Lecture notes Essay

Submitted By Axiahh
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The Australian Legal System and Starting a Business, Choice of Business Structures.
The term "capital market" does not mean the same as "stock market". A capital market is any market in which financial assets are traded. Stocks are a special kind of financial assets - they are shares of ownership in a company. So a stock market is one kind of capital market, but there are other capital markets in which other types of financial assets are traded, such as bond markets.

There is a market in which bank accounts are created, but it is not an active liquid market in the way in which stock markets and bond markets are, where there are many buyers and sellers and the assets change hands frequently. The market in which bank accounts are created consists of banks offering financial products and customers taking advantage of those products by applying for an account. But it is still a capital market because financial assets are created (bank accounts) and funds flow from surplus units (customers) to deficit units (banks).

All capital markets have primary markets, and many have secondary markets. A primary market is a market in which financial assets are first created and funds flow from surplus to deficit units, so in order for a financial asset to exist, there must be a primary market for that asset. The primary markets for shares and bonds consist of public offers, rights issues or private placements, in which investors direclty purchase securities from the deficit economic units.

A secondary market is a market in which financial assets are subsequently traded, and therefore the stock market and bond markets that we observe are secondary markets. Bank accounts cannot be traded. You can't sell your bank account to me. So there is no secondary market for bank accounts.

The phrase "that we observe" was meant to refer to the stock market and bond markets that we see in the financial news. When you hear about a stock going up or down in price, that is something that has happened in the secondary stock market. When you look up bond yields for 3-year or 10-year bonds, for example, those are established in the secondary bond market.

Absolutely there is a primary stock market (e.g. IPOs when shares are first listed on the stock exchange). And individual investors certainly participate in that market. But it doesn't happen very often. The vast majority of transactions involving the purchase of shares happens in the secondary stock market. Similarly, there is a primary bond market where bonds are first issued, allowing the government to borrow money. But we don't hear about that at all, and individuals don't participate in that market. The Governments issues bonds to large institutional investors, such as banks.

All I was trying to say is that the stock and bond markets that we hear about most of the time are secondary markets, even though, as you say, primary versions of those markets exist in order for the securities to be first created.

An economic model is a simplified description of some aspect of reality. If is simplified because we make certain assumptions in building the model - assumptions which aren't necessarily true, but which simplify the model by focusing on some aspects of reality that we are interested in, without invalidating our conclusions.

For example, the following are assumptions we use to build a model in Topic 2:

Time is defined by "now" and "later" (i.e. there are only two time periods - not literally true, but a useful simplification) Individuals try to maximise utility (this is true by the way we have defined "utility") Utility comes only from consumption (probably not true of everyone, but sufficiently true of most people that it is useful to make this assumption because economic markets tends to behave AS IF this is true of everyone) All decisions are made now (not literally true, but a useful simplification) There is an exogenously