already be reflected in the price by the time you