FINANCIAL MARKETS
CHAPTER 1: INTODUCTION
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LEARNING GOALS
Differentiate between primary and secondary
markets.
Differentiate between money and capital
markets.
Understand what foreign exchange markets are.
Understand what derivate security markets are.
Distinguish between the different types of
financial institutions.
Know the risk financial institutions are
regulated.
Appreciate why financial institutions are
regulated.
Recognize that financial markets are becoming
increasingly global.
Why study Financial Markets
and Institutions?
Financial Markets
refer broadly to any marketplace where the trading
of securities occurs.
There exist two different forms
of exchange in financial
markets.
Direct Finance
ex: stock, bonds or foreign
exchange.
Indirect Finance
PRIMARY
MARKETS
SECONDARY
MARKETS
markets in which
users of funds
e.g., corporations and
VS markets in which financial
instruments already in
governments existence are traded
raise funds by issuing
among lenders
financial instruments
e.g., stocks and bonds
MONEY
MARKETS
markets that trade debt
securities with maturities of
one year or less
(e.g., CDs and U.S. Treasury bills) VS
CAPITAL
MARKETS
markets that trade debt (bonds) and
equity (stock) instruments with
maturities of more than one year
Foreign
Exchange (FX) Markets
FX markets
trading one currency for another (e.g., dollar for
yen)
Spot FX
the immediate exchange of currencies at current
exchange rates
Forward FX
the exchange of currencies in the future on a
specific date and at a pre-specified exchange
rate
Derivative
Security Markets
a financial security whose
payoff is linked to (i.e.,
“derived” from) another
security or commodity
generally an agreement to
exchange a standard quantity of
assets at a set price on a specific
date in the future
Financial Market Regulation
The Securities Act of
1933
full and fair disclosure and
securities registration
The Securities
Exchange Act of 1934
Securities and Exchange
Commission (SEC) is the
main regulator of securities
markets
Financial
Institutions (FIs)
institutions through which Types of
suppliers channel money to Financial
users of funds Institutions
• Commercial Banks
Financial Institutions • Thrifts
are distinguished by • Insurance companies
whether they accept • Securities firms and investment bank
deposits • Finance companies
• Mutual Funds
• Hedge Funds
• Pension Funds
Unique Economic Functions Performed by FIs
Monitoring Costs
A supplier of funds who directly invests in a
fund user’s financial claims faces a high cost
of monitoring the fund user’s actions in a
timely and complete fashion
A solution is for many small investors to
group their funds together by holding the
claims issued by a FI
Liquidity and Price Risk
FIs act as asset transformers, financial claims issued by an FI that are more
attractive to investors than are the claims directly issued by corporations
Often, claims issued by FIs have liquidity attributes that are superior to those of
primary securities
FIs diversify away some, but not all, of their investment risk
Reduce monitoring costs
Increase liquidity and lower
price risk
Reduce transaction costs
Provide maturity intermediation BENEFIT BENEFIT
Provide denomination
intermediation
FIs Benefit Suppliers of Funds
Economic Functions
FIs Provide to the Transmission of monetary
Financial System
policy
as a WHOLE Credit allocation
Intergenerational wealth
transfers or time
intermediation
Payment services
Risks Incurred by Financial Institutions
• Default or credit risk
• Foreign exchange risk and sovereign
risk
• Interest rate risk
• Market risk
• Off-balance-sheet risk
• Liquidity risk
• Technology risk
• Operational risk
• Insolvency risk
Regulation of Financial Institutions
FIs are heavily regulated to protect
society at large from market failures
Regulations impose a burden on FIs and
recent U.S. regulatory changes have
been deregulatory in nature
Regulators attempt to maximize social
welfare while minimizing the burden
imposed by regulation
Globalization of
Infographic Style
Financial Markets and
Institutions
Information on foreign
The pool of savings from markets and investments is
foreign investors is becoming readily accessible
increasing and investors and deregulation across the
look to diversify globally globe is allowing even
greater access
now more than ever
before
International mutual funds allow
diversified foreign investment with low
transactions costs
Thank You
ANGTUD. ARADOR. ARNADO. ARONG
