ECONOMICS Y2 Q1
Chapter 24
The firm's financial system is the set of implemented
procedures that track the financial activities of the
company. On a regional scale, the financial system is
the system that enables lenders and borrowers to
exchange funds. The global financial system is
basically a broader regional system that
encompasses all financial institutions, borrowers
and lenders within the global economy.
There are multiple components making up the
financial system of different levels: Within a firm,
the financial system encompasses all aspects of
finances. For example, it would include accounting measures, revenue and expense schedules, wages
and balance sheet verification. Regional financial systems would include banks and other financial
institutions, financial markets, financial services In a global view, financial systems would include the
International Monetary Fund, central banks, World Bank and major banks that practice overseas
lending.
A financial market is a broad term describing any marketplace where buyers and sellers participate in
the trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically
defined by having transparent pricing, basic regulations on trading, costs and fees, and market forces
determining the prices of securities that trade.
Market
Definition
Capital Markets
A capital market is one in which individuals and institutions trade financial securities; maturity > 2
years. Organizations and institutions in the public and private sectors also often sell securities on the
capital markets in order to raise funds. Thus, this type of market is composed of both the primary and
secondary markets. Any government or corporation requires capital (funds) to finance its operations
and to engage in its own long-term investments. To do this, a company raises money through the sale
of securities - stocks and bonds in the company's name. These are bought and sold in the capital
markets.
Official capital market conditions are publicly announced; stock exchange, bonds
Private capital market direct negotiations between parties; real estate investments
Stock Markets
Stock markets allow investors to buy and sell shares in publicly traded companies. They are one of the
most vital areas of a market economy as they provide companies with access to capital and investors
with a slice of ownership in the company and the potential of gains based on the company's future
performance.
This market can be split into two main sections: the primary market and the secondary market. The
primary market is where new issues are first offered, with any subsequent trading going on in the
secondary market.
Primary market
A primary market issues new securities on an exchange. Companies, governments and other groups
obtain financing through debt or equity based securities. Primary markets, also known as "new issue
markets," are facilitated by underwriting groups, which consist of investment banks that will set a
beginning price range for a given security and then oversee its sale directly to investors.
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Book: N. Gregory Mankiw and Mark P. Taylor - Economics
,ECONOMICS Y2 Q1
The primary markets are where investors have their first chance to participate in a new security
issuance. The issuing company or group receives cash proceeds from the sale, which is then used to
fund operations or expand the business.
Secondary market
The secondary market is where investors purchase securities or assets from other investors, rather
than from issuing companies themselves. The Securities and Exchange Commission (SEC) registers
securities prior to their primary issuance, then they start trading in the secondary market on the New
York Stock Exchange, Nasdaq or other venue where the securities have been accepted for listing and
trading.
The secondary market is where the bulk of exchange trading occurs each day. Primary markets can
see increased volatility over secondary markets because it is difficult to accurately gauge investor
demand for a new security until several days of trading have occurred. In the primary market, prices
are often set beforehand, whereas in the secondary market only basic forces like supply and demand
determine the price of the security.
Secondary markets exist for other securities as well, such as when funds, investment banks or entities
such as Fannie Mae purchase mortgages from issuing lenders. In any secondary market trade, the
cash proceeds go to an investor rather than to the underlying company/entity directly.
Bond Markets
A bond is a debt investment in which an investor loans money to an entity (corporate or
governmental), which borrows the funds for a defined period of time at a fixed interest rate. Bonds
are used by companies, municipalities, states and U.S. and foreign governments to finance a variety
of projects and activities. Bonds can be bought and sold by investors on credit markets around the
world. This market is alternatively referred to as the debt, credit or fixed-income market. It is much
larger in nominal terms that the world's stock markets. The main categories of bonds are corporate
bonds, municipal bonds, and U.S. Treasury bonds, notes and bills, which are collectively referred to as
simply "Treasuries.".
Money Market
The money market is a segment of the financial market in which financial instruments with high
liquidity and very short maturities are traded. The money market is used by participants as a means
for borrowing and lending in the short term, from several days to just under a year. Money market
securities consist of negotiable certificates of deposit (CDs), banker's acceptances, U.S. Treasury bills,
commercial paper, municipal notes, eurodollars, federal funds and repurchase agreements (repos).
Money market investments are also called cash investments because of their short maturities < 2
years.
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Book: N. Gregory Mankiw and Mark P. Taylor - Economics
, ECONOMICS Y2 Q1
The money market is used by a wide array of participants, from a company raising money by selling
commercial paper into the market to an investor purchasing CDs as a safe place to park money in the
short term. The money market is typically seen as a safe place to put money due the highly liquid
nature of the securities and short maturities. Because they are extremely conservative, money
market securities offer significantly lower returns than most other securities. However, there are risks
in the money market that any investor needs to be aware of, including the risk of default on securities
such as commercial paper.
Wholesale money market interest rate; euribor/libor
Retail money market interest rate; credit-debit rate
Chapter 8 of Hulleman and Mairjs (parts 8.1-8.3) on BB.
Flat yield = Annual interest on a fixed-income security (without taking into account any capital gain or
loss on redemption) divided by the security's price and expressed as a percentage. Formula:
(Security's annual interest rate x 100) ÷ exchange rate.
The effective yield is the yield of a bond, assuming that you reinvest the coupon (interest payments)
once you have received payment. Effective yield is the total yield an investor receives in relation to
the nominal yield or coupon of a bond. Effective yield takes into account the power of compounding
on investment returns, while nominal yield does not.
For example, if an investor holds a bond that pays a 5% coupon semi-annually, he will actually receive
two coupon payments per annum. If the investor reinvests each coupon payment then his effective
yield will be greater than the stated coupon rate or nominal yield. Reinvesting the coupon will
produce a higher yield, because interest is earned on the interest payments.
Effective yield = flat yield + redemption yield
When investors buy different securities, they want
to be able to compare expected annual returns. For
bonds this is the ‘redemption yield’ or ‘yield to
maturity’. It reflects the annual income and
expected capital gain or loss from holding the
bond.
Say you hold a 6% corporate bond priced at £95,
due to be redeemed in four years’ time. The
income, or ‘flat’, yield is 6/95 x 100, or 6.3%. This is
sometimes flagged in newspapers as ‘FY’. But the
published gross (pre-tax) redemption yield, or ‘GRY’, will be higher, say, 7.6%.
This reflects the annual income from the bond and the fact that if you pay £95 for the bond now
you’ll make a small capital gain on top between now and redemption at £100 in four years’ time.
Redemption yield = (nominal value bond – exchange rate) : years left
Chapter 24
GDP Y = C + I + G + NX
GDP closed economy Y = C + I + G
The private savings equation tells us how much all the people who reside within an economy are
saving. Private savings is defined as the total income (Y) (might be referred to as GDP or National
income or just Income) minus the tax that they pay (T) and how much of their expenditure is used on
consumption (C) = Private saving = (Y – T – C). In essence, private savings is how much income all
private citizens have “left over” after they pay their taxes and purchase all the goods they desire.
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Book: N. Gregory Mankiw and Mark P. Taylor - Economics
