Types of

Financial Markets 12
Multiple Choice
1 C* 6 D 11 B*
2 A* 7 C 12 D
3 B 8 B 13 C
4 B 9 D 14 D
5 A 10 A 15 C
*Indicates that an enhanced answer has been provided in the section below.

Enhanced Answers
1 C An unsecured small business loan will have the highest interest rate because it carries more
risk for the lender than a housing loan (secured by the property), short-term money market
loan (to a major bank), or a bond from a major corporation.

2 A Market capitalisation is calculated by number of shares multiplied by the share price. Wellworth
Developers Ltd has the highest market capitalisation in 2020, of $2,840,000.

Number Share price Market

Company name
of shares in 2020 capitalisation
Eden Construction Ltd 5000 $150.30 $751,500
CSB Ltd 800,000 $3.40 $2,720,000
Sanford Telecom Ltd 1,000,000 $0.10 $100,000
Wellworth Developers Ltd 400,000 $7.10 $2,840,000

11 B Debt financing, or borrowing funds, to expand the business means it is still owned by existing
shareholders. So after loans are serviced, they retain profits and control. The returns are not
the same (answer A). Neither debt nor equity financing are inherently speculative (answer C)
and debt financing is subject to market regulations (answer D).

Short Answers
Question 1

(a) The face value of a bond is the initial price of the bond that the bond issuer must pay back to
the bondholder once the bond matures. In the example this equals $2,000,000.

(b) Coupon payments, also known as the coupon rate, are the fixed stream of interest payments
that paid during the life of the bond. In this example, this is $25,000 p.a. for 10 years.

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 The Market Economy Eighth Edition Workbook Chapter 12: Types of Financial Markets

(c) Coupon rates are fixed for the life of the bond and are therefore not affected by the bond price
regardless of how it changes. The yield of a bond is its rate of financial return, and is calculated
by dividing the coupon payment (that is, the dollar amount of the financial return) by the bond
price (that is, the dollar amount that has been invested). A higher bond price therefore results
in a lower yield – effectively a higher bond price means that a relatively larger amount of money
must be invested to earn the same fixed return.

(d) Bonds are generally considered to be a safer asset to invest in compared to shares because
bonds always earn a fixed financial return, while the returns from shares can be volatile.
However, shares have the potential to earn much greater returns compared to bonds, as there
is no constraint on the price a share can reach or the profits a company can make.

(e) Businesses need savings in order to fund expansions and to invest in capital. Without financial
markets, businesses would have to build up their own savings from the revenue that they
generate to finance these investments (which could be a long time for very large investments).
Instead, financial markets allow businesses to immediately draw on the savings from other
businesses or households in the economy that have a surplus of money that they do not want
to spend (that is, net savers). This means that financial markets enable investments to be
efficiently funded. Financial markets also provide access to funds for households that do not
have enough money to immediately purchase goods and services like houses or overseas
holidays. In this way financial markets can directly facilitate consumption. Financial markets
can also indirectly affect consumption via their effect on the level of household wealth. For
example, a booming share market can increase the household wealth of net savers that have
used their savings to purchase shares in a company (via greater dividends and capital gains).

Question 2

(a) Australian Securities and Investments Commission (ASIC).

(b) The Australian Prudential Regulation Authority directly provides prudential regulation for all
deposit-taking institutions, life and general insurers, and superannuation funds. Its main focus
is to ensure that these financial entities have the capacity to pay back their liabilities – for
example, that banks have enough funds to enable deposit-holders to withdraw their deposit
holdings at any time and insurance companies and can meet their policy obligations. On the
other hand, the Reserve Bank of Australia is only responsible for monitoring the systemic
stability of the entire financial system – the central bank does not regulate individual financial
institutions.

(c) The Australian Treasury plays a vital role in the functioning of Australian markets. As the main
source of economic policy advice to the government, the Treasury can influence how a
government might devise its budgets, collect taxes, allocate expenditure and resources, and
regulate markets. Further, the Treasury can assist in maintaining financial market stability
through advising governments on regulatory settings, corporate practices and consumer
protection. For example, during the Global Financial Crisis in 2008 and 2009, the Treasury kept
the Government up to date on developments in domestic and overseas markets and the best
methods to minimising the impacts of global market disturbances on the Australian economy.

(d) A major regulatory change to Australia’s financial system occurred with the deregulation of
the financial sector in the mid-1980s. This included the floating of the Australian dollar in
1983, as well as the replacement of the Reserve Bank’s direct controls over banks with
broader, indirect controls that affected the system as a whole. Restrictions on foreign banks
entering the Australian market were also lifted around this time. A more recent important
regulatory change was the Government’s decision to completely guarantee all deposits held
at banks up to a value of $1 million per person in 2008 at the height the global financial crisis.
This helped promote confidence in Australia’s financial intermediaries as deposit-holders no
longer had to worry about losing their money in the unlikely event that their bank went bust.

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 The Market Economy Eighth Edition Workbook Chapter 12: Types of Financial Markets

Question 3

(a) Primary markets involve the buying and selling of new financial assets. For example, a
company that has just decided to list on the stock market will issue new shares (called an initial
public offering) that are sold to public investors for the first time. Secondary markets involve
the buying and selling of assets that have already been issued in a primary market. For
example, an investor who already holds assets in a company selling them to another investor
through a stockbroker.

(b) The share market is often referred to as a barometer of economic activity, as share prices
reflect investor expectations that better economic conditions will lead to improved prospects
of profits. Similarly, share prices tend to decrease if economic activity is weak, as firms have
fewer opportunities to increase their profits. This is clearly evident in the graph as the share
market crashes in 2001 and late 2008 are mirrored by slumps in economic growth. Although
the share market is an indicator of economic activity, it is far more volatile than changes in
economic activity as the majority of share trading is done for speculative gains.

(c) One of the main advantages of a company listing on the share market is that they are able to
raise funds for business investment and growth through selling shares rather than borrowing
money and carrying debts. Once a company is listed, it has the opportunity to access more
funds by issuing new shares. Further, if the share price increases, company management may
be rewarded in the form of increased bonuses and job security. On the other hand, the
disadvantage of listing on the share market is that the ownership if the company is now
dispersed, and the autonomy of company management may be compromised, as they have
to address the goal of shareholders to maximise profits and share prices in the shorter term.

(d) Global financial markets have significant influence on Australian financial markets. Australia is an
open economy that relies on borrowing from overseas (foreign debt) and foreign investment and
ownership of Australian companies (foreign equity) to fund investment and growth. Thus, changes
in international financial market conditions, global interest rates and overseas investor sentiment
will affect outcomes in Australian financial markets. For example, Australian financial markets were
impacted by the global financial crisis in 2008, and the European sovereign debt crisis after 2010.
While global investors face uncertain conditions, they are less likely to make large investments in
Australia, lowering Australian share market values in line with global share markets.

Skills Revision Activity 1 – Market Regulation Analysis

Scenario Financial Market Regulator

The government seeks advice regarding strategies to counteract

Australian Treasury
the impacts of a global market disturbance

The economy experiences record high levels of inflation Reserve Bank of Australia

An investigative journalist accuses a company of unethical

Australian Securities and
behaviour because it took advantage of insider trading to make
Investments Commission
record profits on the share market
The Australian dollar continues to rise which places Australian
Reserve Bank of Australia
exports at a disadvantage and threatens economic growth

Ensuring all deposit-holders can take back their deposit money Australian Prudential
when they want it Regulation Authority
New finance companies engaging in consumer credit activities Australian Securities and
require licenses for operation Investments Commission
A financial institution defaults leaving many deposit-holders Australian Prudential
concerned over their funds Regulation Authority

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 The Market Economy Eighth Edition Workbook Chapter 12: Types of Financial Markets

Skills Revision Activity 2 – Economic Terms

• Credit
• All Ordinaries Index
• Dividend
• Capital gains
• Float
• Securities
• Speculation
• Financial intermediaries

Skills Revision Activity 3 – Market Analysis

Scenario Effect on market demand or supply

The Government introduces a law that requires Increase in supply – this law effectively forces
employers to put a greater share of their household to save more of their income.
employees’ incomes into superannuation funds.
An economic downturn forces the government to Increase in demand – governments finance deficits
budget for a larger deficit than expected. by borrowing money in financial markets.
Several large mining companies need a large Increase in demand – the companies would likely
amount of money to fund a new mining project. have to borrow a large sum to invest in a project like
this.
Banks decide to significantly reduce interest rates Movement down along the demand line – this is
on credit card products. effectively a decrease in the price of purchasing a
credit card.
An economic upturn causes households to save a Decrease in supply – savings in the economy
smaller percentage of their disposable income. constitutes supply in financial markets.
A number of public companies decide to distribute Decrease in demand – the issuance of new shares is
less of their profits to shareholders through an example of borrowing.
dividends and retain a greater share of their profits.
A large Chinese bank decides to enter the Increase in supply – the bank is likely bringing a new
Australian financial market for the first time to offer pool of savings generated overseas that can now be
new financial products. lent out to Australian households and businesses.

Skill Revision – Activity 4 Comparative Analysis (Company financing)

Equity financing advantages:

• T
he company does not have to repay the financing with interest, freeing up more future funds for
investment
• The liability and risks of the company are shared with more people

Equity financing disadvantages:

• The company owner’s claim to the future profits of the business is diluted by other interests
• The company has to deal with more public scrutiny

Debt financing advantages:

• The company does not have to comply with complicated securities laws and regulation
• The company completely retains the power to make management decisions
• The company does not have to share profits with other people

Debt financing disadvantages:

• The company is more affected by the level of interest rates in the economy
• The company has to directly repay the financing with interest, reducing the amount of future funds
that can be used for investment

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