Question

1. Explain capital transfers.
2. What are the three primary ways in which capital is transferred between savers and borrowers? Describe each one.
3. What is a financial market?
4. Differentiate between the following markets:
5. Physical asset markets versus financial asset markets
6. Spot markets versus futures market
7. Money markets versus capital markets
8. Primary asset markets versus secondary markets
9. Public markets versus private markets

Answer 1

Capital Transfers

Capital transfers means when money for investment goes from one country to another. It is the transfer of ownership of a fixed asset, the forgiveness of a liability and the transfer of cash that is linked to or conditional on, the acquisition or disposal of a fixed asset. The transfers made by migrants as they move to a new country are an example of a capital transfer.

The three primary ways in which capital is transferred between savers and borrowers

1) Direct transfers of money and securities - The first way is through direct transfer. It refers to a transfer of assets from one type of tax-deferred retirement plan or account to borrower. Direct transfers are not considered to be distributions and not taxable as income or subject to any penalties for early distribution.

2) Indirect transfer through investment bankers - The second way is indirect transfer through investment bankers. Investment bank refers to a financial institution that helps individuals and corporations to raising their capital by underwriting. They also act as the client’s agent when issuance of securities such as stock and bond.

3) Indirect transfer through financial intermediary - The third way is indirect transfer through financial intermediary. Financial intermediary consists of “channeling funds between surplus and deficit agents”. A financial intermediary is a financial institution that connects surplus and deficit agents. The classic example of a financial intermediary is a bank that transforms bank deposits into bank loans. Insurance companies, credit unions, pension fund and mutual funds also include as financial intermediary.

Financial Market

Financial Market refers to a marketplace, where creation and trading of financial assets, such as shares, debentures, bonds, derivatives, currencies, etc. take place. It plays a crucial role in allocating limited resources, in the country’s economy. It acts as an intermediary between the savers and investors by mobilising funds between them.

Physical Asset Market vs Financial Asset Market

Physical Asset Market are tangible assets and can be seen and touched and can be liquidated in the event of default in order to pay off debts, in an accounting point of view. Examples of physical assets are vehicles, real estate, machinery, gold and other form of tangible resources. Physical asset are subject to depreciation, in other words, they usually experience a reduction in value due to wear and tear of the asset through continuous use. Some are also perishable such as food and plants.

Financial Asset Market are intangible, they cannot be seen or felt, except for the documents representing ownership of an asset. A financial asset represents a claim on ownership of a company or legal right to future payments. Some examples of financial assets are stocks, bonds, savings, investments, accounts receivable, options and much more. Financial assets do not depreciate or loss value due to wear and tear like physical assets, it mainly loss value depending on the market conditions.

Lastly, Physical assets also require maintenance, upgrades and repairs, whereas financial assets do not incur such expenses.

Spot Market vs Futures Market

• The first difference between spot market and futures market is in the nature of pricing in the two markets. Futures prices are different from spot market prices because of carrying costs and carrying return.
• The next big difference between spot markets and futures markets pertains to the trade settlement period. For some spot markets, the allowable settlement time period is two working days, which is basically meant for the transfer of cash from the buyer to the seller.
• The relationship between spot markets and futures market is more symbiotic rather than competitive.
• The futures market give the ability to leverage margins, but this facility is not available in the spot market.

Money Market vs Capital Market

• Money markets and capital markets provide investors access to finance which are used for growth and further expansion, and both markets trade on computerized exchanges.

• The main difference between the two markets is the maturity periods of the securities traded in them. Money markets are for short term lending and borrowing, and capital markets are for longer periods.

• The forms of securities traded under both markets are different; in money markets, the instruments include treasury bills, certificates of deposit, banker’s acceptances, commercial papers and repo agreements. In capital markets, instruments include stocks and bonds.

• As an individual investor, the best place to invest your money would be in the capital markets, either the primary market or secondary market. In the perspective of a large financial institution or corporation looking for larger funding requirements, the money market would be ideal.

Primary Market vs Secondary Market

1. The securities are formerly issued in a market known as Primary Market, which is then listed on a recognised stock exchange for trading, which is known as a secondary market.
2. The prices in the primary market are fixed while the prices vary in the secondary market depending upon the demand and supply of the securities traded.
3. Primary market provides financing to new companies and also to old companies for their expansion and diversification. On the contrary, secondary market does not provide financing to companies, as they are not involved in the transaction.
4. At the primary market, the investor can purchase shares directly from the company. Unlike Secondary Market, when investors buy and sell the stocks and bonds among themselves.
5. Investment bankers do the selling of securities in case of Primary Market. Conversely, brokers act as intermediaries while trading is done in the secondary market.
6. In the primary market, security can be sold only once, whereas it can be done an infinite number of times in case of a secondary market.
7. The amount received from the securities are income of the company, but same is the income of investors when it is the case of a secondary market.

Public Markets vs Private Markets

Unlike the more traditional publicly traded stocks and bonds, investments made in the private market are illiquid, meaning that investors should expect to hold onto them until an exit happens. While these private market investments may not experience the same volatility as the public market, the time horizon for a return is much longer. In some cases, private investments can offer higher long-term returns than traditional assets can alone; however, they come with much higher risk with no promise of reward or even return of the original investment amount.