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Questions and Answers
What is the primary purpose of capital market securities?
What is the primary purpose of capital market securities?
- To limit liquidity in the market
- To regulate secondary market transactions
- To trade stocks exclusively
- To finance capital assets (correct)
What does liquidity refer to in the context of secondary markets?
What does liquidity refer to in the context of secondary markets?
- The ability to issue new securities
- The amount of securities available for purchase
- The ease of selling securities without loss of value (correct)
- The regulation of trading hours
Which of the following is a type of capital market security?
Which of the following is a type of capital market security?
- Stocks (correct)
- Derivatives
- Cryptocurrencies
- Commodities
What characterizes an active secondary market for a security?
What characterizes an active secondary market for a security?
What does selling securities in a secondary market allow investors to do?
What does selling securities in a secondary market allow investors to do?
Which of the following is NOT a capital market security?
Which of the following is NOT a capital market security?
Why are secondary markets important for investors?
Why are secondary markets important for investors?
Primary capital markets are distinguished from secondary markets by their focus on what?
Primary capital markets are distinguished from secondary markets by their focus on what?
What is the primary function of financial markets regarding surplus units?
What is the primary function of financial markets regarding surplus units?
What do deficit units access from financial markets?
What do deficit units access from financial markets?
What marks the time when surplus units can redeem debt securities?
What marks the time when surplus units can redeem debt securities?
What do surplus units receive periodically from debt securities they purchase?
What do surplus units receive periodically from debt securities they purchase?
Who typically incurs debt by issuing debt securities?
Who typically incurs debt by issuing debt securities?
What is a key characteristic of capital markets?
What is a key characteristic of capital markets?
How do financial institutions function within financial markets?
How do financial institutions function within financial markets?
What is represented by debt securities issued by a deficit unit?
What is represented by debt securities issued by a deficit unit?
What is the primary benefit of increased financial disclosure in a country?
What is the primary benefit of increased financial disclosure in a country?
What type of institution is primarily responsible for providing credit to deficit units?
What type of institution is primarily responsible for providing credit to deficit units?
What is one function of depository institutions?
What is one function of depository institutions?
How does international integration of financial markets benefit governments and corporations?
How does international integration of financial markets benefit governments and corporations?
Why are financial institutions necessary in addressing market imperfections?
Why are financial institutions necessary in addressing market imperfections?
What is a characteristic of depository institutions in relation to investors?
What is a characteristic of depository institutions in relation to investors?
What factor contributes to the willingness of investors to participate in financial markets?
What factor contributes to the willingness of investors to participate in financial markets?
How does the enforcement of securities laws differ among countries?
How does the enforcement of securities laws differ among countries?
What role do commercial banks play in relation to surplus and deficit units?
What role do commercial banks play in relation to surplus and deficit units?
How does international financial market integration impact countries?
How does international financial market integration impact countries?
What is a key advantage of commercial banks in evaluating creditworthiness?
What is a key advantage of commercial banks in evaluating creditworthiness?
What is necessary for a bank to meet regulatory requirements?
What is necessary for a bank to meet regulatory requirements?
Which is a primary function of the federal funds market?
Which is a primary function of the federal funds market?
How do commercial banks typically gather funds relative to their loan requirements?
How do commercial banks typically gather funds relative to their loan requirements?
What happens when depository institutions do not exist for surplus and deficit unit transactions?
What happens when depository institutions do not exist for surplus and deficit unit transactions?
What is a characteristic of how banks manage loan diversification?
What is a characteristic of how banks manage loan diversification?
What is the role of savings institutions in the financial system?
What is the role of savings institutions in the financial system?
Which of the following distinguishes a loan from a debt security?
Which of the following distinguishes a loan from a debt security?
What might cause surplus units to refrain from lending their funds to deficit units?
What might cause surplus units to refrain from lending their funds to deficit units?
What is the significance of the federal funds market for savings institutions?
What is the significance of the federal funds market for savings institutions?
What type of institution is classified as a credit union?
What type of institution is classified as a credit union?
Which statement accurately describes commercial banks?
Which statement accurately describes commercial banks?
What is a key feature of the loan agreement provided by savings institutions?
What is a key feature of the loan agreement provided by savings institutions?
What might lead to a surplus unit's decision to hold their funds tightly?
What might lead to a surplus unit's decision to hold their funds tightly?
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Study Notes
Capital Markets
- Capital markets facilitate the issuance of long-term securities by deficit units such as corporations and governments.
- Capital markets provide a means for investors to invest surplus funds.
- Capital markets allow corporations to obtain new funds.
- Securities traded in capital markets are referred to as capital market securities.
- Examples of capital market securities include bonds, mortgages, and stocks.
Secondary Markets
- Secondary Markets facilitate the trading of existing securities, allowing investors to change their investments by selling their securities and buying different ones.
- Liquidity is a key characteristic of securities traded in secondary markets, meaning that securities can be readily sold without a significant loss of value.
- In active secondary markets, many buyers and sellers of the security are present at any given moment.
Role of Financial Markets
- Financial markets accommodate surplus units who want to invest their funds in debt or equity securities.
- Financial markets act as intermediaries between surplus units and deficit units, channeling funds from surplus to deficit.
- Financial institutions serve as intermediaries in financial markets.
- As shown in Exhibit 1.1, financial institutions also act as investors and channel their own funds to corporations.
Market Imperfections
- Countries with lower financial disclosure tend to have less liquid financial markets because investors are less willing to invest in securities without adequate information about the issuing corporations.
- Financial institutions bridge the gap between investors and deficit units, offering expertise in assessing the creditworthiness of borrowers.
- This ensures that deficit units are able to access funding that may be otherwise difficult due to a lack of information or risk aversion.
Depository Institutions
- Depository institutions accept deposits from surplus units and provide credit to deficit units through loans and the purchase of securities.
- Depository institutions offer deposit accounts that meet the needs of most surplus units in terms of amount and liquidity.
- They repackage deposit funds to offer loans in amounts and maturities desired by deficit units.
- They assume the risk of default on the loans they provide to deficit units.
- Depository institutions have more expertise than individual surplus units in evaluating the creditworthiness of borrowers.
- These institutions use their expertise to diversify their loans among multiple deficit units.
- This diversification helps them absorb defaults better than individual surplus units.
Federal Funds Market
- The federal funds market facilitates the flow of funds between depository institutions, including banks.
- Commercial banks with excess funds can lend to institutions in need of funds for short-term periods (typically 1 to 5 days).
- Commercial banks are subject to regulations aimed at limiting their exposure to the risk of failure.
- These regulations include requirements for minimum levels of capital relative to their size to protect against loan defaults.
Savings Institutions
- Savings institutions, also known as thrift institutions, are a type of depository institution.
- Savings and loan associations (S&Ls) and savings banks are examples of savings institutions.
- Similar to commercial banks, they accept deposits from surplus units and lend these funds to deficit units.
- Savings institutions rely on the federal funds market to lend excess funds or borrow funds short-term.
Credit Unions
- Credit unions are financial cooperatives that are owned and controlled by their members.
- Credit unions offer financial services to members who share a common bond (e.g., employment, geographic location, or membership in a particular organization).
- They often offer more favorable interest rates on loans and savings accounts compared to commercial banks.
- Credit unions are not-for-profit institutions, so any profits are distributed to members.
- Credit unions play a crucial role in delivering financial services to underserved communities and promoting financial inclusion.
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