Capital Markets BASIC

Question 1

What is the importance of Capital Markets?

Answer 1

• Capital are the physical assets and resources required for productive activities
• The production process involves both K and L
• Labour cannot function without Capital

Question 2

How is capital linked to investment?

Answer 2

• Poor economies have <10% investment
• US, UK and China have large investment rates
• Consider the Solow growth model
• Capital markets are vital from chanelling savings into investment
• If they fail, there are huge ramifications -> Barings Bank/GFC

Question 3

What are different economic systems?

Answer 3

• Market economies: Resources allocated through a market mechanism
• Command economies: Government controlled allocation of resources
• Mixed economies: Combination of both system- followed by mosed people
• Market style can be measured by %G
• During times of stress, Keynesianism rose

Question 4

What are Capital Markets? How can this be viewed?

Answer 4

• CMs are a specific type of FM with >1yr returning assets
• Broadly FM are closely linked to CM
• Can be compared in Buy Side Vs Sell Side, Asset classes, Direct Vs indirect financing, business stages and the age of markets

Question 5

What is the difference between buy and sell side within Capital Markets?

Answer 5

• Very similar to the Supply + Demand of a good
• BUY SIDE: Purchase Assets
• Goal is to generate return on investments
• Such as- pensions, Mutual funds, Hedge funds, AM, PE
• SELL SIDE: Selling Assets
• Goal is to minimise financing costs
• Such as- IB, Commercial Banks
• Linked with CAPM: E(R) = Rf + β (E[Rm] -Rf), with performance measured by an α term
• Empirical evidence suggests that α<0, implying persistently beating market is not common- as stated by EMH

Question 6

What is the difference between direct and indirect financing within Capital Markets?

Answer 6

• DIRECT FINANCING: Transparent
• Such as- IBs, IPOs, Decentral Finance
• INDIRECT FINANCING improves efficiency- commercial banks
• Indirect financing is fundamentally based on a lack of trust within FMs
• GFC stemmed from the poor banking system

Question 7

What is the difference between primary and secondary markets within Capital Markets?

Answer 7

• PRIMARY MARKET: New securities are issued and sold
• This occurs in an IPO: Sketcher’s and Birkenstocks are recent examples of this
• SECONDARY MARKET: Existing securities are bought and sold
• Such as- NYSE, LSEG, NASDAQ, FTSE

Question 8

What are the different asset within Capital Markets?

Answer 8

• Evolution from paper based towards digitalisation
• Equity
• Fixed income
• Commodities
• Currencies
• Crypto assets
• Derivatives

Question 9

What is the different business stages within Capital Markets?

Answer 9

• Seed Stage: Founders, family, friends, angel investors
• Early Stage: Angel investors and venture capital
• Mid Stage: Private Equity
• Late Stage: Gearing up for an IPO
• Public Stage: IPO

Question 10

How can capital markets be modelled (NEOCLASSICAL)?

Answer 10

• Self-Interested individuals make rational decisioins; lenders and borrowes maximise utility subject to B.C.
• Competition leads to an equilibrium IR
• If the IR is too high; S>D, competition is increased, credit is reduced
• WIthout FMs, Individuals are stuck at endowment- reducing utility

Question 11

How can capital markets be modelled (PRINCIPAL-AGENT PROBLEM)?

Answer 11

• The interest aligns with the decision makers, but not necessarily with the owners {conflict of interest}
• Bankers are likely to take on excessive risk to enhance profit and commission

Question 12

How can capital markets be modelled (BEHAVIOURAL ECONOMICS)?

Answer 12

• Overconfidence bias; Overestimation of uncertain situations due to their own ability (Lehmann Brothers)
• Herding Behaviour; Similarity of investors/banks due to other people doing a paricular thing
• Short-termism; focus on achieving immediate, SR results based on subjective discount thus the future is too greatly discounted

Question 13

What are some impacts of Capital Markets?

Answer 13

• Inital increase in growth, and then decline
• Supply-Leading hypothesis: Financial development promotes growth in productivity. This is done via transferring resources in non-growth sectors to growth sectors
• Demand-Following hypothesis: Levine (2001) suggests that SLH reverses the causality, and instead growth causes demand for financial services
• UK is currently in excess of capital- potentially causing poor productivity
• Inequality declines due to welfare state, but Thatermism increased this due to financial deregulation

Question 14

What policies can be implemented to aid capital markets?

Answer 14

• Competition Policy
• Income Tax Policy
• Financial transaction Tax policy
• Financial Policy