For the Week 2 Case Study, you will review the following case. Upon thorough review of the case, you will then answer the 11 questions below:
Assume that you recently graduated with a Bachelor’s degree in finance and have just reported to work as a financial investment adviser at the brokerage firm of Willox Financial & Co. Your first assignment is to explain the nature of the U.S. financial markets to Manuel Jones, a professional basketball player who recently came to the US from Mexico. Mr. Jones is a highly ranked basketball player who expects to invest substantial amounts of money through Willox Financial. He is very intelligent; therefore, he would like to understand in general terms what will happen to his money. Your supervisor has developed the following questions that you must use to explain the U.S. financial system to Mr. Jones.
- What are the three (3) primary ways in which capital is transferred between savers and borrowers? Describe each one.
- What is a market? Differentiate between the following types of markets: physical asset markets versus financial asset markets, spot markets versus futures markets, money markets versus capital markets, primary markets versus secondary markets, and public markets versus private markets.
- Why are financial markets essential for a healthy economy and economic growth?
- What are derivatives? How can derivatives be used to reduce risk? Can derivatives be used to increase risk? Explain.
- Briefly describe each of the following financial institutions: investment banks, commercial banks, financial services corporations, pension funds, mutual funds, exchange-traded funds, hedge funds, and private equity companies.
- What are the two leading stock markets? Describe the two (2) basic types of stock markets.
- If Google decided to issue additional common stock, and Mr. Jones purchased 100 shares of this stock from Willox Financial, the underwriter, would this transaction be a primary or a secondary market transaction? Would it make a difference if Mr. Jones purchased previously outstanding Google stock in the dealer market? Explain.
- What is an initial public offering (IPO)? Why is it important that Mr. Jones know about this?
- What does it mean for a market to be efficient? Explain why some stock prices may be more efficient than others.
- After your consultation with Mr. Jones, he wants to discuss these two (2) possible stock purchases:
a. While in the waiting room of your office, he 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, Mr. Jones wants to buy many shares of that company’s stock. Assuming the stock market is highly efficient, what advice would you give him and why?
b. He has read a number of newspaper articles about a huge IPO being carried out by a leading technology company. He wants to purchase 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 him?
- How does behavioral finance explain the real-world inconsistencies of the efficient markets hypothesis (EMH)?