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solved assignment 2014 MF0010 SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT Q1. Financial markets bring the providers and users in direct contact without any intermediary. Financial markets permits the businesses and governments to raise the funds needed by sale of securities. Describe the money market/capital market – features and its composition.

Answer: The money market exists as a result of the interaction between the suppliers and demanders of short-term funds (those having a maturity of a year or less). Most money market transactions are made in marketable securities which are short-term debt instruments such as T-bills and commercial paper.

Characteristics of money market instruments:
Short-term debt instruments (maturity of less than 1 year)
Services immediate cash needs
  • Borrowers need short-term “working capital”.
  • Lenders need an interest-earning “parking space” for excess funds.
Instruments trade in an active secondary market.
  • Liquid market provides easy entry & exit for participants.
  • Speed and efficiency of transactions allows cash to be “active” even for very short periods of time (over night).
Large denominations
  • Transactions costs are low in relative terms.
  • Individual investors do not actively participate in this market.
Low default risk
  • Only high quality borrowers participate.
  • Short maturities reduce the risk of “changes” in borrower quality.
Insensitive to interest rate changes
  • They mature in one year or less from their issue date.

Composition: Money markets deal with creditworthy entities- governments, large corporations and banks; therefore the problem of asymmetric information is not severe for money markets. Thus money market exists for short term loans and short term deposits of high-quality entities like governments, large corporations and banks.

Capital Market – Features and Composition
The capital markets are the markets in equity (shares) and long-term debt (bonds); in other words, the markets for long-term capital. In this market, the capital funds comprising both equity and debt are issued and traded. Capital market can be further divided into primary and secondary markets.
1)    Primary market is a market where securities are offered to public for subscription for the purpose of raising capital. The primary market is the first-sale market.
2)    Secondary market is a market where already existing (pre-issued) securities are traded amongst investors.


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