chapter two overview of the financial system slide 2–3 function of financial markets allows...
TRANSCRIPT
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Chapter Two
Overview of the Financial System
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Slide 2–3
Function of Financial Markets
• Allows transfers of funds from person or business without investment opportunities to one who has them
• Improves economic efficiency
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Slide 2–4
Figure 2-1: Flow of Funds Through the Financial System
Function of Financial Markets
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Slide 2–5
Classifications of Financial Markets
1. Debt Markets– Short-Term (maturity < 1 year) Money Market
– Long-Term (maturity > 1 year) Capital Market
2. Equity Markets– Common Stock
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Slide 2–6
Classifications of Financial Markets
1. Primary Market– New security issues sold to initial buyers
2. Secondary Market– Securities previously issued are bought and sold
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Slide 2–7
Classifications of Financial Markets
1. Exchanges– Trades conducted in central locations
(e.g., New York Stock Exchange)
2. Over-the-Counter Markets– Dealers at different locations buy and sell
NYSE home pagehttp://www.nyse.com
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Slide 2–8
Internationalization of Financial Markets
• International Bond Market– Foreign bonds
– Eurobonds (now larger than U.S. corporate bond market)
• World Stock Markets– U.S. stock markets are no longer always the largest—
at one point, Japan's was larger
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Slide 2–9
Function of Financial Intermediaries
• Financial Intermediaries1. Engage in process of indirect finance
2. More important source of finance than securities markets
3. Needed because of transactions costs and asymmetric information
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Slide 2–10
Function of Financial Intermediaries
• Transactions Costs 1. Financial intermediaries make profits by reducing
transactions costs
2. Reduce transactions costs by developing expertise and taking advantage of economies of scale
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Slide 2–11
Asymmetric Information: Adverse Selection and Moral Hazard
• Adverse Selection1. Before transaction occurs
2. Potential borrowers most likely to produce adverse outcome are ones most likely to seek loan and be selected
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Slide 2–12
Asymmetric Information: Adverse Selection and Moral Hazard
• Moral Hazard1. After transaction occurs
2. Hazard that borrower has incentives to engage in undesirable (immoral) activities making it more likely that won't pay loan back
• Financial intermediaries reduce adverse selection and moral hazard problems, enabling them to make profits
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Slide 2–13
Financial Intermediaries
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Slide 2–14
Size of Financial Intermediaries
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Slide 2–15
Regulatory Agencies
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Slide 2–16 SEC home pagehttp://www.sec.gov
Regulation of Financial Markets
• Three Main Reasons for Regulation1. Increase Information to Investors
• Decreases adverse selection and moral hazard problems • SEC forces corporations to disclose information
2. Ensuring the Soundness of Financial Intermediaries• Prevents financial panics• Chartering, reporting requirements, restrictions on assets
and activities, deposit insurance, and anti-competitive measures
3. Improving Monetary Control• Reserve requirements• Deposit insurance to prevent bank panics