Financial Market: concept, functions and aims
Financial Market: concept and functions
What is a Financial Market?
Place or mechanism where financial assets* are traded and their price is determined.
* A financial asset is a liquid asset that gets its value from a contractual right or ownership claim.
Examples of Financial Assets: Cash, stocks, bonds, mutual funds, derivatives, and bank deposits.
What determines the value of a Financial Asset?
There are two things that determine the price;
Supply & demand
Risk
A financial market contacts two kinds of economic agents:
Surplus Spending Unit: economic unit that earns more than it spends (you have savings in your account, it means that you have been earning more than spending). BUYERS.
Deficit Spending Unit: economic unit that has spent more than it has earned over a period of time. To finance their deficit, they may sell debt (or equity). SELLERS.
What is understood by Spending Units?
Spending units could be the government, family, private investors, company and also the foreign sector (imports and exports).
The Concurrence of those who demand and supply funds in the financial market (the trade of financial assets for cash).
@Tecnocampus 2019 - Financial Management
There could be two different ways of transactions;
Indirect Transactions; between the buyer and seller, there has to be a middle man, it could be a bank for example. An exact example would be a banking deposits; the bank is using the money to buy the shares of a company.
Direct Transactions; are direct actions, you as a private investor decide to buy a share from a company.
@Tecnocampus 2019 - Financial Management
@Tecnocampus 2019 - Financial Management
What are the main functions of financial markets?
The goals of the financial market are;
Put in touch the economic units that supply and demand funds: It's where the supply and demand can find each other.
Assign prices to financial products: It's where the price of the assets is settle down.
Facilitate the liquidity of assets: It's where you can turn, easily, a specific asset into cash.
Reduce the terms and intermediate costs: It's where it is easier to reduce intermediate costs.
What are perfect Financial Markets?
The ideal situation of a financial market:
Great amount of agents, both supplying and demanding funds: Great amount of agents because it means that there is enough supply and demand for the assets.
Lack of transaction costs: There shouldn’t be many transactions costs, because it makes it harder to convert the assets into cash.
No restrictions when buying and selling: There shouldn’t be many restrictions. The less restrictions, the more perfect it should be.
Perfect information for everybody (no insider trading): It means that verybody has to have the same information about the assets, if not there is a risk to have an insider trading. Example; If a share costs 10€ now but, someone knows that tomorrow it will be 20€, then they will buy it or, make others not buy it. Therefore, it’s an unfair advantage because they have an information that nobody else has (they have the information that tomorrow the price will increase). So, it’s a crime. You decide to buy a share before it’s publicly announced.
So, what is a Financial System?
A Financial System is a set of financial markets (all of them together) that exists in a country.
Financial Management: Aims
Overall aim: maximise corporate value.
Specific aims: maximise corporate value for shareholders* A better situation of the company implies that it can obtain debt to finance the investments. Occasionally, there might be conflicts of interest between managers and shareholders.
"A shareholder, also referred to as a stockholder, is a person, company, or institution that owns at least one share of a company’s stock, which is known as equity." - Investopedia
Investment decisions: how to decide which investments to make. In which assets will we invest?
Financing decisions: how to obtain funds* and determine the optimal proportion of them. How can we find funds for our business idea or project?
"A fund is a pool of money that is allocated for a specific purpose. A fund can be established for any purpose whatsoever, whether it is a city government setting aside money to build a new civic center, a college setting aside money to award a scholarship, or an insurance company setting aside money to pay its customers’ claims." - Investopedia
Dividends decisions: how to generate returns for shareholders. How much dividends* we want to pay to shareholders?
"A dividend is the distribution of reward from a portion of the company's earnings and is paid to a class of its shareholders." - Investopedia
Growth strategies: how to create value, and how can we maximize the value of our company and project?
*All content was gathered from Tecnocampus' slides and implemented by my own notes.
Comments