© 2006 thomson business and professional publishing. all rights reserved. t h i r d e d i t i o n...

PowerPoint Presentation by Charlie CookThe University of West Alabama

PowerPoint Presentation by Charlie CookThe University of West Alabama

© 2006 Thomson Business and Professional Publishing. All rights reserved.© 2006 Thomson Business and Professional Publishing. All rights reserved.

T H I R D E D I T I O NT H I R D E D I T I O N

Domestic and International Financial MarketsDomestic and International Financial MarketsChapter 3Chapter 3

Unit 1 IntroductionUnit 1 Introduction

© 2006 Thomson Business and Professional Publishing. All rights reserved. 3–2

Fundamental IssuesFundamental IssuesFundamental IssuesFundamental Issues

1. What is the main economic function of financial markets?

2. What are primary and secondary markets for financial instruments?

3. What are money markets, and what are key money market instruments?

4. What capital markets, and what are key capital market instruments?


Fundamental Issues (cont’d)Fundamental Issues (cont’d)Fundamental Issues (cont’d)Fundamental Issues (cont’d)

5. Why has automated financial trading grown, and what are its implications for world financial markets?

6. What are vehicle currencies, and what are the predominant vehicle currencies in international markets?


Access to the powerpoint notes!Access to the powerpoint notes!

• http://domin.dom.edu/faculty/adjunct/tporebski/econ367/index.htm

• From there, each chapter is linked to the schedule page.

• About a chapter a week will be linked.

http://domin.dom.edu/faculty/adjunct/tporebski/econ367/index.htm

http://domin.dom.edu/faculty/adjunct/tporebski/econ367/index.htm


Saving and InvestmentSaving and Investment

• The major purpose of financial markets is to channel savings to productive investment

• Saving:Forgone consumption.

• Investment:Additions to the stock of capital goods.

• Capital goods:Goods that may be used to

produce other goods or services in the future.


Financial Markets and InstrumentsFinancial Markets and Instruments

• Financial instruments (also called securities):• What are financial “instruments”?• Just as a surgeon uses tools or instruments, so do

people in financial markets, but here the instruments are in the form of paper documents.

• These instruments connect buyers and sellers• Claims that those who lend their savings have on the

future incomes of the borrowers who use those funds for investment. Used to undertake crucial exchanges of financial resources Help to reduce risks of financial loss


The Function of Financial MarketsThe Function of Financial Markets

Figure 3–1

Financial markets facilitate the transfer of funds from savers to those who wish to invest in capital goods. For instance, companies that wish to undertake investment projects offer financial instruments to savers in exchange for funds to finance the projects.


Ways of classifying financial marketsWays of classifying financial markets

• By the type of instrument, such as stocks, bonds, etc

• Primary and Secondary Financial Markets• By term to maturity, money markets and capital

markets.


Primary and Secondary Financial MarketsPrimary and Secondary Financial Markets

• Primary market: A financial market in which newly issued financial instruments

are purchased and sold. Initial public offerings (IPOs) of stocks are underwritten and

marketed by investment banks. Underwrites means the investment bank guarantees the initial

fixed share price.

• Secondary market: A financial market in which financial instruments issued in the

past are traded.

• Brokers: Institutions that specialize in matching buyers and sellers of

financial instruments in secondary markets.


Primary and Secondary Financial MarketsPrimary and Secondary Financial Markets

• Secondary markets help make financial instruments more liquid.


Money Markets and Capital MarketsMoney Markets and Capital Markets

• Short-term maturity (money markets):Maturity of less than one year.Service current liquidity needs.

• Intermediate-term maturity (capital markets):Maturity between one year and ten years.Fund long-term capital investments.

• Long-term maturity (bond markets):Maturity of more than ten years.


Money Market InstrumentsMoney Market Instruments

• Treasury bills (T-bills):Short-term debt obligations of the federal

government issued with maturities of three, six, or twelve months. No explicit interest payments Sold at a discount Highly liquid, active secondary market Safest of the money market instruments


Money Market InstrumentsMoney Market Instruments

• Commercial paper:A short-term debt instrument issued by businesses

in lieu of borrowing from banks.

• Certificates of deposit (CDs):Time deposits issued by banks and other depository

institutions that are negotiable instruments traded in secondary markets. Can be resold in secondary market Minimum denomination of $100,000 (in practice, to trade

in secondary market the minimum is $2,000,000)


Money Market Instruments (cont’d)Money Market Instruments (cont’d)

• Repurchase agreementA contract to sell a financial asset with the

understanding that the seller will buy back the asset at a later date and, typically, at a higher price. Usually the financial asset sold is a government security.

– Used by banks and large corporations



• Federal funds market:The money market in which banks borrow from and

lend to each other deposits that they hold at Federal Reserve banks. Generally very short loans, often overnight Basically a market for excess reserves: banks that are

short on excess reserves borrow from banks with such reserves

Borrowing bank pays an interest rate known as the Federal Funds rate



• Banker’s acceptance:A bank loan typically used by a company to finance

storage or shipment of goods. Instruments created in course of financing international

trade Bankers acceptance is a bank draft, like a check,

guaranteeing future payment Active secondary market


Money Market Instruments OutstandingMoney Market Instruments Outstanding

Figure 3–2 SOURCE: Board of Governors of the Federal Reserve System, Federal Reserve Bulletin Statistical Supplement, April 2005.


International Money MarketsInternational Money Markets

• Capital mobility:The extent to which savers can move funds across

national borders for the purpose of buying financial instruments issued in other countries.

• International money markets: Markets for cross-border exchange of financial

instruments with maturities of less than one year.Many such instruments traded, the biggest being the

market for foreign exchange. International derivative securities, whose returns are

derived from other instruments, are sometimes classified here as well.


The Eurocurrency MarketsThe Eurocurrency Markets

• Eurocurrency markets:Markets for bonds, loans, and deposits denominated

in the currency of a given nation but held and traded outside that nation’s borders.

• Eurocommercial paper:A short-term debt instrument issued by a firm and

denominated in a currency other than that of the country where the firm is located.

• Eurocurrency deposits:Bank deposits denominated in the currency of one

nation but located in a different nation.


Cross-Border Positions of Major World Cross-Border Positions of Major World Banks (Exchange-Rate-Adjusted Changes)Banks (Exchange-Rate-Adjusted Changes)

Table 3–1 SOURCE: Bank for International Settlements, International Banking Statistics, June 2005, and authors’ estimates.


Foreign Deposits Held at Offices of U.S. Banks.Foreign Deposits Held at Offices of U.S. Banks.

Figure 3–3 SOURCE: Federal Deposit Insurance Corporation, authors’ estimates.


Capital Market Instruments: EquitiesCapital Market Instruments: Equities

• Equities:Shares of ownership, such as corporate stock,

issued by business firms.Owners of equities are residual claimants on the

income and net worth of a corporation, meaning other debt holders of the corporation are paid first.

The rate of return on equities varies with the profitability of the firm.

• Dividends:Periodic payments to holders of corporate equities.


Types of EquitiesTypes of Equities

• Common stock:Shares of corporate ownership that entitle the owner

to vote on management issues but offer no guarantees of dividends or of market value in the event of corporate bankruptcy.

• Preferred stock:Shares of corporate ownership that entail no voting

rights but entitle the owner to dividends if any are paid by the corporation and to any residual value of the corporation after other creditors have been paid.


Stock (Equity) ExchangesStock (Equity) Exchanges

• Stock exchanges:Organized marketplaces for corporate equities and

bonds.

• New York Stock Exchange (NYSE)The oldest (1792) and largest exchange where

roughly half of the stock trading in the United States is done—shares of more than 3,000 companies are traded there.

The number of NYSE membership positions, called “seats,” is fixed at 1366.

http://www.nyse.com/home.html




Stock (Equity) ExchangesStock (Equity) Exchanges

• Over-the-counter (OTC) stocks:Equity shares offered by companies that do not meet

listing requirements for major stock exchanges, or choose not to be listed there, and instead are traded in decentralized markets.

• National Association of Securities Dealers Automated Quotation (Nasdaq):The electronic network of 500 dealers over which

most over-the-counter stocks are traded.Microsoft, Intel, and Cisco trade on this exchange. http://www.NASDAQ.com

http://www.nasdaq.com/

http://www.nasdaq.com/


Reading Reading Stock Stock QuotationsQuotations

Figure 3–5

52 Week Hi: Highest dollar price of a share of J. P. Morgan Chase common stock during the past 52 weeks, which was $40.45.

52 Week Lo: Lowest dollar price of a share of J. P. Morgan Chase common stock during the past 52 weeks, which was $33.35.

Stock: Corporate name of J. P. Morgan Chase.

Sym: Symbol identifying J. P. Morgan Chase, which is JPM.

Div: Annual dollar dividend per share, which was $1.36 per share.

Yld %: Stock yield measured as the annual dividend as a percentage of the closing price for the day, which was $1.36 divided by $35.71 times 100, or approximately 3.8%.

PE: Ratio of stock price to the annual earnings per share, which was equal to 30 for J. P. Morgan Chase.

Vol 100s: Hundreds of J. P. Morgan Chase shares traded this day, or 9,026,200 shares.

Close: Price of J. P. Morgan Chase shares at day’s end, or $35.71 per share.

Net Chg: Dollar change in price of J. P. Morgan Chase shares relative to previous day’s trading, which was an increase of $0.11.


Capital Market InstrumentsCapital Market Instruments

• Corporate bonds:Long-term debt instruments of corporations.

Issued by corporations– Usually have excellent credit ratings– Pay interest twice a year and principal at maturity– Maturities range from 2 – 30 years– Convertible bonds can be redeemed for shares of

stock



• Treasury notes and bonds:Notes have maturities ranging from one to ten years.Bonds have maturities of ten years or more.

Issued by U.S. Treasury to finance deficits of federal government

Pay semiannual dividends and return of principal at maturity



• Securities of U.S. Government Agencies: Long-term bonds issued by various

government agencies that support Commercial, residential, & agricultural real estate

lending Student loans

General National Mortgage Association (GNMA) “Ginnie Mae” Securities back by the value of household mortgages http://www.ginniemae.gov/

http://www.ginniemae.gov/




Capital Market Instruments (cont’d)Capital Market Instruments (cont’d)

• Municipal bonds:Long-term debt instruments issued by state and local

governments.

Long-term instruments issued by state and local governments to finance expenditures on schools, roads, college dorms and the like.

• One advantage is tax status: exempt from Federal income tax and also state taxes for investors living in the issuing state.



• Mortgage loans:Long-term loans to individual homeowners or to

businesses for purchases of land and buildings.

• Mortgage-backed securities:Financial instruments whose return is based on the

underlying returns on mortgage loans.



• Commercial loans:Long-term loans made by banks to businesses.

• Consumer loans:Long-term loans made by banks and other

institutions to individuals.Not as many secondary markets for these loans


Capital Market Instruments Outstanding.Capital Market Instruments Outstanding.

Figure 3–4 SOURCE: Board of Governors of the Federal Reserve System, Federal Reserve Bulletin Statistical Supplement, April 2005; 3.1 Flow of Funds Release, June 9, 2005.


International Capital MarketsInternational Capital Markets

• Euronotes:Medium-term debt instruments issued in a currency

other than that of the country where the instruments are issued.

• Eurobonds:Long-term debt instruments issued in a currency

other than that of the country where the instruments are issued.


The Cybertrading Revolution and Its The Cybertrading Revolution and Its International RamificationsInternational Ramifications

• Electronic trading began in the 1990’s, companies like etrade.com, etc. Can now buy stocks online

• Electronic communication networks (ECNs) link buyers and sellers of stock around the worldLower fees and transaction costsSpeedier access to market information and tradesLower printing costs to brokerages Some companies now offer commercial paper online.



• International Cybertrading has taken off• CORES: Computer assisted order routing and

execution systems, CATS, computer assisted trading system, and many others, all making for computer purchase and sale of securities.



• International Cybertrading ConcernsRules for securities trading in a global environment:

not all nations have the same trading rulesExacerbation of financial uncertainty leading to crisesEnforcement of capital controls restricting the ability

of a nation’s residents to hold and trade assets denominated in foreign currencies. Cybertechnology makes such controls more costly and difficult.


Vehicle CurrenciesVehicle Currencies

• Vehicle currency:A commonly accepted currency that is used to

denominate a transaction that does not take place in the nation that issues the currency.

The U.S. dollar has traditionally been the predominant vehicle for international transactions.

Shift is toward the use of multiple currencies (e.g., euro, yen, and pound)


A Timeline of Vehicle CurrenciesA Timeline of Vehicle Currencies

Table 3–4

The U.S. dollar is the latest in a long line of vehicle currencies.

SOURCE: Robert Mundell, “The International Impact of the Euro and Its Implications for Transition Economies,” in Central Banking, Monetary Policies, and the Implications for Transition Economies, ed. Mario Blejer and Marko Skreb (Boston: Kluwer Academic Publishers, 1999), pp. 403–428.


Leading Vehicle CurrenciesLeading Vehicle Currencies

Table 3–5

SOURCE: Data from Bank for International Settlements, International Banking Statistics and Securities Statistics, 2005.