### 날짜 : 2024-04-15 14:48 ### 주제 : Capital Markets and Investment Decisions #economics ---- ### 7.2 Capital Markets and Investment Decisions Capital markets are venues where savings and investments are channeled between suppliers who have capital and those who are in need of capital. These markets are critical for economic growth since they facilitate the transfer of funds from those who save money to those who invest money in productive activities. #### Capital Markets **Characteristics of Capital Markets:** - **Instruments Traded**: They include long-term securities like stocks, bonds, debentures, and other financial instruments. - **Participants**: Individual investors, institutional investors, banks, insurers, companies, and governments. - **Primary Market**: Where new issues of stocks and bonds are sold to the public for the first time. - **Secondary Market**: Where securities are traded after the initial public offering (IPO), which provides liquidity for investors. - **Regulation**: Capital markets are heavily regulated to ensure fairness, transparency, and efficiency. Within capital markets, investment decisions are made based on risk-return assessments and the overall portfolio strategy: #### Investment Decisions 1. **Individuals and Businesses**: To determine which securities to invest in, individuals and businesses often consider factors such as the rate of return, risk level, and the duration of the investment. Investment decisions by companies often involve not just security selection but also reinvestment in their own business operations or capital projects. 2. **Fundamental Analysis**: This involves assessing a company’s financial health, the state of the economy, industry conditions, and other factors that affect the value and future performance of an investment. 3. **Portfolio Diversification**: Investors spread their investments across a variety of assets to manage risk. The idea is to balance the portfolio with different types of investments, some of which might perform well when others are not. 4. **Time Value of Money**: This principle means that a sum of money is worth more now than the same sum in the future due to its potential earning capacity. This is critical to capital budgeting decisions — the process of planning and managing a firm's long-term investments. 5. **Risk Assessment**: Assessing the level of risk associated with different investments is crucial. This involves evaluating market risk, credit risk, liquidity risk, and other types of financial risks. 6. **Efficient Market Hypothesis (EMH)**: An investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. #### Factors Affecting Capital Markets and Investment Decisions 1. **Interest Rates**: Movement in interest rates can affect investment decisions since they influence the cost of borrowing money and the return on savings and investments. 2. **Economic Indicators**: Indicators like GDP growth rate, unemployment rate, inflation, and others influence market trends and investor confidence. 3. **Government Policies**: [[Fiscal policy, monetary policy]], and regulations can have a significant impact. For example, tax benefits for certain investments can steer funds in particular directions. 4. **Global Events**: Events like geopolitical conflicts, international trade policies, and global financial crises can have profound impacts on the capital markets. #### Example: Real Estate Investment Trusts (REITs) Consider a Real Estate Investment Trust (REIT), which allows individual investors to buy shares in commercial real estate portfolios. Here’s how the capital market and investment considerations apply: - **Capital Markets Role**: REITs raise money in capital markets to purchase and manage a portfolio of real estate properties, and investors buy shares of REITs to gain exposure to real estate without having to buy, manage, or finance properties themselves. - **Investment Decisions**: An investor assessing a REIT will look at factors such as the property types in the REIT's portfolio (e.g., residential, commercial, industrial), historical dividend payments, performance under different economic conditions, and management quality. - **Market Dynamics**: Changes in interest rates can significantly affect REITs because real estate often involves high levels of debt financing. If rates increase, the cost of borrowing goes up, which can put pressure on REITs' profit margins and consequently impact the distribution of dividends to shareholders. Capital markets thus play a crucial role in economic growth, influencing personal wealth, corporate growth, and the overall economic health of societies. They offer a framework for which investment decisions are made, determining the direction and flow of capital, and shaping the future of industries and economies. #### Deep Dive into Capital Markets Capital markets consist of both primary and secondary markets. These financial markets serve as a platform for different entities to access various forms of capital from a diverse array of willing investors: 1. **Primary Markets**: This is where the issuing of new securities occurs. Companies, governments, or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through public offerings or private placements. 2. **Secondary Markets**: Once new securities are sold in the primary market, they are traded in the secondary market. This provides liquidity for investors, allowing them to buy and sell securities more freely. Unlike the primary market, where prices are often set beforehand, prices in the secondary market are determined by the forces of supply and demand. 3. **Stock Exchanges and Over-the-Counter (OTC) Markets**: These are the venues where secondary market activities mainly occur. Stock exchanges, like the New York Stock Exchange (NYSE) or NASDAQ, have specific physical locations and operate under a set of regulated listing requirements. OTC markets are less formal, decentralized, and consist of groups of securities dealers who transact directly with each other, often electronically. 4. **Market Participants**: Include retail investors, institutional investors (such as mutual funds, pension funds, and insurance companies), governments, businesses, and market intermediaries (like brokers and dealers). #### Deep Dive into Investment Decisions Investment decisions in capital markets revolve around several core principles and factors that influence investor choices: 1. **Expected Return**: This is the gain or loss that an investor anticipates on an investment. It is often considered relative to the amount of risk taken, with higher-risk investments generally requiring a higher expected return. 2. **Diversification**: This is the strategy of spreading investments across various financial instruments, industries, and other categories to minimize risk. It is based on the premise that a portfolio constructed of different kinds of investments will yield higher long-term returns and lower the risk of any single investment. 3. **Time Value of Money (TVM)**: TVM is a core principle that informs the present value of future cash flows from an investment. The idea is that money available now is worth more than the same amount in the future due to its potential earning capacity. It's a critical concept in discounted cash flow (DCF) analysis, a method used to value an investment based on its expected future cash flows. 4. **Risk and Return Tradeoff**: Investors have to balance their appetite for risk with their desire for returns. Generally, low levels of uncertainty (low risk) are associated with low potential returns, whereas high levels of uncertainty (high risk) are associated with high potential returns. 5. **Market Efficiency**: [[Efficient market hypothesis (EMH)]] suggests that it's impossible to consistently achieve higher returns than average market returns on a risk-adjusted basis, given that market prices should only react to new information. 6. **Portfolio Theory**: [[Modern portfolio theory (MPT)]] is a framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. 7. **Fundamental vs. Technical Analysis**: These are two different approaches to making investment decisions. Fundamental analysis evaluates securities by attempting to measure their intrinsic value, while technical analysis looks at statistical trends in market activity like price and volume. 8. **[[Capital Asset Pricing Model (CAPM)]]**: This model describes the relationship between systematic risk and expected return for assets, particularly stocks and is widely used in the finance industry for the pricing of risky securities and generating expected returns for assets given the risk of those assets and the cost of capital. 9. **Regulatory Environment**: The decisions of investors are also affected by the regulatory environment in which capital markets operate. Regulations can impact trade activities, reporting requirements, and overall market transparency and fairness. #### Capital Markets and Investment Decisions in Practice For instance, a portfolio manager making investment decisions for a pension fund: - Will consider **total return prospects** of various asset classes. - May utilize **diversification** to allocate investments across stocks, bonds, real estate, and potentially commodities. - Will evaluate investment opportunities using DCF analysis to understand the **TVM**. - Will weigh **risks** with prospective returns, considering the long-term time horizon of pension obligations. - Considers **market conditions** and **economic indicators**, possibly adapting a mix of fundamental and technical analysis, and may consult **CAPM** for evaluating investment risks. - Finally, the manager will observe **regulatory compliance** and consider tax implications for the fund. Understanding the deep mechanisms and concepts of capital markets and investment decisions can lead to more educated and strategic investing, potentially better risk management, and more informed oversight and policy-making.