Introduction Of Market Place Lec1-Investment Managment And Portfolio-Lecture Notes, Study notes of Investment Management and Portfolio Theory

Download Introduction Of Market Place Lec1-Investment Managment And Portfolio-Lecture Notes and more Study notes Investment Management and Portfolio Theory in PDF only on Docsity! y g ( ) Lesson # 2 INTRODUCTION OF MARKET PLACE Capital markets are the hallmark of the capitalized system. With the collapse of the Soviet Union, hundreds of delegations from the former communist bloc countries have visited the United States to learn about out markets and to facilitate the development of markets in Eastern Europe. Stock markets are one of humankind’s greatest inventions; they raise everyone‘s standard of living,. Capital growth promotes job creation, increases disposable income, and increases charitable giving. The capital markets enable better use of the resources we have, allowing us to alter our consumption pattern over time. Despite these benefits, many Americans are ignorant of how markets work. For them, the nightly newscast is largely incomprehensible when the talk turns to the day’s activity on Wall Street. This chapter serves as a primer on our markets, how they work, and why we have them. More detail follows in subsequent chapters. This chapter also introduces the Association for Investment Management and Research (AIMR), and the Chartered Financial Analyst (CFA) program. The CFA is a prestigious credential for those involved in the investment business. Many firms require participation in the CFA program as a condition of employment. Sections of this book and end-of-chapter problems related to the CFA program are marked with the symbol shown in the margin. THE ROLE OF THE CAPITAL MARKETS: Why is there a New York stock Exchange, or a Chicago Board of Trade, or a Chicago Board option Exchange? An exchange serves three principal functions: an economic function, a continuous pricing function, and a fair pricing function. Although exchange function is a topic in macroeconomics, the concept is sufficiently important to warrant discussion in an investments text. ECONOMIC FUNCTION: The most important function is the economic function. This mechanism facilitates the transfer of money from savers to borrowers. As an example, consider the secondary market for home mortgages. Many small communities in the United States contain middle-class residents with modest savings. Still, the houses they buy are expensive, and virtually everyone needs to borrow money to buy a house. A town’s residents usually have a bank relationship because of the convenience checking and savings accounts offer. People also look to banks for home mortgages suppose one person goes to the local bank and is able to get a $100000 loan. Three other families do the same thing shortly thereafter. Very quickly, the entire saving of the town is loaned out. The bank cannot loan money it does not have. Does this mean that no one else in the town can buy a house? Fortunately, it does not. Elsewhere in the United States, individual investors want to lend money rather than borrow it. The key is to match up the would-be borrowers with the available savers. THE local banks holding the mortgage certificates can sell these mortgages to someone else, and routinely do so. Government agencies like the Government National Mortgage Association and the Federal National Mortgage Association help facilitate these sales. Once the local bank sells a mortgage, it receives an inflow of money that can be used to finance someone else’s home mortgage. These mortgages can be sold, too, and the cycle goes on. Similarly, corporations periodically need to raise money and often sells stocks and bonds to the public. The U.S government never has enough money, it seems, and sells treasury bonds to buyers all over the world. Investors with surplus cash buy these securities. Individual docsity.com y g ( ) who already own stock and suddenly need to raise cash con sell their shares to someone else. These are all the examples of the economic function of the capital markets: Facilitating the flow of capital from those who have it and wish to invest it to those who need it and want to borrow it. When a firm sells securities to the public for the first time, it does so in the primary market. The firm receives cash in the exchange for the creditor position. After their initial sale, securities trade in the secondary market, also known as the used of securities market. After selling shares in the primary market, the issuing firm receives cash. Concurrently, the shareholders equity portion of the corporate balance sheets changes. Trading in the secondary market, however, does not affect the firm’s financial statements. If X buys 100 shares of the Intel common stock for $ 64, he pays $ 6400 to the seller of the shares. Intel receives nothing from the trade. Similarly, if y sells her Saturn automobile, the sale has not impact on the automobile company’s financial statements. When people talk about what happened on the stock market, they usually mean the secondary market. The economic functions of the capital markets: facilitating the flow of capital from savers to borrowers. Continuous Price Function: A second function of the capital markets is the continuous pricing function. It means precisely what the name indicates – prices are available moment by moment – and provides a tremendous advantage to the security investors. Consider the case of alternative investments: How much is an antique grandfather’s clock worth? How about Chinese porcelain, or 50 acres of southern pine timberland? Determining the value of these items is not always cays, nor can the task always be accomplished quickly. First, an appraiser checks authenticity and condition. Having established this, we may need to check recent sales of comparable items. This could involve researching catalogs and auction reports or making numerous telephone calls. The necessary activities in this process can be time consuming and even nuisance These problems are not an issue with financial assets as sticks and bonds. In most cases, anyone can discover the prices of the various financial assets instantly during the business day. People routinely call their broker and ask, “How’s IBM? How about Texaco?” they fully expect and have come to take for granted an instant reply. Alternatively, one can always check the wall street journal or other newspaper with a business section or pull prices off the internet. Some securities seldom trade, and we would be less confident in our ability to get a quick notation of a firm that is too small to be carried in the electronic price reporting system. Still, we could probably get a good estimate more quickly than we could for an attic full of uncategorized art or shoebox full of old coins. The continuous price function enables market participants to get accurate, up-to-date price information. Fair Pricing Function: Fair pricing is the third function of the capital markets. Some people consider it the most important because it means that we can trust the system. You can tell you broker to sell your stock at the going price and be assured of getting a fair price. docsity.com