Finance

14-1. What are financial markets? What function do they perform? How would an economy be worse off without them?

Financial markets are institutions and procedures that facilitate transactions in all types of financial claims.

The functions that financial markets perform are, financial markets exist in order to allocate the supply of savings in the economy to the demanders of those savings. The central characteristic of a financial market is that it acts as the vehicle through which the forces of demand and supply for a specific type of financial claim (such as a corporate bond) are brought together.

The wealth of the economy would be less without the financial markets. The rate of capital formation would not be as high if financial markets did not exist. This means that the net additions during a specific period to the stocks of (1) dwellings, (2) productive plant and equipment, (3) inventory, and (4) consumer durables would occur at lower rates.

14-3. Distinguish between the money and capital markets.

The key distinguishing feature between the money and capital markets is the maturity period of the securities traded in them. The money market refers to all institutions and procedures that provide for transactions in short-term debt instruments generally issued by borrowers with very high credit ratings. The capital market refers to all institutions and procedures that provide for transactions in long-term financial instruments.

14-4. What major benefits do corporations and investors enjoy because of the existence of organized security exchanges?

The major benefits that corporations and investors enjoy because of the existence of organized security exchanges are:

1. A continuous market provides a series of continuous security prices.

2. An organized exchange permits security prices to be set by competitive forces. They are not set by negotiations off the floor of the exchange, where one party might have a bargaining advantage.

3. Because a...