Financial Markets and Institutions
Role of Financial Markets
Financial markets play a significant role in creating wealth in the United States. At the heart of this role is that financial markets facilitate the economically efficient allocation of capital. The holders of capital need places to invest that capital in a way that earns them a return, but they do not always have the best ideas with respect to how to use that capital, nor the skills to do so. There are others who have ideas and skills, but lack the capital to maximize those. Financial markets allow for those with capital to allocate their money to those who need it, and those who need it to acquire it. With opportunities to invest, and opportunities for ideas to come to life, the economy benefits significant. The more efficiently the financial markets can allocate capital, the more they will help the economy to grow. Thus, economic wealth is created by putting surplus capital to use in the most efficient manner possible (Duisenberg, 2001).
Financial markets can advantages from either scale or specialization. The United States is the largest financial market in the world, for example, and this facilitates a highly-efficient flow of capital through the financial system. In other countries, the financial markets have specializations that allow them to be highly-efficient with respect to capital flows -- Hong Kong has become a specialist in Asian companies, Toronto in mining companies, for example, and both tap into different capital pools than New York does. But the fewer barriers that there are between those who have capital to invest and those who need investment, the more efficient the capital markets will be. That efficiency will create greater opportunities for economic growth.
Three Securities
The first security is the stock of Tesla Motors (TSLA). The current price of one share of Tesla is $208.26. This company has only been around for a few years, and its stock price has been quite volatile in that time. In the past year, the low was $141.05 and the high $285.65(MSN Moneycentral, 2016). The second company is Google, which is currently priced at $698.88 per share. The company has historically enjoyed strong upward performance for its stock, because it has grown rapidly for most of its history. The 52-week range for Google is $515.18 to $789.87(MSN Moneycentral, 2016), again demonstrating a fair degree of volatility in its price. The third security is perhaps more secure, and that will be Boeing. The current price for Boeing is $127.88, and the 52-week range is $102.10 to $150.59(MSN Moneycentral, 2016), showing a little bit less volatility than the other two companies, which are much younger. Boeing instead has two established income streams, one of the duopoly in commercial aviation, the other from the Department of Defense, where it is one of the major contractors.
Risk-Return Relationship
The risk of a stock is the volatility, and that is expressed by the beta. The beta for the market is 1.0, and the greater the deviation from this, the greater the deviation the company has from the market risk. Higher than 1.0 reflects a security that is more volatile than the market, and lower reflects a security that is less volatile, as a general rule (McClure, 2016). The betas for these three securities are as follows (MSN Moneycentral, 2016):
Stock
Tesla (TSLA)
1.33
Alphabet (GOOG)
1.03
Boeing (BA)
1.09
The betas for these companies are interesting.. Tesla, predictably, is the riskiest of these companies, and for a couple of reasons. It is the youngest, and has the least-certain cash flows. The company is growing rapidly, but has never turned a profit. Tesla is also a stock that speculators and day traders love, so it tends to be much more volatile than the market as a whole.. Google is only slightly more volatile than the general market. The beta can be explained in a couple of ways. First, there is a massive amount of information about the company, because it is such a high profile company, that the stock trades in line with its performance. The other factor is that Google generally outperforms the market over its history, and that should be reflected in a beta that reflects higher risk, because the company delivers higher reward.
Boeing is actually riskier than the market overall, which is somewhat surprising because it is a Dow component. Boeing's commercial aviation income streams are fairly predictable, because it has a multi-year backlog of orders, only one major competitor...
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