Question

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1. Explain the difference between primary and secondary capital markets and discuss why the existence of secondary markets is important.
2. What are the reasons why debt capital in a firm typically has a lower cost of capital than does equity capital in the same firm? Will debt capital in a firm always have a lower cost of capital than equity capital in a different firm? Why or why not?
3. Explain the difference between systematic risk and non-systematic risk and support your answer with a diagram and examples as appropriate.

Answer 1

A. Primary market is the market for issuance of securities for the first time, where as in secondary market shares who have already been issued are traded.

in primary markets the price of the securities are fixed where as in the secondary market they are fluctuating according to the demand and supply

In primary markets, the price received is the income of the company, whereas in the secondary market the price received is the income of the investors

B. Debt capital in a firm typically has lower cost of capital than equity capital in the same firm because there is a tax deductible component associated with the cost of debt because interest which are to be paid on debt finance are tax deductible in nature, whereas dividend and all other elements which are to be paid to equity holders are not Tax deductible so that is the main reason for the difference in the cost of equity and cost of debt.

Cost of debt capital would not be always higher than cost of equity capital because various different firm obtained debt at different prices and they will always be differing according to the the advantage associated with their reputation and creditworthiness while obtaining of debt, so various firms will have a higher cost of debt, and that would be even higher than the cost of equity of other firm.it is also about the management of the capital by different firms in different ways

C. Systematic risk which are associated with the overall risk of the market while non-systematic are the risk which are firm specific or industry specific in nature.

Systematic risk are uncontrollable in nature whereas unsystematic risk are controllable in nature

Systematic risk are majorly caused because of external factors where as unsystematic risk are majorly caused because of internal factors.

One can protect from systematic risk through asset allocation where as one can protect himself from unsystematic risk from portfolio diversification.