Ch.5 Capital Markets This chapter looks at how capital market work by drawing on the models of the market. Imperfect information and uncertainty play an important role in the context of effectively with them. Then, capital markets are introduced, they are classified into three forms: Informal formal organized capital markets

Ch.5 Capital Markets Capital Markets brings together those with surplus funds (lenders) and those who wish to invest in real assets (investors, entrepreneurs and borrowers). What is the importance of finance in facilitating transactions? They play an important role in capitalist society: 1)To facilitate physical investment and the accumulation of capital. 2)Well-functioning financial system direct investment towards its productive uses.

Ch.5 Capital Markets What mechanisms ensure co-coordination between the supply and demand for capital? In the case of capital, an interest rate will co-ordinates the action of savers/lenders with borrowers/investors. If demand for funds by borrowers exceeds the quantity offered by lenders, interest will be high. To attract the scarce funds of lenders, investors will have to offer an attractive rate of return. Funds then will go to those investors who are able to offer the highest rate of return to savers. Willingness to pay by a borrower should equate his or her expected return.

Ch.5 Capital Markets The summary is that: A properly functioning capital market will ensure that the investment projects chosen are those which offer the highest prospective rate of return. The price mechanism should ensure that society receives the benefits of an optimal level and allocation of investment.

Ch.5 Capital Markets Neoclassical theory: shows that the resulting level of investment will maximize consumption growth over time. The impact of imperfect invormation and of uncertainty has led some to criticize this neoclassical argument: - Keynes referred as ‘the dark forces of time and ignorance’. -J Stiglitz has pioneered the application of the new economics of information to finance. One can appraise the quality and performance of financial systems by coping with imperfect information.

Ch.5 Capital Markets Capital markets are a mechanism which brings borrowers /investors together with savers /lenders. 1) Informal Markets: It is the private markets that the rural poor have traditionally turned to service their financial needs. This was known as notary where anyone needing funds would approach his functionary. The role of a notary was an important step towards the development of a formal financial market.

Ch.5 Capital Markets 2) Formal Financial markets: contain institutions and organizations which borrowers, investors (savers, lenders) can approach to borrow (lend) funds. 3)Organized financial markets: These markets have a formal system of exchange with a legal existence and a formal procedure for settlement. Part of this was the BROKER who brings buyers and sellers together. He is part of the Stock Exchange.

Ch.5 Capital Markets What is Security and what are its types? A lender, saver acquires a claim on a borrower as a consequence of a capital market transaction. A security is a fungible, negotiable interest representing financial value. Securities are broadly categorized into DEBT and EQUITY securities. The company or other entity issuing the security is called the issuer. 1) Debt contract:تعريف من الكتاب وبعدين ارجع لهالشرح debt is a means of using future purchasing power in the present before a summation has been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy. Under a debt contract, the amount that the borrower must repay is independent of both the outcome of the project and the borrower’s net worth, income but it may depend upon the state of the world.

Ch.5 Capital Markets 2) Equity contract: Under an equity contract the amount received by the saver depends on either the outcome of the project or the borrower’s condition (income/net worth). Holders of equity are entitled to all that is left after all the other claimants on the firm have been paid. Liquidity: Liquidity measures the ease with which an asset can be converted into purchasing power.

Ch.5 Capital Markets What are the forms of capital markets? Three : 1) Broker markets: 2) Intermediary markets: 3) Internal Capital Markets: Each of these institutional forms has some merits and demerits. Discuss.. Broker brings buyers and sellers together such as estate agents. Individual agents acquire claims on the financial user of the funds and have no direct claim on the broker.

Ch.5 Capital Markets Intermediary markets is that the provider of funds acquires a claim not on the final user but on an intermediary; similarly, the user of funds acquires an obligation to the intermediary. They offer advantages both to the individual investors and to companies in whom investment is made. Some of other advantages are Economies of scale and Risk reduction. Broker and intermediary markets are external capital markets. Internal capital market is a holding company whose only assets are shares of other companies which it then controls.

Ch.6 Financial Systems and Innovation Financial institutions play a central role in the process of capital accumulation. They facilitate the transfers of savings towards useful investment projects. This chapter examines how financial systems deal with a particular category of investment projects, investment in innovation. Financial system are classified into two main types: - Bank-based - Stock market-based.

Ch.6 Financial Systems and Innovation Stock market-based and bank-based system differ along three main dimensions: 1. The relative importance of long-term bank lending versus equity finance. 2- The nature of the relationship between banks and firms. What are the differences between stock market- based systems and bank-based systems ? Explain the properties of the two systems..

Ch.6 Financial Systems and Innovation Innovation requires investment. Financial transactions are fraught with uncertainty and information asymmetries. The level of uncertainty is particularly high in the case of innovative investment as the capital accumulated is mostly intangible. Explain more… Gains and losses from reducing uncertainty: One of the great challenge to the financial system is to reduce that uncertainty as far as possible. A well –organized and expert financial institution can reduce the uncertainty, Choosing the best chance of success. Diversification can be made to reduce the uncertainty.

Ch.6 Financial Systems and Innovation Innovative activities differ across industries. There are 3 sorts of differences: 1.The visibility of innovation.. Explain. 2.The appropriability of innovation.. Explain. 3.The novelty of innovation.. Explain. How do you define a venture capitalists ?