Question

1. Discuss why financial markets are important to a healthy economy and how they contribute to economic growth.

2. Assume that you recently graduated with a degree in finance and have just reported to work as an investment adviser at the brokerage firm of Smyth Barry & Co. Your first assignment is to explain the nature of the U.S. financial markets to Michelle Varga, a professional tennis player who recently came to the United States from Mexico. Varga is a highly ranked tennis player who expects to invest substantial amounts of money through Smyth Barry. She is very bright; therefore, she would like to understand in general terms what will happen to her money. After your consultation with Michelle, she asks to discuss these two scenarios with you:

a. While in the waiting room of your office, she overheard an analyst on a financial TV network say that a particular medical research company just received FDA approval for one of its products. On the basis of this “hot” information, Michelle wants to buy many shares of that company’s stock. Assuming the stock market is highly efficient, what advice would you give her?

b. She has read a number of newspaper articles about a huge IPO being carried out by a leading technology company. She wants to get as many shares in the IPO as possible and would even be willing to buy the shares in the open market immediately after the issue. What advice do you have for her?

Answer 1

1]

Financial markets are important to a healthy economy and they contribute to economic growth because :

• They channelize the savings of the economy into their most productive uses by enabling deposit-taking institutions such as banks to lend to productive businesses
• They provide an organized medium where suppliers of capital (investors) can transact with those who require capital (businesses) in a fair, transparent and orderly manner
• They provide liquidity to financial assets and enable the discovery of fair prices for financial assets
• They lower the cost of transacting by providing liquidity, transparency and order.