2.1 Financial Institutions and Markets ➔ Review Questions, Study notes of Business Finance

Download 2.1 Financial Institutions and Markets ➔ Review Questions and more Study notes Business Finance in PDF only on Docsity! 2.1 Financial Institutions and Markets ➔ Review Questions 2–1 Who are the key participants in the transactions of financial institutions? Who are net suppliers, and who are net demanders? Key participants in transactions of financial institutions include: a) Depositors and savers: They provide funds to financial institutions such as banks and credit unions. b) Borrowers: Individuals, businesses, and governments borrow funds from financial institutions. c) Financial institutions: These entities, such as banks, credit unions, and insurance companies, act as intermediaries between depositors and borrowers. d) Investors: Individuals and institutions who invest in financial instruments like stocks, bonds, and mutual funds. e) Regulators: Government agencies that oversee and regulate financial institutions to ensure stability and protect consumers. Net suppliers in this context are individuals or entities who provide excess funds (e.g., savers and investors). Net demanders are those who require funds (e.g., borrowers). 2–2 What role do financial markets play in our economy? What are primary and secondary markets? What relationship exists between financial institutions and financial markets? Financial markets play a crucial role in the economy by facilitating the exchange of funds and financial instruments. They provide the following functions: a) Allocation of capital: Financial markets direct funds from savers and investors to borrowers, enabling businesses to finance growth and individuals to purchase homes and other assets. b) Price discovery: Markets determine the prices of financial instruments based on supply and demand. c) Liquidity: They provide a platform for buying and selling assets, enhancing their liquidity. d) Risk management: Markets offer derivatives and other instruments for hedging and managing financial risks. Primary markets are where new securities are issued and sold to the public, while secondary markets are where existing securities are traded among investors. Financial institutions often play a role in both primary and secondary markets by underwriting new issues and facilitating trading. 2–3 What is the money market? What is the Eurocurrency market? The money market is a segment of the financial market where short-term debt securities with maturities typically less than one year are traded. It includes instruments like Treasury bills, commercial paper, and certificates of deposit. The Eurocurrency market refers to the market for currencies deposited outside their home countries, often in European financial centers like London. Eurocurrency market instruments include Eurodollar deposits. 2–4 What is the capital market? What are the primary securities traded in it? The capital market is where long-term debt and equity securities are bought and sold. Primary securities traded in it include: a) Stocks (equity securities): Represent ownership in a company. b) Bonds (debt securities): Represent loans made to a company or government in exchange for periodic interest payments and the return of the bond's face value at maturity. 2–5 What are broker markets? What are dealer markets? How do they differ? Broker markets and dealer markets are two types of financial markets: a) Broker markets: In these markets, brokers facilitate trades by matching buyers and sellers. The broker does not buy or sell the securities themselves but acts as an intermediary. Examples include stock exchanges like the New York Stock Exchange (NYSE). b) Dealer markets: In dealer markets, market makers (dealers) directly buy and sell securities from their own inventory. They quote bid and ask prices at which they are willing to buy and sell securities. Over-the-counter (OTC) markets, where stocks not listed on major exchanges are traded, are an example of dealer markets. The primary difference is in how transactions are executed, with brokers facilitating trades and dealers actively participating by buying and selling securities. 2–6 Briefly describe the international capital markets, particularly the Eurobond market and the international equity market. International capital markets encompass global financial activities, including the Euro bond market and international equity market:  Euro bond market: It involves the issuance and trading of bonds denominated in a currency different from the currency of the country where it is issued. Eurobonds are typically issued in major currencies like the Euro (EUR), U.S. Dollar (USD), or Japanese Yen (JPY).  International equity market: This refers to the global trading of stocks of companies from various countries. Investors can buy and sell shares in foreign companies through exchanges or depositary receipts like American Depositary Receipts (ADRs). These markets allow businesses and investors to access international capital and diversify their portfolios globally. 2–7 What are efficient markets? What determines the price of an individual security in such a market? Efficient markets are markets where all available information is rapidly reflected in the prices of securities. In such markets, it is challenging to consistently achieve above-average returns through trading because prices already incorporate all known information.