Basic Capital Flow Analysis of a Securities Market
A Two-Player Securities Market
Capital Flow Analysis makes use of Federal Reserve Flow of Funds Accounts to explain supply and demand in securities markets.
This learning module explains how to read these tables and the basic concepts that you use to interpret these numbers.
Although flow of funds information is public and easy to access, surprisingly few market observers know how to read and understand the implications of these useful statistics.
Once you master this first lesson, you may know more about capital market flows than many who work on Wall Street.
When examining market trends, Capital Flow Analysis gives insights and advantages that escape many bankers, brokers, and investors.
Although this lesson is simple, it puts forth the basic concepts needed to benefit from Capital Flow Analysis.
The Simplest Flow of Funds Model
The simplest model of a securities market would have only one security and two players:
- an issuer, and
- an investor.
Normally, the issuer will be a net seller of securities and the investor will be a net buyer of securities.
Instrument flow of funds table F.2XX, below, illustrates such a situation.
From the table we see that the issuer has sold a net $200 billion of security 'A' during 'year 1', while the investor has bought a net $200 billion during the same year.
The red background indicates sellers of securities, while the green background indicates buyers of securities.
F.2XX Security 'A' |
|
|---|---|
Year 1 |
|
Issuer: |
200 |
Investor: |
200 |
The $200 billion is the net amount purchased or sold.
The investor may have bought $1,200 billion and sold $1,000 billion, for a net purchase of $200 billion, or the investor may have bought $500 billion and sold $300 billion, for the same net $200 billion.
Flow of funds tables do not show the volume of transactions, but only net changes over a period.
Flow Tables and Level Tables
For each flow table there is a corresponding level table that shows balances at the end of each period.
If we were to look at the level table for Security 'A', (L.2XX), we might find the balances shown in the next illustration.
In this example, we see that the position in security 'A' held by the investor increased from $5,000 billion to $5,200 billion, for a net change of $200 billion.
This confirms the flow shown in table F.2XX. above.
L.2XX Security 'A' |
||
|---|---|---|
Year 0 |
Year 1 |
|
Issuer: |
5000 |
5200 |
Investor: |
5000 |
5200 |
By comparing table F.2XX and table L.2XX, we note that due to the net purchases, the investor's holdings in Security 'A' increased by 4%, and the issuer's outstanding securities rose by the same percentage.
Flow of funds tables that begin with the code 'F.2' or 'L.2' are instrument tables and show flows and levels for specific types of securities, such as stocks, bonds, or mortgages.
Finding Motivation of Issuers and Investors
In reading flow of funds tables, we want to know not only what happened in the market for a specific type of security, but why it happened.
This reason we call motivation.
In addition to instrument tables, the flow of fund accounts contain sector tables that begin with the code 'F.1' or 'L.1' and that show asset and liability flows and balances for specific types of market players, such as 'nonfarm nonfinancial business corporations' or 'state and local governments'.
With respect to Security 'A', we can look at the sector table for the issuer (see table F.1XX, below).
The yellow background indicates a source of funds; the blue background indicates a use of funds.
Reading this table together with table F.2XX above, we see that the issuer used the $200 billion raised from selling securities, together with $100 billion from current income, to increase fixed assets by $200 billion and bank deposits by $100 billion.
If Security 'A' was common stock, we might conclude that the issuer was raising funds for long-term business expansion.
F.1XX Issuer |
|
|---|---|
Year 1 |
|
Income |
100 |
Fixed Assets |
200 |
Bank Deposits |
100 |
Issue Security 'A' |
200 |
Examining the sector table for the investor (table F.1XX Investor, below), we see that the investor used savings from current income of $50 billion plus security credit (margin from broker-dealers) of $300 billion to buy a net $150 billion in consumer durables and $200 billion in Security 'A'.
This might suggest that the investor was acting like a gambler, buying securities on margin, while spending current savings on automobiles and refrigerators.
F.1XX Investor |
|
|---|---|
Year 1 |
|
Savings |
50 |
Consumer Durables |
150 |
Security 'A' |
200 |
Security Credit |
300 |
By analyzing the flow of fund tables for financial instruments together with the tables for the relevant sectors, we can trace supply and demand in the capital market.
What Flow of Funds Accounts Tell Us
This simple example shows how information derived from the flow of funds accounts of the Federal Reserve Board can be used to explain supply and demand in the U.S. securities market.
The important concepts to understand are:
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the difference between a flow table and a level table;
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the difference between sector tables and instrument tables; and
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the type of information you should look for to explain capital market flows.
An uncoded flow table
Here is the type of information you should look for when examining flow of funds tables:
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What sectors are buying and selling a particular class of securities?
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How significant are the net purchases or sales, compared to the total wealth of each sector?
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Where did the buyers get the money to effect their purchases?
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What did the sellers do with the proceeds?
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Knowing the sources of buyers' funds and the use of sellers' proceeds, what might we conclude about their behavior?
Once you understand the basics of flow of funds accounts, you can look at current Federal Reserve tables and understand the money flows that drive security prices.
Color-Coded Flow Tables
This web site has flow of fund tables for the principal instruments traded in the U.S. capital market, color-coded for easy use.
The same table as above, color-coded
You can use these tables, together with the official definitions and supplementary research links, essays, and tutorials on this site, to find out rather surprising things about the market that are frequently ignored by the financial press.
The navigation bar on the top of each page leads to the flow tables you need.
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The Instruments tab on the navigation bar leads to the color-coded flow of fund instrument tables, with definitions.
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The Players tab leads to color-coded flow of fund sector tables.
In both cases, there are also links to the relevant level tables on the Federal Reserve site. (Level tables are not color coded.)
In this lesson, you have learned the basics of how to use flow of funds tables to interpret supply and demand for the major classes of securities in the U.S. capital market.
Before proceeding, check your progress:
Self-Test
The simplest model of a securities market would have:
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A flow table shows:
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Which of the following is true?
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learning module : continued >
