Capital Markets and Secondary Markets Overview

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Questions and Answers

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?

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?

Stocks (correct)

Derivatives

Cryptocurrencies

Commodities

What characterizes an active secondary market for a security?

Many willing buyers and sellers Signup and view all the answers

What does selling securities in a secondary market allow investors to do?

Change their investments Signup and view all the answers

Which of the following is NOT a capital market security?

Treasury bills Signup and view all the answers

Why are secondary markets important for investors?

They allow for the easy liquidation of investments Signup and view all the answers

Primary capital markets are distinguished from secondary markets by their focus on what?

Issuing new funds Signup and view all the answers

What is the primary function of financial markets regarding surplus units?

To allow surplus units to invest their excess funds. Signup and view all the answers

What do deficit units access from financial markets?

Funds by issuing securities. Signup and view all the answers

What marks the time when surplus units can redeem debt securities?

The maturity date. Signup and view all the answers

What do surplus units receive periodically from debt securities they purchase?

Interest payments based on the maturity rate. Signup and view all the answers

Who typically incurs debt by issuing debt securities?

Deficit units that borrow funds. Signup and view all the answers

What is a key characteristic of capital markets?

They facilitate the issuance of new long-term securities. Signup and view all the answers

How do financial institutions function within financial markets?

They act as intermediaries channeling funds between surplus and deficit units. Signup and view all the answers

What is represented by debt securities issued by a deficit unit?

A legal obligation to repay borrowed funds. Signup and view all the answers

What is the primary benefit of increased financial disclosure in a country?

It improves the liquidity of financial markets. Signup and view all the answers

What type of institution is primarily responsible for providing credit to deficit units?

Depository institutions Signup and view all the answers

What is one function of depository institutions?

Accepting deposits and offering credit Signup and view all the answers

How does international integration of financial markets benefit governments and corporations?

It provides easier access to funding. Signup and view all the answers

Why are financial institutions necessary in addressing market imperfections?

They help assess the creditworthiness of borrowers. Signup and view all the answers

What is a characteristic of depository institutions in relation to investors?

They can offer investment opportunities across different countries. Signup and view all the answers

What factor contributes to the willingness of investors to participate in financial markets?

The availability of comprehensive information about firms. Signup and view all the answers

How does the enforcement of securities laws differ among countries?

Enforcement can vary significantly, affecting market practices. Signup and view all the answers

What role do commercial banks play in relation to surplus and deficit units?

They act as intermediaries, providing loans to deficit units. Signup and view all the answers

How does international financial market integration impact countries?

It allows one country’s problems to impact others. Signup and view all the answers

What is a key advantage of commercial banks in evaluating creditworthiness?

They can absorb defaulted loans better than individuals. Signup and view all the answers

What is necessary for a bank to meet regulatory requirements?

They must maintain a minimum level of capital. Signup and view all the answers

Which is a primary function of the federal funds market?

It enables short-term lending between banks. Signup and view all the answers

How do commercial banks typically gather funds relative to their loan requirements?

Some banks have more deposits than they need for loans. Signup and view all the answers

What happens when depository institutions do not exist for surplus and deficit unit transactions?

Deficit units will have to find direct lending opportunities. Signup and view all the answers

What is a characteristic of how banks manage loan diversification?

They diversify loans among numerous deficit units. Signup and view all the answers

What is the role of savings institutions in the financial system?

They channel deposits from surplus units to deficit units. Signup and view all the answers

Which of the following distinguishes a loan from a debt security?

A loan agreement is personalized and not easily marketable. Signup and view all the answers

What might cause surplus units to refrain from lending their funds to deficit units?

Unsatisfactory credit evaluations of potential borrowers. Signup and view all the answers

What is the significance of the federal funds market for savings institutions?

It enables them to borrow or lend excess funds on a short-term basis. Signup and view all the answers

What type of institution is classified as a credit union?

A member-owned financial cooperative lending primarily to its members. Signup and view all the answers

Which statement accurately describes commercial banks?

They are the most dominant type of depository institution. Signup and view all the answers

What is a key feature of the loan agreement provided by savings institutions?

It contains specific provisions that can vary between borrowers. Signup and view all the answers

What might lead to a surplus unit's decision to hold their funds tightly?

Uncertainty regarding the general economic climate. Signup and view all the answers

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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Description

This quiz covers the fundamental concepts of capital markets, including their role in issuing long-term securities and the features of secondary markets that facilitate trading existing securities. Test your understanding of how these markets function and their importance to investors and corporations alike.