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Lecture 1
Lecture 1
Lecture 1
EC1030 LECTURE 1
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A market is any arena in which buyers and sellers meet to exchange items of value.
(a) The market for manufactured goods and services is called the product market.
(b) The market for factors of production such as labour and capital is called the
factor market.
The financial market is one particular part of the product market - the market for
financial assets.
A. FINANCIAL ASSETS
The entity that has agreed to make future cash payments is called the issuer
(borrower) of the asset; the owner of the asset is referred to as the investor (or
lender).
(a) Commercial bank loans e.g. Barclays makes a loan to Mr.X to purchase a car
the borrower must make specified payments to the bank over time - these include
repayment of the amount borrowed and interest.
(b) Government bonds e.g. A bond issued by the U.K. government the gov
(issuer/borrower) agrees to pay the holder (investor/lender) the bond interest
payments every period + the original amount borrowed on the maturity date.
(d) Equities e.g. An ordinary share issued by Vodafone the investor (shareholder)
is entitled to receive the dividends distributed by the company.
The claim that the owner of a financial asset has may be either a fixed amount or a
varying amount.
If fixed the financial asset is a debt instrument e.g. car loan, gov bond, and
corporate bond.
If variable the financial asset is an equity instrument e.g. the ordinary share.
Expected cash flow the stream of cash payments the holder expects to receive in
the future.
Present value the worth of a future stream of income expressed in today’s value.
e.g. U.K. Gov Bond. Pays £50 every 6 months for 30 years and £1000 on maturity.
Both the £50 every 6 months and the £1000 after 30 years can be regarded as cash
flows.
Obviously, £1000 in 30 years’ time is not the same as £1000 today.
To work out the price of this financial asset we need to somehow work out the
present (today’s) value of these expected cash flows - done by discounting future
values to their present values.
Pt+1 Pt
E(rate of return) = 100%
Pt
If the price of a financial asset is currently £100 and its only cash flow is expected to
be £105 one year from now, then
105 - 100 5
E(rate of return) = 5%
100 100
(a) They act as intermediaries for the transfer of funds from surplus to deficit units.
(b) They facilitate the transfer of risk from those wanting to avoid it to those willing
to bear it.
B. FINANCIAL MARKETS
(a) Households e.g. when buying or selling shares, borrowing from commercial
banks etc..
(b) Companies e.g. raising finance for investments, insuring themselves against
certain types of risk etc...
(c) Governments e.g. raising finance for public spending.
(d) Supranational organisations e.g. World Bank provides capital for member
countries at preferential rates.
(e) Regulators
(a) Exchange (buy and sell) financial assets on behalf of their customers i.e. provide
a brokerage service.
(b) Exchange financial assets for their own accounts.
(c) Assist in the creation of financial assets for their customers and then sell those
financial assets to other market participants i.e. provide an underwriting service.
(d) Provide investment advice to other market participants.
(e) Manage the portfolios of other market participants.
(f) Transform financial assets acquired through the market into more widely
preferable types of assets - which become their own liability.
This last service is provided by Financial Intermediaries.
Thus, the commercial bank has transformed the deposit into a desirable financial
asset - the loan - which is more preferred.