EC5532 Financial Analysis: Allocation of Capital Resources
Task:
Answer:
Introduction
The term “market” in economics, means the place of interaction between the buyers and the sellers of different goods and services. In this context, financial market refers to the forum where the buyers and sellers exchange monetary assets which includes stocks, exchanges (both domestic and foreign), bonds and other monetary assets. The market deals with risks and returns in commercial activities and plays a huge role in allocation of capital resources, in both domestic as well as international market, with the help of the different components and tools present at their disposal, which will be discussed in the following assignment (Grinblatt and Titman 2016).
Financial markets and allocation of capital resources
A lot of the profitability of the businesses operating in a country as well as the economic health of the country itself depends on how appropriately the capital resources present in the economy is used. For the same proper allocation of these scarce resources are also required, which is expected to be facilitated by the financial market.
The primary role played by the financial market in this aspect is the channeling of funds to those investment projects, both in the domestic as well as international domains, which brings back maximum returns for the investors in particular and economy as a whole. For this often-economic tools like Tobin’s Q and others are used (Gopinath, Helpman and Rogoff 2014). The Tobin’s Q is the ratio of the market value of the asset of a company and the replacement cost of the same asset of the company. The higher is the value of this index the more lucrative is the company for the investors to invest their money (Bond, Edmans and Goldstein 2012).
There are sectors in the financial market, which play important role in capital allocations. This includes the stock market, the bond market, the derivatives and others. The above-discussed method of operation falls under the stock market operations, which deals with the share trading of the ownership of different enterprises. Through this mechanism, also the financial market facilitates both domestic and international allocation of capital resourced efficiently as people tend to buy shares of those companies, which seem to be profitable.
Another component of the financial system is the bond market. Bonds are a monetary tool used to build up assets as well as regulate money supply in the economy. Bonds include treasury, corporate, municipal and other bonds, which are bought by people to build up assets. This operation of the financial market is regulated with the help of rate of interest, which is decided by the monetary institution of the country, which in turn regulates the liquidity in the economy. The Foreign Direct Investment coming from other countries to an economy and from an economy to other countries also depend on the investment prospects in different sectors of the economy. This is again determined by the operations in the financial market (Soumaré and Tchana Tchana 2015).
Limitation
Financial market, do have significant roles in allocating the capital resources, as can be seen from the above discussion. Therefore, for efficient allocation and utilization of resources a robust framework in the financial market is required. There are however, many exogenous factors, other than financial market, which also affect the allocation of the capital resources. This includes the overall performance of the economy, the policy frameworks of the government and other socio political aspects in the domestic as well as global economic scenario.
References
Bond, P., Edmans, A. and Goldstein, I., 2012. The real effects of financial markets. Annu. Rev. Financ. Econ., 4(1), pp.339-360.
Gopinath, G., Helpman, E. and Rogoff, K. eds., 2014. Handbook of international economics (Vol. 4). Elsevier.
Grinblatt, M. and Titman, S., 2016. Financial markets & corporate strategy.
Soumaré, I. and Tchana Tchana, F., 2015. Causality between FDI and financial market development: evidence from emerging markets. The World Bank Economic Review, 29(suppl_1), pp.S205-S216.
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