1.5 Markets and Participants
4 min read•june 18, 2024
Financial markets are the lifeblood of the economy, facilitating the exchange of capital between investors and businesses. They're divided into , where new securities are issued, and , where existing securities are traded among investors.
Understanding the roles of , , and is crucial for navigating these markets. Each plays a unique part in facilitating transactions and providing , helping investors buy and sell securities efficiently.
Financial Markets
Primary vs secondary markets
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- Primary markets involve the issuance and sale of new securities (stocks, bonds) directly from the issuing company or government to investors
- Proceeds from the sale go directly to the issuer to raise capital for operations, expansion, or other purposes
- Examples include ###initial_public_offerings_()_0### where a private company offers shares to the public for the first time, and bond issuances where governments or corporations borrow money from investors
- Secondary markets facilitate the trading of previously issued securities among investors
- Transactions occur between investors, and the proceeds go to the selling investor, not the original issuer
- Provides liquidity for investors by allowing them to buy and sell securities as needed
- Examples include stock exchanges (NYSE, NASDAQ) where investors trade shares of publicly listed companies, and bond markets where investors buy and sell previously issued debt securities
Roles in market transactions
- act as principals in transactions, buying and selling securities for their own account
- Profit from the , which is the difference between the price at which they are willing to buy (bid) and sell (ask) a security
- Provide liquidity to the market by holding an inventory of securities and standing ready to buy or sell
- Examples include investment banks and market makers who specialize in specific securities
- Brokers serve as intermediaries between buyers and sellers, executing trades on behalf of their clients
- Charge a commission for their services, which can be a flat fee or a percentage of the transaction value
- Do not hold an inventory of securities, but instead match buyers and sellers in the market
- Examples include retail brokers who serve individual investors, and institutional brokers who work with large organizations
- Financial intermediaries pool funds from many individual investors and invest in a diversified portfolio of assets
- Offer benefits such as professional management, diversification, and economies of scale that may not be available to individual investors
- Examples include that pool money to invest in stocks, bonds, or other securities; that manage retirement assets for employees; and insurance companies that invest premiums to pay future claims
Market characteristics
- refers to how well prices reflect all available information
- Efficient markets quickly incorporate new information into asset prices
- This concept is closely related to the idea of fair pricing in financial markets
- Liquidity describes the ease with which an asset can be bought or sold without significantly affecting its price
- Highly liquid markets have many buyers and sellers, facilitating smooth transactions
- represents the total value of a company's outstanding shares
- Used to categorize companies as large-cap, mid-cap, or small-cap, which can influence investment strategies
Investing Approaches
Direct investing vs intermediaries
- involves buying and managing investments oneself
- Advantages include having full control over investment decisions and potentially lower fees compared to using intermediaries
- Risks include the need for significant time, knowledge, and effort to research and manage investments effectively, and the potential lack of diversification unless the investor has a large portfolio
- Examples include buying individual stocks or bonds, or investing in rental properties
- Using financial intermediaries involves entrusting funds to professionals who manage investments on behalf of many investors
- Advantages include access to professional management, a diversified portfolio with a smaller investment, and potentially lower transaction costs due to economies of scale
- Risks include higher fees that can impact returns over time, less control over specific investment decisions, and the possibility of underperformance relative to benchmarks or investor expectations
- Examples include investing in mutual funds, exchange-traded funds (), or hiring a financial advisor to manage a portfolio
Investment considerations
- involves distributing investments among different asset classes to balance risk and return
- This strategy aims to optimize the based on an investor's goals and risk tolerance
- The risk-return tradeoff principle suggests that higher potential returns generally come with higher levels of risk
Key Terms to Review (31)
Amazon: Amazon is a multinational technology and e-commerce company founded by Jeff Bezos in 1994. It is one of the largest companies by market capitalization and a key player in various market sectors including cloud computing, digital streaming, and artificial intelligence.
Asset Allocation: Asset allocation is the process of dividing an investment portfolio among different asset classes, such as stocks, bonds, and cash, in order to manage risk and optimize returns. It is a fundamental concept in finance that helps investors achieve their financial goals by balancing the risks and rewards associated with different investment options.
Bank of America Merrill Lynch: Bank of America Merrill Lynch (BofA Merrill Lynch) is the investment banking division of Bank of America. It provides services in mergers and acquisitions, equity and debt capital markets, lending, trading, risk management, and research.
Bid-Ask Spread: The bid-ask spread is the difference between the price a buyer is willing to pay (the bid) and the price a seller is willing to accept (the ask) for a particular financial instrument in a market. It represents the cost of executing a trade and is a key measure of market liquidity and efficiency.
Brokers: Brokers are financial intermediaries who act as agents to facilitate transactions between buyers and sellers in various financial markets. They connect parties interested in buying and selling assets, such as securities, commodities, or real estate, and earn commissions or fees for their services.
Dealers: Dealers are financial intermediaries who buy and sell securities on their own account, often facilitating liquidity and market efficiency. They profit from the spread between the buying and selling prices of the securities they trade.
Dealers: Dealers are market participants who buy and sell financial instruments, such as securities, commodities, or currencies, with the intention of profiting from the difference between the buying and selling prices. They play a crucial role in facilitating the efficient functioning of financial markets by providing liquidity and ensuring the continuous trading of these instruments.
Direct Investing: Direct investing refers to the practice of individuals or institutions directly purchasing and holding securities, such as stocks or bonds, without the involvement of an intermediary like a broker or investment fund. This approach allows investors to have more control over their investment decisions and portfolio composition.
E-Trade: E-Trade is the process of buying and selling financial securities and assets through electronic platforms. It allows investors to conduct transactions over the internet without needing to physically interact with brokers.
ETFs: ETFs, or Exchange-Traded Funds, are investment vehicles that track the performance of an underlying index, commodity, or basket of assets. They provide investors with a diversified and cost-effective way to gain exposure to a wide range of markets and asset classes.
Facebook: Facebook is a social media platform that allows users to connect, share content, and communicate with each other. It has grown into one of the largest digital advertising platforms, influencing market trends and corporate valuations.
Financial Intermediaries: Financial intermediaries are entities that facilitate the flow of funds between savers and borrowers, serving as a bridge between these two parties. They play a crucial role in the financial markets and instruments by providing various services and products that help channel capital to where it is needed most.
Financial intermediary: Financial intermediaries are entities that facilitate transactions between savers and borrowers, helping to allocate capital efficiently within an economy. Common examples include banks, insurance companies, and investment funds.
Initial public offerings (IPOs): An Initial Public Offering (IPO) is the process through which a private company becomes publicly traded by offering its shares to the public for the first time. This event allows companies to raise capital from public investors and can significantly impact their growth potential.
IPOs: IPOs, or Initial Public Offerings, refer to the process by which a private company sells its shares to the public for the first time, allowing it to raise capital and become a publicly traded company. IPOs are a significant event in the life of a company and play a crucial role in the financial markets and the careers of finance professionals.
Liquidity: Liquidity refers to the ease and speed with which an asset can be converted into cash without significant loss in value. It is a crucial concept in finance that encompasses the ability of individuals, businesses, and markets to readily access and transact with available funds or assets.
Market capitalization: Market capitalization, or market cap, is the total value of a company's outstanding shares of stock. It is calculated by multiplying the current share price by the total number of outstanding shares.
Market Capitalization: Market capitalization, often shortened to 'market cap,' is the total value of a company's outstanding shares of stock. It is calculated by multiplying the current market price of a single share by the total number of shares outstanding. Market capitalization provides a measure of a company's size and is an important factor in various financial analyses and investment decisions.
Market Efficiency: Market efficiency is a concept that describes the degree to which asset prices fully reflect all available information. In an efficient market, prices adjust rapidly to new information, and it is not possible to consistently earn excess returns through active trading strategies.
Money market mutual funds (MMMFs): Money Market Mutual Funds (MMMFs) are investment funds that invest in short-term, high-quality financial instruments such as Treasury bills, commercial paper, and certificates of deposit. These funds aim to provide investors with a safe place to invest easily accessible cash-equivalent assets while offering higher returns than savings accounts.
Morgan Stanley: Morgan Stanley is a leading global financial services firm providing investment banking, securities, wealth management, and investment management services. It operates in more than 40 countries and serves clients including corporations, governments, institutions, and individuals.
Mutual Funds: Mutual funds are investment vehicles that pool money from multiple investors and invest in a diversified portfolio of securities, such as stocks, bonds, or a combination of both. They provide investors with professional management, diversification, and access to a wide range of investment opportunities.
Nike: Nike, Inc. is a multinational corporation that designs, manufactures, and sells footwear, apparel, equipment, and accessories worldwide. It is one of the largest suppliers in the global market for athletic shoes and apparel.
Pension Funds: Pension funds are investment pools that manage and invest the retirement savings of individuals, typically employees, to provide them with income during retirement. These funds play a crucial role in the financial markets and the broader economy as they accumulate and allocate capital for long-term investment purposes.
Primary market: The primary market is a financial market where new securities, such as stocks and bonds, are issued and sold to investors for the first time. Companies use this market to raise capital by offering shares directly to institutional or retail investors.
Primary Markets: Primary markets are financial markets where new securities, such as stocks and bonds, are issued and sold for the first time directly from the issuing company or government to investors. These markets facilitate the initial sale of financial instruments and allow issuers to raise capital for their operations, investments, or other purposes.
Risk-Return Tradeoff: The risk-return tradeoff is a fundamental concept in finance that describes the relationship between the level of risk associated with an investment and the potential return it can generate. It suggests that higher-risk investments typically offer the potential for higher returns, while lower-risk investments generally provide lower returns.
Robinhood: Robinhood is a financial services company that offers commission-free trading of stocks, ETFs, and cryptocurrencies via a mobile app. It aims to democratize finance for all by making investing more accessible to the general public.
Seasoned equity offerings (SEOs): Seasoned equity offerings (SEOs) are the issuance of additional shares by a company that is already publicly traded. They are used to raise extra capital for various business needs.
Secondary market: The secondary market is a financial market where previously issued securities, such as stocks and bonds, are bought and sold by investors. It provides liquidity for investors looking to sell their holdings and allows new investors to buy existing securities.
Secondary Markets: Secondary markets refer to the trading of financial instruments that have already been issued and are being resold by investors. These markets provide a platform for the exchange of existing securities, allowing investors to buy and sell assets without directly involving the original issuer.