FINC300 Week 7 Assignment (1)

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1 Understanding Markets, Investors, and Contracts First Last American Military University FINC300: Foundations of Financial Management Dr. Karin Ford-Torres March 24, 2024

2 Understanding Markets, Investors, and Contracts There are many different types of financial markets, and each one has its own purpose and value to the economy. Understanding primary and secondary markets is important to financial institutions. Additionally, understanding market efficiency, institutional investors, and financial contracts can help financial managers avoid a Ponzi scheme. Financial Markets The primary purpose for financial markets is to bring together buyers and sellers (Irons, 2019). Basically, there are people who need money and people who have excess money. The people who need funds will represent the buyers and the people who have excess funds represent the sellers. There are many different types of markets available for people to maximize their goals of buying and selling funds. Primary vs Secondary Market A primary market is where the funds essentially flow from and to the corporation. A secondary market is where the funds don’t flow to the corporation (Irons, 2019). The majority of the transactions in stock occur in the secondary market, making the secondary market bigger than the primary market. Secondary markets are more active but that doesn’t necessarily make one more important than the other. Each market has its own purpose, and one can’t exist without the other. For example, securities are created in the primary market and then traded by investors in the secondary market. Ponzi Schemes A Ponzi scheme is a form of fraud that involves “using profits from new investors to pay returns to earlier investors” (Irons, 2019, p. 179). A Ponzi scheme usually starts as a result of falling stock prices. Companies will then start to do fraudulent financing and make false

3 adjustments on their financial statements. Once a business starts to lie on statements and use new investors to pay for earlier investors returns, then they will have to keep relying on new investors in order to keep it going and hide their illegal activity (Irons, 2019). If they can’t get new investors, then this scheme will not last long. Market Efficiency In a perfectly efficient market, stocks are appropriately priced, and the rerun earned by investors is also equally proportionate or appropriate (Irons, 2019). There are some things that can affect market efficiency. Essentially, information available on the market is what drives efficiency. Then, market participation comes to play. If there’s not enough people buying stocks, then it will not be an efficient market. As participation increases, market efficiency increases (Forjan, 2019). Institutional Investors Institutional investors are those entities that invest a substantial portion of stocks in order to influence key decisions (Irons, 2019). These investors include mutual funds, insurance companies, and trust departments, just to name a few. Additionally, institutional investors often have a seat on a firm’s board of directors (Irons, 2019). They are needed in our economy because they are able to “influence the actions of major corporations” (Irons, 2019, p. 197). Forward vs Futures Contracts Forward contracts and futures contracts are derivative securities, which is a contract whose value is dependent on an underlying asset such as a stock or bond (Irons, 2019). A forward contract is an agreement between two entities for something specific at a later date whereas a futures contract is more standardized to trade with daily stock changes (Irons, 2019).

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4 Furthermore, forward contracts are unregulated because they are private between two parties whereas future contracts are more regulated. Conclusion In summary, knowing the purpose of financial markets and understanding the major differences between a primary and secondary market is important for financial management teams. Additionally, making honest investments and conducting accurate financial statements can help avoid fraudulent illegal issues like a Ponzi scheme. There are forces that can help make markets more efficient and certain institutional investors are important to the economy. Finally, there are different options for contracts that can help businesses maximum their profits, which is why they should know the difference between forward and futures contracts.

5 References Forjan, J. (2019, June 15). Factors that affect a market’s efficiency. AnalystPrep. https://analystprep.com/cfa-level-1-exam/equity/factors-affect-markets-efficiency/ Irons, R. (2019). The fundamental principles of finance . Taylor & Francis Group. http://ezproxy.apus.edu/login?url=https://ebookcentral.proquest.com/lib/apus/ detail.action?docID=5839953

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