Financial system

Extract

[...] We can use the market price as a signal of judgment. - Money versus capital markets Money markets: trade debt securities or instruments with maturities of one year or less Most US money markets are over the counter OTC markets. Capital markets: trade debt (bonds) and equity (stocks) instruments with maturities of more than one year. Wider price fluctuations than money market instruments Broker: no use of the personal portfolio Dealer and market maker: directly involved in the market exchange with our portfolio. [...]

[...] - Foreign exchange risk - Country (that is, sovereign) risk - Interest rate risk - Market risk, or asset price risk - Off-balance sheet risk (related to bonds and off-balance items) - Liquidity risk (ability to convert Financial instruments in cash) - Technology and operational risk - Insolvency risk The interest rates Nominal interest rates could be observed in financial markets. The higher is the interest rate the higher is the expected risk. An interest rate would have an influence on the willingness to invest. Loanable theory = equilibrium interest rates in financial markets is the result of the supply of and demand for loanable funds. Generally, the quantity of loanable funds supplied increases as interest rates rise. [...]

[...] For example, it's forbidden to use inside information about our own firms to trade our own securities. The objective is to avoid market failures. Two main reasons of market regulation: - Reduce information asymmetries: investors could be subject to adverse selection and moral hazard. - Ensure the soundness of the system: restriction on entry, disclosure of reporting requirements, restrictions on assets and activities, deposit insurance, restriction on interest rates, tight capital requirements. In a world without Financial Institutions the flow of funds would be quite low due to monitoring costs, liquidity risk, price risk. [...]

[...] On the contrary, the quantity of loanable funds demanded increase as interest rates fall. The interest rate is the cost of borrowing thus the longer is the maturity the higher is the cost of borrowing the higher is the interest rate. A coupon rate could be fixed or follow an observable rate on a chosen market. Example: 63.5228 FV= 100 RFR= 0.5% DRP= 2.5% SCP= LP= MP= 0.5% thus 9.5% 5 years to maturity PV = 100/(1+9.5%)^5 = 63.52276 63.5228 = = 9.5% in this case we buy the bound 2 years later the market price P = 75 Realized rate of return = 8.66% n^racine(FV/PV-1) In case we increase our r to PV = 100/ = 56.743 Current price face value = retain something on the coupon rate Maturity 10 years, r face value 50 1st interest payment for a coupon = 1.5 and the 9 following are going to be 1.5 The same if we get a coupon or a coupon. [...]

[...] Financial markets can be distinguished between two major dimensions: - Primary versus secondary markets Primary market = 2 economic agents, one with a shortage of funds and one with the excess When the initial investor by the security, then the first agent in shortage gets funds, and the security could be exchanged again and again on the secondary market. Primary markets: users of funds raise funds through new issues of financial instruments, such as stocks and bonds, including issues of equity by firms initially going public, referred to as initial public offerings. Secondary market: markets that trade financial instruments once they are issued. This market is the mirror of the project which needs funds, if the price is rising it means that the project is appreciated and vice versa. [...]