Discussion – Financial Markets

Discussion – Financial Markets

Financial markets are crucial economic drivers. Financial markets are any marketplace where securities are traded. They entail institutions where individuals with surplus funds can directly lend to a borrower (Mankiw, 2020). The typical markets include the forex market, stock market, bond market, commodity market, cryptocurrency market, money market, and derivatives market. Each market specializes in trading specific securities. The forex market facilitates the trade of foreign exchanges, while the bond market provides capital by issuing bonds. Stock markets raise resources by issuing common stock or shares in an organization. Commodity markets deal with the trade of natural products in the fundamental economic sector. The commodities market is categorized into soft commodities, which refer to products such as crops, sugar, and livestock, and hard commodities, including minerals such as oil and gold. Money markets raise funds by providing short-term debts and investments, while derivatives market seeks to [provide tools for managing financial risks. The cryptocurrency market, a new entrant in the financial markets, facilitates the trade of financial technology assets and cryptocurrencies.

Financial markets are categorized into primary and secondary markets. Primary markets facilitate the trading of new securities such as Initial Public Offerings (IPOs). Secondary markets facilitate the trading of existing securities. In primary markets, transactions are conducted between investors and the issuer of the securities, while secondary markets support peer-to-peer transactions. For primary markets, investors seek to invest their resources for a specific period to earn profits. However, secondary markets support liquidity where securities are sold to raise capital without impacting their value (Musciotto et al., 2018). The essence of forex markets is to enable smooth operations for economies. These markets provide liquidity for businesses and allocate investment resources. Further, these markets secure the traded financial assets and enhance interactions among investors. For instance, the money markets provide short-term debts for businesses to fund their operations, while capital markets enable businesses to secure long-term funding. For the economy, financial markets enhance the smooth flow of investments and savings while also providing capital for producing goods and services.

Financial intermediaries are crucial players in the financial sector. The financial intermediaries act as the bridge between two parties involved in a transaction (Di Tella, 2019). They ensure that financial resources are collected and distributed to the transacting parties. Financial intermediaries include commercial and investment banks, stock exchanges, pension funds, credit unions, and insurance companies. These institutions function by securing resources from individuals with surplus resources and channeling these resources to individuals looking to fund economic activities. These surplus resources are provided in the form of mortgages or loans. Further, the intermediaries may opt to use financial disintermediation to lend these resources directly through the financial markets. In financial development or climate finance, the intermediaries provide these resources on non-commercial terms through private equity firms, venture capital funds, insurance, leasing companies, and micro-credit institutions. Financial intermediaries are crucial towards safeguarding and developing the economy through the collection and provision of resources. Further, they ensure smooth operations by quelling the conflicting interests between the lenders and borrowers. The intermediation role is essential in preventing market failures that can cause the economy to collapse.

Budget deficits are essential signals on the financial health of the federal government. Budget deficits occur when the expenses exceed the revenue generated. Budget deficits are a severe threat to the nation’s savings. These deficits force the government to allocate funds from its reserves to fund its activities. Further, deficits can cause inflation due to an increment in commodities prices. The government raises interest rates due to declining currency power in such situations. The long-term effect is that the allocations for government expenses make the economy vulnerable since it denies the government funds to avert a financial crisis. Budget deficits can be fixed through various strategies. The government can reduce its expenditure by suspending less critical operations. Alternatively, it can increase revenue-generating activities to meet its operational costs and boost its reserves. The national debt refers to the amounts that the government owes its creditors. This debt constitutes the public and intragovernmental debts. The national debt is crucial since it provides resources to fund national projects, translating to economic development.

Consumers are considered to be risk-averse. The term is used to refer to the low-risk appetite in customers. Customers prefer to purchase products whose risks are known. They apply caution in their buying decisions to avoid risk on commodities, and they prefer certainty in their favorite products. Although the risk is avoidable, there are various ways to deal with risk when it emerges. The first step involves identifying and analyzing the risk. After that, analyzing individual risk appetite will enable the individual to embrace or avoid the risk. The next step is to decide on the importance of taking the risk. The individual should check for the advantages and disadvantages of the risk before deciding.

A dollar today is worth more than a dollar tomorrow is a phrase that seeks to explain the impact of inflation. Inflation causes commodities prices to increase, thus reducing the dollar’s buying power. The current dollar can purchase more products than the one given tomorrow since inflation will change. The purchasing power of a currency is essential in keeping the economy vibrant. Inflation affects the economy by raising the cost of borrowing. When borrowing costs soar, investors cannot access resources. Further, inflation causes unemployment to lack the funds to invest and create employment (Rochon & Rossi, 2018). Further, inflation causes foreign exchange rates to slump. Nations have to pay more for their imports due to their weakening currency.

The difference between the present value of a future sum of money and the future value of a present sum of money lies in the value of the sum in question. Present value dictates that the sum of money in the present is worth more than a similar sum in the future. The present value refers to the current value, while the future value refers to the anticipated value after a particular period. These concepts are crucial in economics as they guide investment decisions. The present value combines the discounted rate and interest rate, allowing investors to accept or reject investment offers. Future value entails the interest rate, enabling investors to estimate their profits based on the interest rate.

Depositing $1,000 to earn an interest rate of six percent will take 11.9 years to double the amount. The formula to use is: A=P(1+r/n)^nt

A = 2000    P = 1000   r = 0.06    n= 1  t=?

2000  =  1000(1 + 0.06/1)^(1·t)

2000  =  1000(1.06)^t

Divide by 1000:

2  =  (1.06)^t

Exponent variables require logs:

log(2)  =  log( 1.06^t )

An exponent in a log develops a multiplier:

log(2)  =  t·log(1.06

Divide by log (1.06):

log(2) / log(1.06)  =  t

t  =  11.9  years

References

Di Tella, S. (2019). Optimal regulation of financial intermediaries. American Economic Review, 109(1), 271-313.

Mankiw, N. G. (2020). Brief principles of macroeconomics. Cengage Learning.

Musciotto, F., Marotta, L., Piilo, J., & Mantegna, R. N. (2018). Long-term ecology of investors in a financial market. Palgrave Communications, 4(1), 1-12.

Rochon, L. P., & Rossi, S. (2018). The relationship between inflation and unemployment: a critique of Friedman and Phelps. Review of Keynesian Economics, 6(4), 533-544.

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Your niece just started her college career with a major in economics. She is curious as to the interrelationship between the success of an economy and the financial markets, concepts, and financial institutions. Accordingly, she has developed a list of questions addressing these issues and has asked that you explain the ideas.

What are the financial markets and what purposes do they serve?
What are financial intermediaries? How do these intermediaries function in the economy?
What is a federal government budget deficit? What is the national debt? How does a budget deficit affect the economy?
She is also curious about the time value of money concepts. Specifically, she has the following questions about these concepts:

Why are consumers considered to be risk-averse? What methods could be used to deal with risk?
It has been said that a dollar received today is worth more than a dollar received tomorrow. What does this mean and what is the significance to the economy?
What is the difference between the present value of a future sum of money and the future value of a present sum of money? What is the significance of these concepts to economics?
If you deposited $1,000 in an account paying 6% interest compounded annually, how long would it take to double?