2.2 Financial Market and Institutions

2.2.1 Financial Markets

In varying degree, all businesses get involve in financial system, which consists of a number of institutions and markets serving business firms, individuals, and governments. Financial markets are the markets for channeling saving sector to the investment sector.

（1）The flow of funds

The function of financial market is shown diagrammatically as Figue 2.1.

The channeling of funds from savers to spenders is a crucial function for the economy. Without financial markets, it is hard to transfer funds from a person with surplus funds and no investment opportunity to one who has investment opportunities but no funds.

Financial markets are thus essential to promoting economic efficiency by allocating saving efficiently to ultimate users. The flow of funds from surplus units to deficit units may be direct or indirect.

· Direct funding means the funds flow directly from the purchasers of the securities to the issuing company.

·Indirect funding occurs through financial intermediaries, such as banks.

（2）Types of financial markets

Financial market that deal with different types of instrument, or serve different types of customers, can be classified along various dimensions：

貨幣市場和資本市場

·Money market and capital market.

The money market is concerned with the buying and selling of short-term financial instruments, operated by the banks and other financial institutions.

The capital market deals with long-term debt and equity instruments（e.g., bonds and shares）.

一級市場和二級市場

·Primary market and secondary market.

Primary market is a“new issue”market, where enable organizations to raise new finance.

Secondary market isthe market where existing securities are sold and bought. Transactions in these already existing markets do not provide additional funds to finance capital investment.

The existence of secondary market makes it easier for investors to consider buying a new issue because there is mechanism at hand to sell the securities when he/she no longer want it. Thus, the existence of a strong secondary market enhances the efficiency of the primary market.

2.2.2 Financial Intermediaries

通過金融中介可實現規模經濟、風險分攤、期限轉換等功能，使金融市場動作更高效。

The flows of funds from savers to investors can be direct, or be indirectly if financial intermediaries are involved. A financial intermediary links lenders with borrowers, providing aggregation and economies of scale, risk pooling and maturity transformation, and make the financial market more efficient.

Financial intermediaries include:commercial banks, insur ance companies, mutual funds, investment bank, financial brokers, etc.

Financial markets and institutions play vital roles in corporate financing; we will give more detailed information when we come to financing decision in later chapter.

Summary

·Economic policy refers to the actions that taken by government to pursue economic growth, low inflation, full employment and balance of payments stability.

·Government use multiple policy tools, such as interest rate and money supply, tax and government spending, tariffs, exchange rates, labor market regulations, and many other aspects of government instruments.

·Monetary policy aims to influence monetary variables such as interest rate and the money supply.

·Fiscal policy seeks to influence the economy by managing government spending and taxation.

·All businesses get involve in financial market where financial assets are trading, including money market and capital market, primary market and secondary market.

·Financial intermediary links lenders with borrowers, providing aggregation and economies of scale, risk pooling and maturity transformation, and make the financial market more efficient.

Questions

1．The following statements relate to fiscal policy andmonetary policy.

i. High interest rates encourage companies to make investments.

ii. A government can reduce demand in an economy by raising taxes.

Are the statements true or false?（　）.

A. Both statements are true

B. Both statements are false

C. Statement i is true and statement ii is false

D. Statement ii is true and statement i is false

2．The following are important functions of financial markets：

i. source of financing; ii. provide liquidity; iii. reduce risk; iv. source of information.

A. i only

B. i and ii only

C. i, ii, iii, and iv

D. iv only

3．The financing process involves a flow of funds from the（　）.

A. Savings deficit to savings surplus units

B. Savings surplus to savings deficit units

C. Primary market to secondary market

D. Central bank to the savings deficit unit

4．The market for new issues of securities where the sale proceeds go to the issuer of the securi ties is known as（　）.

A. Secondary market

B. Seasoned market

C. Liquid market

D. Primary market

5．An example of a direct form of funding is（　）.

A. Raising finance through financial intermediaries

B. A bonus share issue

C. An issue of debentures

D. The purchase of debentures

6．An example of an indirect form of funding is（　）.

A. Issuing share

B. Bank loan

C. Trade credit

D. Share repurchase

7．Secondary markets（　）.

A. Do not raise new funds, but provide liquidity

B. Facilitate capital-raising in the primary market

C. Allow borrowers to raise long-term funds

D. All of the given options

8．Briefly discuss the effects on business investment decision and share price of a policy of high interest rates.

9．Suppose that the interest rate is expected to rise during the next year. ABC company is considering to raise long-term fund by issuing bond. How would the expectation affect company's decision？

10．Discuss the function of financial intermediaries.