Download - Chap-1 Financial Markets & Institutions
Financial Markets and InstitutionsBy Jeff Madura
Prepared byNazmul H. Palash
Lecturer-Finance & Banking, DIU.
CHAPTER
11 Role of Financial Markets and Institutions
Chapter ObjectivesChapter Objectives
Describe the types of financial markets
Describe the role of financial institutions with financial markets
Identify the types of financial institutions that facilitate transactions
Overview of Financial MarketsOverview of Financial Markets
Financial markets provide for financial intermediation--financial savings (Surplus Units) to investment (Deficit Units)
Financial markets provide payments system Financial markets provide means to manage risk
Financial Market: a market in which financial assets (securities) such as stocks and bonds
can be purchased or sold
Broad Classifications of Financial Markets
Money versus Capital Markets
Primary versus Secondary Markets
Organized versus Over-the-Counter Markets
Overview of Financial MarketsOverview of Financial Markets
Primary vs. Secondary MarketsPrimary vs. Secondary Markets
PRIMARYPRIMARY New Issue of Securities
Exchange of Funds for Financial Claim
Funds for Borrower; an IOU for Lender
SECONDARYSECONDARY Trading Previously Issued
Securities
No New Funds for Issuer
Provides Liquidity for Seller
Money vs. Capital MarketsMoney vs. Capital Markets
MoneyMoney Short-Term, < 1 Year
High Quality Issuers
Debt Only
Primary Market Focus
Liquidity Market--Low Returns
CapitalCapital Long-Term, >1Yr
Range of Issuer Quality
Debt and Equity
Secondary Market Focus
Financing Investment--Higher Returns
Organized vs. Over-the-Counter Organized vs. Over-the-Counter MarketsMarkets
OrganizedOrganized Visible Marketplace
Members Trade
Securities Listed
New York Stock Exchange
OTCOTC Wired Network of
Dealers
No Central, Physical Location
All Securities Traded off the Exchanges
Money Market Securities Debt securities Only
Capital market securities Debt and equity securities
Derivative Securities Financial contracts whose value is derived from the values of
underlying assets Used for hedging (risk reduction) and speculation (risk seeking)
Securities Traded in Financial MarketsSecurities Traded in Financial Markets
Debt vs. Equity SecuritiesDebt vs. Equity Securities
Debt Securities: Contractual obligations (IOU) of Debtor (borrower) to Creditor (lender) Investor receives interest Capital gain/loss when sold Maturity date
Debt vs. Equity SecuritiesDebt vs. Equity Securities
Equity Securities: Claim with ownership rights and responsibilities Investor receives dividends if declared Capital gain/loss when sold No maturity date—need market to sell
Valuation of SecuritiesValuation of Securities
Value a function of: Future cash flows When cash flows are received Risk of cash flows
Present value of cash flows discounted at the market required rate of return
Value determined by market demand/supply Value changes with new information
Investor Assessment of New InformationInvestor Assessment of New Information
Exhibit 1.3
Economic Conditions
Industry Conditions
Firm Specific Information
Impact of Future Cash Flows
Evaluation of Security
Pricing
Investor Decision to Trade
Security prices reflect available information
New information is quickly included in security prices
Investors balance liquidity, risk, and return needs
Financial Market EfficiencyFinancial Market Efficiency
Financial Market RegulationFinancial Market Regulation
To Promote Efficiency
High level of competition
Efficient payments mechanism
Low cost risk management contracts
Why Government Regulation?
To Maintain Financial Market Stability Prevent market crashes
Circuit breakers Federal Reserve discount window
Prevent Inflation--Monetary policy
Prevent Excessive Risk Taking by Financial Institutions
Financial Market RegulationFinancial Market Regulation
Why Government Regulation?
To Provide Consumer Protection Provide adequate disclosure Set rules for business conduct
To Pursue Social Policies Transfer income and wealth Allocate saving to socially desirable areas
Housing Student loans
Financial Market RegulationFinancial Market Regulation
Why Government Regulation?
Financial Market GlobalizationFinancial Market Globalization
Increased international funds flow Increased disclosure of information Reduced transaction costs Reduced foreign regulation on capital flows Increased privatizationResults: Increased financial integration--capital
flows to highest expected risk-adjusted return
Role of Financial Institutions in Financial Role of Financial Institutions in Financial MarketsMarkets Information processing Serve special needs of lenders (liabilities) and
borrowers (assets) By denomination and term By risk and return
Lower transaction cost Serve to resolve problems of market
imperfection
Role of Financial Institutions in Role of Financial Institutions in Financial MarketsFinancial Markets
Types of Depository Financial Institutions
CommercialBanks
$5 TrillionTotal Assets
Savings Institutions
$1.3 TrillionTotal Assets
Credit Unions$.5 TrillionTotal Assets
Types of Nondepository Financial Types of Nondepository Financial InstitutionsInstitutions
Insurance companies Mutual funds Pension funds Securities companies Finance companies Security pools
Role of Nondepository Financial Role of Nondepository Financial InstitutionsInstitutions
Focused on capital market Longer-term, higher risk intermediation Less focus on liquidity Less regulation Greater focus on equity investments
Trends in Financial InstitutionsTrends in Financial Institutions
Rapid growth of mutual funds and pension funds
Increased consolidation of financial institutions via mergers
Increased competition between financial Institutions
Growth of financial conglomerates
Global Expansion by Financial Global Expansion by Financial InstitutionsInstitutions
International expansion International mergers Impact of the single European currency Emerging markets