PartRGHubbardMoneytheFinancialSystemandtheEconomyZhengChangjun.pptVIP

Financial Markets in the Financial System (Cont’d) Providing Risk-Sharing, Liquidity, and Information Services (cont’d) There is no single “secondary market”. Indeed, we can categorize secondary markets by (1) what maturity level characterizes the claims being traded, (2) how trading take place, and (3) when settlement takes place. Financial Markets in the Financial System (Cont’d) Providing Risk-Sharing, Liquidity, and Information Services (cont’d) Maturity: money and capital markets. —Debt instruments that have a maturity of greater than one year are traded in capital markets. —Equities, which have no fixed maturity, are also traded in capital markets. —Short-term instruments, with a maturity of less than one year, are traded in money markets. Financial Markets in the Financial System (Cont’d) Providing Risk-Sharing, Liquidity, and Information Services (cont’d) How do investors decide which instruments to buy? There are three differences between money market and capital market instruments that result from differences in risk, liquidity, and information. —First, short-term instruments have relatively small increases or decreases in price, so they are less risky as investments than long-term instruments are. As a result, financial institutions and corporations typically invest short-term surplus funds in money markets. Some financial institutions, such as pension funds and insurance companies, are willing to hold assets for a long time and risk price fluctuations in capital markets. Financial Markets in the Financial System (Cont’d) Providing Risk-Sharing, Liquidity, and Information Services (cont’d) —Second, money markets instruments are generally more liquid than capital instruments because their trading volume is greater and the cost of buying and selling is low. Thus households and businesses can invest their funds for a short period of time relatively cheaply. —Finally, information costs are lower for money mar