Financial Markets Financial Markets &&

Interest RatesInterest Rates

Financial SystemFinancial System

Surplus Economic UnitsSurplus Economic Units

Deficit Economic UnitsDeficit Economic Units

SecuritiesSecurities

Documents that represent the right to Documents that represent the right to receive funds in future.receive funds in future.

Holder of security is the bearer. Holder of security is the bearer. Ease the exchange of funds in Ease the exchange of funds in

financial system.financial system. IOU may also state when you are to IOU may also state when you are to

be paid.be paid. Trading of securities is done through Trading of securities is done through

financial intermediaries.financial intermediaries.

Financial IntermediariesFinancial Intermediaries

Investment BankersInvestment Bankers

BrokersBrokers

Dealers Dealers

Investment BankersInvestment Bankers

Help businesses, state and local Help businesses, state and local government to sell their securities to government to sell their securities to

investors.investors.

Underwriting BasisUnderwriting Basis

Best Effort Basis Best Effort Basis

BrokersBrokers

Representative of IBs.Representative of IBs.

Handle orders to buy and sell Handle orders to buy and sell securities.securities.

Commission is provided in lieu of Commission is provided in lieu of their services. their services.

DealersDealers

Make their living by trading of Make their living by trading of securities.securities.

Bid PriceBid Price

Ask/Offer Price.Ask/Offer Price.

Financial MarketsFinancial Markets

Primary MarketPrimary Market When a corporation issues securities, cash When a corporation issues securities, cash

flows from investors to the firm.flows from investors to the firm. Usually an underwriter is involvedUsually an underwriter is involved

Secondary MarketsSecondary Markets Involve the sale of “used” securities from one Involve the sale of “used” securities from one

investor to another.investor to another. Securities may be exchange traded or trade Securities may be exchange traded or trade

over-the-counter in a dealer market.over-the-counter in a dealer market.

Financial MarketsFinancial Markets

Money MarketMoney Market

Capital MarketCapital Market

OTCOTC

Market EfficiencyMarket Efficiency

Securities in Money Securities in Money MarketMarket

Best Place for the parking of surplus Best Place for the parking of surplus funds for the short period of time.funds for the short period of time.

Treasury BillsTreasury Bills Negotiable certificates of depositNegotiable certificates of deposit Commercial PapersCommercial Papers Euro DollarsEuro Dollars Bankers Acceptance Bankers Acceptance

Treasury BillsTreasury Bills

Issued by United States on weekly Issued by United States on weekly basis.basis.

At maturity government pays the At maturity government pays the face value.face value.

Considered as bench mark of safety.Considered as bench mark of safety. Essentially having no risk at all. Essentially having no risk at all.

Negotiable Certificates of Negotiable Certificates of DepositDeposit

Issued by local banks.Issued by local banks. To be paid on certain date along To be paid on certain date along

with interest.with interest. Small denominations are safe Small denominations are safe

investmentsinvestments Large denominations are negotiable Large denominations are negotiable

CDs.CDs.

Commercial PapersCommercial Papers

Short term promissory notes.Short term promissory notes. Issued by large corporation with Issued by large corporation with

strong credit rating.strong credit rating. Unsecured due non existence of Unsecured due non existence of

collateral.collateral. Most of the buyers are large Most of the buyers are large

institution. institution.

Euro DollarsEuro Dollars

Banker’s AcceptanceBanker’s Acceptance

Securities In the Capital Securities In the Capital MarketMarket

When organizations want to raise When organizations want to raise money for a long period of time, they money for a long period of time, they

issue capital securities.issue capital securities.

BondsBonds

StocksStocks

BondsBonds

IOU that promises to pay their owner IOU that promises to pay their owner a certain sun of money along with a certain sun of money along with

periodic payments of interest. periodic payments of interest.

Bond Terminology & Bond Terminology & TypesTypes

Face ValueFace ValueThe amount that the bond promises to pay The amount that the bond promises to pay

in future.in future. Maturity DateMaturity Date

The date on which issuer is obligated The date on which issuer is obligated to pay the face valueto pay the face value

Coupon InterestCoupon Interest

The interest payments made to bond The interest payments made to bond owner during the life of the bondowner during the life of the bond

Treasury Notes & BondsTreasury Notes & Bonds

Municipal BondsMunicipal Bonds

Corporate BondsCorporate Bonds

Types Of BondsTypes Of Bonds

MunisMunis General Obligation BondsGeneral Obligation Bonds Revenue BondsRevenue Bonds Investment Grade BondsInvestment Grade Bonds Junk BondsJunk Bonds

Corporate StockCorporate Stock

Shares of ownership interest.Shares of ownership interest. Bearer/Investors are called stock Bearer/Investors are called stock

holders.holders. Money raised from sale of stock Money raised from sale of stock

doesn't ever have to be paid back..doesn't ever have to be paid back.. Common StockCommon Stock Preferred stock Preferred stock

InterestInterest

Interest represents the return or Interest represents the return or compensation a lender demands compensation a lender demands before agreeing to loan money.before agreeing to loan money.

Determinants of Interest Determinants of Interest RateRate

Nominal interest rateNominal interest rate Real rate of interestReal rate of interest Inflation premiumInflation premium Maturity risk premiumMaturity risk premium Liquidity risk premiumLiquidity risk premium Default risk PremiumDefault risk Premium