Finance Chapter on Transaction Costs and Asymmetric Info

Types of Securities

• Stocks do not provide a fixed return through interest payments.
• Bonds represent a claim on future income or assets.
• Securities can be broadly categorized into four types: Equity Securities, Debt Securities, Derivative Securities, and Money Market Instruments.

Financial Markets

• The primary purpose of trading securities in financial markets is to facilitate the flow of funds from savers to borrowers.
• The foreign exchange market is referred to when trading currencies.
• Financial markets significantly impact personal wealth by providing avenues for investment and wealth creation.
• Financial intermediaries reduce transaction costs by providing a platform for buyers and sellers to meet.
• Financial intermediaries do not eliminate risk associated with transactions.

Financial Intermediaries

• Adverse selection in the context of financial transactions occurs when one party in a transaction has more information than the other, leading to an imbalance in the deal.
• After a transaction is established, the borrower may engage in riskier activities due to moral hazard.

Risks and Problems in Markets

• Adverse selection is a problem associated with the situation where unhealthy individuals seek insurance for pre-existing conditions.
• Risk sharing allows investors to handle greater risks by acquiring riskier assets.

Liquidity and Intermediation

• Financial intermediaries provide liquidity to customers by buying and selling assets, connecting buyers and sellers, and facilitating transactions.
• The primary purpose of an initial public offering (IPO) is to raise capital for a company by selling shares to the public.

Equity Securities

• Equity securities represent ownership in a company, not a loan.
• The two main types of equity securities are common stock and preferred stock.

Primary and Secondary Markets

• The distinction between primary and secondary markets is valid for all securities.
• Asset transformation is the process of converting assets into different forms, for example, by a bank taking deposits and using them to make loans.

Stock Prices and Markets

• Supply and demand, company profitability, and investor expectations primarily determine the price of a stock in the secondary market.
• Stockholders do not receive dividends regardless of a company’s earnings.

Market Types

• Money markets trade short-term debt instruments with maturities of less than a year.
• Capital markets trade long-term debt instruments and equity securities.
• Primary markets are where new securities are issued and sold for the first time.
• Secondary markets are where existing securities are bought and sold.