Chapter 2, Problem 1IC

a.

Summary Introduction

To describe: The primary ways to transfer the capital.

Capital:

Capital refers the amount of money, which is required for the investment to start a business or venture. Businesses raise the capital from the various sources such as initial public offerings and follow up public offering.

Answer to Problem 1IC

• A direct transfer through the sale of stocks or bonds.
• A transfer through investment banking.
• A transfer through a financial intermediary.

Explanation of Solution

• Directly transfer of the stock and bonds to savers is one of the kinds to transfer of capital. Businesses directly transfer the capital to the investors who are ready to give money.
• Investment banks bought the stock and bond from the companies and sell the securities to the savers. That is one of the ways to transfer capital.
• The financial intermediaries exchange their own securities to raise the fund from the public and the raised fund can be used to buy more securities. It helps in the increment of the capital market.

Conclusion

Hence, direct and indirect there are majorly two ways to transfer capital.

b.

Summary Introduction

To explain: A market and the difference between the various types of market such as: financial asset markets versus physical asset markets, futures markets versus spot markets, money markets versus capital markets, primary markets versus secondary markets, and private markets versus public markets.

Market: A medium through which the subject matter can be transferred from the supplier to its receiver on demand or any other purpose is known as a market.

Physical Asset Markets: Markets, where the trade of commodities between the suppliers and receiverstake place, are known as physical asset markets.

Financial asset market: Markets, where the trade of financial securities or commodities between the suppliers and receivers take place, are known as financial asset markets.

Spot Markets: Markets, where trade, for the purpose of immediate delivery of financial securities or commodities,takes placeare known as spot markets.

Futures Markets: Markets, where the contractfor future trade takes place, is known as futures markets.

Money Market: Markets where the companies issue the highly liquid or short-term securities are known as money markets.

Capital Market: Markets where the companies are registered and issue the long-term debt and equity securities to the public. Primary market and secondary market are the types of capital markets. Capital markets mainly raise the long-term finances.

Primary Markets: Markets where the companies firstly invite to the public to buy the securities are known as primary markets.

Secondary Markets: Markets, where the companies invitedthe public to buy the securities, are known as a secondary market.

Public Market: Markets, which exist for the purpose to provide the securities or commodities to the public, are known as a public market.

Private Market: Markets, where the trade of securities or commodities between the pre-existing investors takes place, are known as a public market.

Answer to Problem 1IC

• A market is a place where the price of all the commodities set on the basis of their demand and supply.
• The price of commodities increases due to a decrease in demand and the price decreases due to increase in demand in the market which refers the inverse relationship between the price and demand.
• The price of commodities increases due to increase in supply and the price decrease due to a decrease in supply in the market which refers the direct relationship between the price and supply.

Difference between physical asset markets and financial asset market

Basis	Physical Asset Markets	Financial Asset Markets
Form of commodities	A market,where the trade of tangiblecommodities takes place, is known as physical asset market.	A market,where the trade of financial securities takes place, is known as financial asset market.
Assets	The assets to the trade of physical asset market are cars, arts, and real estates.	The assets to the trade of financial asset market mainly are stock, bonds, swaps,and futures.

Difference between spot markets and futures markets

Basis	Spot Markets	Futures Markets
Meaning	Spot markets refer the immediate delivery of commodities.	Futures markets refer the delivery of the commodities at the future date.
Price difference	The price of spot market commodities doesn’t include the carrying cost and interest.	The price of futures market commodities includes the carrying cost and interest.

Difference between money markets and capital markets

Basis	Money Markets	Capital Markets
Investments	Markets, where the short-term commodities are sold, are known as the money market.	Markets, where the long-term commodities are sold, are known as the capital market.
Assets	The money markets include the trade of treasury bills and overdraft facility.	The capital markets include the trade of in land, building, and machinery.

Difference between primary markets and secondary markets

Basis	Primary Markets	Secondary Markets
Time period	Markets, where the companies issue their stock for the first time, is known as the primary market.	Markets, where the companies issue their stock after the issuance in the primary market, is known as a secondary market.
Liquidity	The liquidity from the primary market is lesser than the secondary market.	The liquidity from the secondary market is higher than the primary market.

Difference between public markets and private markets

Basis	Public Markets	Private Markets
Terms and Conditions	The terms and conditions in the public market are fixed standardized.	There are no standardized terms and conditions in private market as decided by the parties between who the contract takes place.
Example	The issue of new stock for the time is an example of a public market trade.	Agreement for the loan between bank and customer is an example of the private market

Explanation of Solution

• A place where the suppliers provide their services and take money from the buyers refers as a market.
• Physical asset markets and financial asset markets are different due to commodities provided by them.
• Spot market and futures markets are different due to the time of delivery of the commodity. Spot markets provide the immediate delivery and futures markets provide the delivery at a future date.
• Money market and capital market are different due to the time duration of provided goods and services. Money markets provide the short-term securities and capital markets provide long-term securities.
• Companies issue their securities in the primary market and then in the secondary market.
• Public markets have the standardized terms and conditions and the private market does not.

Conclusion

Hence, for the trade of commodities, a place is required and it is known as market and the different markets have their own purposes.

c.

Summary Introduction

To explain: The reason of significance of the financial market for the economic growth.

Financial Market: A market where the trade the financial securities such as equity, and bonds are known as a financial market. Money market and capital market are the types of financial market.

Answer to Problem 1IC

There are the two most important reasons for the importance of financial market

• The financial market helps to transfer the funds from one place to the other place mainly to the suppliers and to made payment as soon as possible is the main characteristic of a healthy economy.
• To create a new wealth is very important for each and every country and financial market is the place which helps in the wealth creation also and provides the security to the funds.

Explanation of Solution

• To have a strong and healthy economy it is very important for the country to make the payment on time because the delay in the payment shows a negative impact of the country on the supplier.
• To grow the economy in a positive manner is very important and financial markets help to the economy in that aspect also. Wealth creation can be possible with the help of financial markets.

Conclusion

Hence, to develop a healthy economy financial markets are very important.

d.

Summary Introduction

To explain: The derivatives, its use in the reduction of risk and can be possible to increase the risk.

Derivatives:

Derivatives are a financial tool for minimization or maximization of the risk of the underlying assets.

Answer to Problem 1IC

• The price of the derivatives derives from the underlying assets and these assets are the commodities, metals, stocks, and foreign currency.
• Risk minimization is the main purpose of the derivatives market due to which it is also known as hedging of risk.
• Derivatives can be possible for the increment of the risk as its activity of speculation.

Explanation of Solution

• The risk minimization of the derivatives market can be understood by an example,

Example,

A person from Country A bought the product from the person of Country B. The agreement between the both made that the payment will be made after the 6 months. The product price is $20 million and conversion rate of dollar is 50 per dollar.

To have a safety from the future increment of the exchange rate, importer decides to go to the bank and make the agreement with the bank to buy some securities at the fixed rate in future. That kind of contract is known as the derivatives contract.

• The increase in the risk of the derivatives market can be understood by an example,

Example,

A person from Country A bought the product from the person of Country B. The agreement between the both made that the payment will be made after the 6 months. The product price is $20 million and conversion rate of dollar is 50 per dollar.

If, exporter expects the decrement in the value of the currency than exporter decides to go to the bank and make the agreement with the bank to buy some securities at the fixed rate in future. That kind of contract is known as the derivatives contract.

Conclusion

Hence, the derivatives are the market which provides the facility to risk minimization as well as risk increment.

e.

Summary Introduction

To explain: The investment banks, financial corporations, commercial banks, pension funds, exchange-traded funds, mutual funds, hedge funds, and private equity companies.

Financial Institutions: A financial institution is an institution which involves the financial activities such as deposit money, stock exchange, investments and currency exchange. The institutions refer the dealing of monetary transaction.

Answer to Problem 1IC

Investment Bank:

A mediator between the issuer of the securities and investor who do the underwriting is known as the investment bank.

Commercial Banks:

A commercial bank is the bank which provides the depository and borrowing services to the customers.

Financial Corporations:

A financial corporation refers a corporation which involves the financial activities such as deposit money, stock exchange, investments and currency exchange.

Pension Funds:

The pensionfund is the type of retirement fund which provides a certain amount at the time of retirement to an individual.

Mutual Funds:

The best investment option for investors who do not have more money to invest, a mutual fund is the best-diversified investment avenue.

Exchange Traded Funds:

The purchase of different stock from the different market to make a portfolio is the exchange-traded fund.

Hedge Funds:

A fund which is formed by the collection of money from the public is known as a hedge fund.

Private Equity Funds:

A fund which is formed by the collection of money from the company to have a private control on it is known as a hedge fund.

Explanation of Solution

• To raise the capital and acts as an underwriter are the main functions of the investment bank.
• On deposited money banks offer the interest and on loan, the borrowed money banks change the interest.
• The monetary transactions of the country are done by the financial corporations.
• In the pension fund, the employees of the company contribute and form a fund for the retirement purpose.
• An organization which collects the many funds on the same platform is known as the mutual fund organizations and provides the funds on funds.
• A stock exchange which deals in the stock exchange is the exchange-traded fund.
• The investment of large amount is required by the hedge fund and doesn’t regulate by any board or commission.
• In the private equity fund, the investor targets the company to have its authority in future and then buy the fund accordingly.

Conclusion

Hence, different financial terms have their different perspectives.

f.

Summary Introduction

To identify: The two stock exchanges and two basic types.

New York stock exchange: New York stock exchange is a U.S. stock exchange, founded in 1792 by intercontinental exchange, to buy and sell the securities and provide a direct connection between buyer and seller.

NASDAQ: NASDAQ is an American exchange, founded in 1971, to trade the stocks of telecommunication platform and provide a virtual connection between buyer and seller.

Answer to Problem 1IC

New York stock exchange and NASDAQ are the main stock exchanges.

Explanation of Solution

• New York stock exchange was founded in 1792 for the purpose to buy or sell the securities and to provide a direct connection of trade between buyer and seller.
• The intercontinental exchange is the founder of New York stock exchange and it charges $500,000 annual fees from the companies.
• NASDAQ was founded in 1971for the purpose of trade of stock and to provide a virtual connection of trade between buyer and seller.
• NASDAQ is its own owner and charges$27,000 annual fees from the companies.

Conclusion

Hence, New York stock exchange and NASDAQ are the main stock markets of the U.S. market which are different o the basis of services provided by them.

g.

Summary Introduction

To identify: The related markets which reflect the situations.

Financial Market: A market where the trade the financial securities such as equity, and bonds are known as a financial market. Money market and capital market are the types of financial market.

Answer to Problem 1IC

• To buy the stock from the underwriters refers the transaction of the primary market.
• To buy the previously outstanding stock from the dealer market refers the transaction of the secondary market.

Explanation of Solution

• If the company wants to raise the fund that can sell the stock to the underwriters and investors buy the stock of company-specific from the underwriters in the primary market.
• If Company V buy the stock from the dealer market which is previously outstanding then that transaction refers to the secondary market.

Conclusion

Hence, the situation to buy the stock from underwriters refers the transaction of primary market and to buy the stock from the dealer market refers the transaction of the secondary market.

h.

Summary Introduction

To explain: The initial public offering.

Answer to Problem 1IC

Initial public offering refers to the offering which is done first time by any private corporation to invite the public to buy the stock in the primary market. To raise the more funds company go for the initial public offering.

Explanation of Solution

• The primary market is the place where the companies firstly invite to the public to buy the shares.
• Before the initial public offering, companies raise the funds from the investors and after the initial public offering, companies can offer the stock to the public to raise fund.

Conclusion

Hence, the issue of stock for the first time to the public is known as an initial public offering.

i.

Summary Introduction

To describe: The efficiency of a market and the reason for the more or less effectiveness of some stock markets.

Financial Market: A market where the trade the financial securities such as equity, and bonds are known as a financial market. Money market and capital market are the types of financial market.

Answer to Problem 1IC

Cost efficient market refers a market for the investors is ready to invest more money due to which money supply increase and price of goods and services reduced.

The reasonfor the stock exchanges might be more efficient:

• A stock exchange where all the information available in the market might be considered as the cost-efficient market.
• A stock exchange about which everything is disclosed in the market and nothing is undisclosed might be considered as cost-efficient stock exchange.

Explanation of Solution

• If any stock exchange discloses the information such as past records or past stock prices and all publically required information then it might be considered as cost-efficient stock exchange.
• A stock exchange which doesn’t hide anything and there is nothing which is undisclosed about that might be considered as cost-efficient stock exchange.

Conclusion

Hence, the stock exchange about which nothing is undisclosed can be considered as cost-efficient stock exchange.

j. 1.

Summary Introduction

To identify: The best option to buy an initial public offering.

Initial Public Offering:

Initial public offering refers to the offering which is done first time by any private corporation to invite the public to buy the stock in the primary market. To raise the more funds company go for the initial public offering.

Answer to Problem 1IC

Person M should not buy the stock from the company. Though the company is cost effective it is just received the approval from the Food and Drug Administration for its products and it is not safe to buy its hares when the company is in the initial stage.

Explanation of Solution

• It is not sure about a company which just got an approval for its product from FDA that it will grow in the future or not.
• To buy the stock from the company which is cost efficient is good but if a company is in the initial stage so it can make default in future.

Conclusion

Hence, Person M should not prefer to buy the stock.

2.

Summary Introduction

To identify: The best option to buy an initial public offering.

Initial Public Offering:

Initial public offering refers to the offering which is done first time by any private corporation to invite the public to buy the stock in the primary market. To raise the more funds company go for the initial public offering.

Answer to Problem 1IC

Person M should buy the stock if a company raises IPO as IPO would be raised on the premium and due to the oversubscription, the return on the investment can be higher.

Explanation of Solution

• When a company raises its capital then it goes for the IPO and usually makes available its stock at a premium.
• If the stock available in the market at a premium then the stock can be oversubscribed and in future, there are many chances for the company to grow and to invest in such company is profitable.

Conclusion

Hence, Person M should prefer to buy the stock.

k.

Summary Introduction

To explain: The concept of behavioral finance in respect of the inconsistencies of the real world of the efficient market hypothesis.

Answer to Problem 1IC

According to the theory of efficient market hypothesis, the rational behavior of the investors is to buy the stock when the stock price continuously increases and it is the assumption the stock would be sold when the market goes more up.

Explanation of Solution

• The market which indicates its market price close to its theoretical price.
• The investors invest in the company which shows the good income and the performance of the company is also good.
• The investors don’t invest in the company which shows the negative or comparatively bad income and the performance of the company is also bad.

Conclusion

Hence, the behavioral finance reflects the tendency of the investment of the investors.