1) Physical vs Financial assets Markets
-Physical assets means "real" or "tangibles, therefore refers to products such as wheat, real estate and machinery, etc.
-financial assets deals with stocks, bonds, notes, mortgages and others that claims on real assets.
2) Spot vs Futures Market
- In spot markets, assets are bought "on the spot" and are bought/sold within days of transaction.
- In futures markers, an agreement is made to between individuals to buy or sell an asset at some future date.
- eg. A farmer may enter into a futures contract in an agreement to sell 5000 bushels of soybeans 6mths from now at $5/bushel. On the other hand, an international food producer may enter into a futures contract in which it agrees to buy soyabeans 6mths from now.
3) Money vs Capital Markets
- Money markets deals with short term highly liquid debt securities (The New York, London, and Tokyo money markets are among the world's largest)
- Capital markets on the other hand are for intermediate/long term debt or coporate stocks. (The New York Stock exchange is a prime example of capital market)
- There is no hard and fast rule to describe debt markets, but generally, long term refers to >10years, intermediate refers to 1 to 10 years, and short term refers to less than 1year
4) Primary vs Secondary Markets
- Primary markets are the place where coporations raise new capital. If a coporation were to sell a new issue of common stock to raise capital, this would be a primary market transaction. The coporation selling the newly created stock would receive the proceeds from the sale in a primary market transcation.
- Secondary markets are markets in which existing and already outstanding securites are traded among investors. The New York Stock Exchange is a secondary market because it deals with in outstanding stocks and bonds, as opposed to newly issued stocks. Secondary markets also exists for mortgages and other various types of loans and financial assets. The coporation whose securites are being traded is not involved in a secondary market transcation, and thus does not receive any funds from such transactions.
5) Private vs Public Markets
- Private market transactions are worked out directly between two parties. Eg. bank loans and private debt placements with insurance companies. As they are private transactions, they may be structured in any way that appeals between the two parties.
- Public market transactions are standardized contracts traded on organized exchanges. By contrast they are traded on public markets and ultimately held by large number of individuals. As such they must have fairly standardized contractual features to appeal to a broad range of investors and also because public investors usually do not have the time and expertise to study each unique and non-standardized contracts.
- Therefore private market securites are more tailor-made and less liquid than publicly traded securites which are subjected to greater standardization.
- Any financial asset whole vaule is derived from the value of some "underlying" asset.
- eg. An option to buy IBM stock (the value of IBM option depends on the price of IBM's stock)
- eg. A contract to buy Japanese yen six months from now ( the value of Japanese's yen "future" depends on exchange rate between yen and dollars)
- Derivatives can be used to either reduce risks or to speculate.
- eg. Suppose an importer's cost rises and its net income falls when the dollar falls relative to the yen. That company could then reduce its risk by purchasing derivates that increase in values when the dollar declines. This is a hedging operation that reduces risk exposure.
- Speculation on the other hand is done in the hope of high returns but at the expense of increased risk exposure.
A healthy economy is dependent on efficient transfers of funds from people who are net savers to firms and indivuals who need capital. Without efficient transfers, the economy simply could not function. For example, and electrical company could not raise capital. The citizens of that area would have no electricity and adequate housing. An individual would have no place to invest her savings and so on. The level of employment and productivity, hence our standard of living would be affected and lowered.
(more to be updated soon..........)