Finance Function

Financial Market Functions

• Transfer of funds

• Providing of liquidity

• Securities pricing

• Resource allocation

Transfer of Funds

Financial markets facilitate the transfer of funds from savers and investors to spenders. In the terminology used by some a textbook authors, the funds are transferred from a surplus spending units ( SSU’s ) to deficit spending units ( DFU’s ). These funds transfers occur in the primary financial markets.

SSU = net saver

DSU = net spender

• 3 Major Sectors

o Households - typically net SSU’s

o Business - typically net DSU’s

o Government - almost always net DSU’s

Providing of liquidity

The financial markets provide liquidity for sellers of securities in the secondary market. Liquidity is usually defined as the ease with which you can sell an asset on short notice without a loss in its value.

• Assets with good liquidity:

o Stock issues included in the Dow Jones Averages or the NASDAQ 100 index

o Options on popular stocks

o Gold coins

o Treasury Bills, Notes, and Bonds

• Assets with poor liquidity:

o Enron Common Stock

o Russian bonds issued by the Czar in 1905

Securities pricing

Financial markets facilitate pricing of various financial securities. Securities pricing is accomplished through the supply-demand forces in a potential market.

Behind the supply and demand forces, however, individual investors make decisions about what they feel are the intrinsic values of different financial assets. Where the supply and demand curves meet the market arrives at an equilibrium price.

Resource allocation

In the primary financial markets, securities are sold by businesses and government entities that are raising money. Firms raising money for investment purposes must compete with other security issuers ( public and private ) for available money.

Since the investors...