Question

Flight to quality is the action of investors moving their capital away from riskier investments to safer ones. Uncertainty in the financial or international markets usually causes this herd-like shift. However, at other times, the move may be an instance of individual or smaller groups of investors cutting back on the more volatile investments for conservative ones.

1. Discuss the relationship between flight to quality and stock market liquidity with the view of systematic risk and unsystematic risk.
2. Why is flight to quality important across developed and developing markets?

Please try to stick to the word limit (1000 words). Number of words is calculated excluding tables, graphs/figures and references.

Answer 1

a. Flight to quality means investing in those investment avenues where returns are assure & has almost no risk. There is lot of volatility in lower rating companies stock so there is an option to make more money is there but they are very risky too. To avoid this uncerytaintity in returns investors seeks quality investment options. Higher graded shares have lot of liquidity & almost guarnted returns (but these returns are quite less, but it is safe to invest in them). The stock with high volatility has sometime liquidty issue too due to nonsystematic risk so investing in these stock will bring the issue of liquidity. systematic risk is applicable to overall market it does not affect sttock liquidity but it affect the overall trend of market like economic recssion or boom.

b. The stock returns in devloped nation are less in comparision too devloping nation, because devloped nation has less growth rate in comparision to devloping nation. Devloping nation like India has a big market & lot of un exploited sectos for further devlopment like infrastructure etc. in fact goverment are promoting lotr of venture capital & low cap companies in these nation so the stock of these kind of companies shows lot of volatility but they are high risk & high return investment. Lot of unsystematic risk are invove in these kind of investment, because there are lot of chances of failure & insolvancy are involve in these kind of companies. apart of this lot of biug business houses use to do lot of scam & when things go tp public, stocks meltdown to their bottom point or liquidity problem occure in these kind of stocks eg Kingfisher airlines stock in India.

to avoid such situation of fraud, insolvancy or project failureit is advisable to investors to invest in quality stock which has strong fundamentals .apart of these company specific risk there is systematic risk too which affect overall market. due to market integration the impact of such systematic risk are visible across the globe . eg. US subprime crisis in 2007 & european debt crisis in 2009.

In this way it is always advisable to invest in secure or highely rated stock & goverment securities because market are highely volatile and some toime it is difficult to predict the trend so flight to quality is important in devloped & devloping nations.