1. What are financial markets? Why do they exist? Financial markets are where financial securities are bought and sold. They exist primarily to bring deficit economic units (those needing money) and surplus economic units (those having extra money) together. 2. What is a security? Securities are claims on financial assets. They can be described as “claim checks” that give their owners the right to receive funds in the future. Securities are traded in both the money and capital markets. Money market securities include Treasury bills, negotiable certificates of deposit, commercial paper, and banker’s acceptances. Capital market securities include bonds and stock. 3. What are the characteristics of an efficient market? The term market efficiency refers to the ease, speed, and cost of trading securities. In an efficient market, securities can be traded easily, quickly, and at low cost. Markets lacking these qualities are considered to be inefficient. 4. How are financial trades made on an organized exchange? Each exchange listed security is traded at a specified location on the trading floor called the post. The trading is supervised by specialists who act either as brokers (bringing together buyers and sellers) or as dealers (buying or selling the stock themselves). Prominent international securities exchanges include the New York Stock Exchange (NYSE) and major exchanges in Tokyo, London, Amsterdam, Frankfurt, Paris, Hong Kong, and Mexico. 5. How are financial trades made in an over the counter market? Discuss the role of a dealer in the OTC market. In contrast to the organized exchanges, which have physical locations, the over the counter market has no fixed location,or more correctly, it is everywhere. The over the counter market, or OTC, is a network of dealers around the world who maintain inventories of securities for sale. If you wanted to buy a security that is traded OTC, you would call your broker, who would then shop among competing dealers who have the security in their inventory. After locating the dealer with the best price, your broker would buy the security on your behalf. The role of dealers: Dealers make their living buying securities and reselling them to others. They operate just like car dealers who buy cars from manufacturers for resale to others. Dealers make money by buying securities for one price (called the bid price) and selling them for a higher price, (called the ask price). The difference, or spread, between the bid price and the ask price represents the dealer’s fee. 6. What is the role of a broker in security transactions? How are brokers compensated? Brokers handle orders to buy or sell securities. Brokers are agents who work on behalf of an investor. When investors call with an order, brokers work on their behalf to find someone to take the other side of the proposed trade. If investors want to buy, brokers find sellers. If investors want to sell, brokers find buyers. Brokers are compensated for their services when the person whom they represent, the investor, pays them a commission on the sale or purchase of securities. 7. What is a Treasury bill? How risky is it? Treasury bills are short term debt instruments issued by the U.S. Treasury that are sold at a discount and pay face value at maturity. They are very nearly risk-free as they are backed by the U.S. Government which could, if need by, print money to pay their holders at maturity. 8. Would there be positive interest rates on bonds in a world with absolutely no risk (no default risk, maturity risk, and so on)? Why would a lender demand, and a borrower be willing to pay, a positive interest rate in such a no risk world? Yes, there would be a positive rate of interest in a risk-free world. This is because regardless of risk, lenders of money must postpone spending during the time the money is loaned. Lenders, then, lose the opportunity to invest their money for that period of time. To compensate for the cost of losing investment opportunities while they postpone their spending, lenders demand, and borrowers pay, a basic rate of return, the real rate of interest.
Posted on: Mon, 08 Jul 2013 16:13:14 +0000
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