Question

1. Explain how the price of any financial instruments is determined in general term?   

b) Explain why capital market instruments are riskier than money market instruments?

1. Is the following statement true or false, please justify your answer?

“SEC regulations are intended to ensure that investors have full and accurate   information available when making their investment decisions”

Answer 1

a) How is the price of any financial instrument determined in general terms?

The price of the financial instrument is determined by the demand and supply forces in its market. If the liquidity in the market is good it will drive up the prices, since demand for the instruments is higher. While, on the other hand, if liquidity in the market falls, supply of such instruments would be relatively higher than demand, thus resulting in lower prices.

Price could also be determined by the quality of the underlying security or the issuer of the security. For instance, if a company has not performed in line with the expectations of the markets, the price of its equity shares would more likely fall, even if the general markets are performing well. If the credit quality of an issuing company deteriorates or is expected to deteriorate, the yields of the bond issued would rise, since the investors will charge higher premium in exchange of higher risk.

In primary markets, price of the financial instruments issued by a corporate are also affected by the brand, corporate image, corporate governance, sentiments of the industry etc. If more number of investors are interested in buying the security, the issuer has a higher negotiating power; and thus can charge a higher premium.

b) Capital market instruments are issued for a longer duration (equity, bonds) - generally, more than one year. While, money market instruments (T-bills, Certificate of Deposits, CPs) are issued for a shorter duration - less than one year. Furthermore, money market is more liquid as compared to capital market; as financial instituitions, banks, central banks, mutual fund companies etc. participate more actively and in significantly higher volumes. As a result, the returns expected from money market instruments are also lower as compared to capital market instruments.

Due to the above reasons, capital market instruments are riskier than money market instruments.

c) "SEC regulations are intended to ensure that investors have full and accurate information available when making their investment decisions”

The statement is true. The objective of SEC regulations is to ensure that companies communicate accurate and timely information to public investors, so that the latter make informed decision. SEC is also responsible to ensure that companies are compliant with various regulations in order to protect the interests of investors.

For instance, companies are required to disclose relevant information in their filings related to their operations, risks, corporate actions etc. Board members are respresentatives of shareholders, and SEC compliances mandate minimum number of board meetings to be held in a quarter and a financial year. Important agendas are required to be discussed and voted upon in board meetings. Another example would be proxy statements, wherein companies shall file the document with SEC where shareholder voting is required. The document shall mention all the relevant information and mechanism of voting.