College of Education

School of Continuing and Distance Education 2017/2018 – 2018/2019 ACADEMIC YEAR

Introduction to Financial Markets & Institutions

LECTURER: (Elikplimi Komla Agbloyor, PhD ) DEPARTMENT: (Department of Finance, UGBS) (Contact Information: ekagbloyor@ug.edu.gh)

Course Information

Provide the following information:

Course Code:

Course Title:

Course Credit 3 Credit(s)

Session Number & Session Title:

1 – Introduction to Financial Markets & Institutions

Semester/Year: 2nd Semester - 2017/18Year

Teaching Assistant Francis K. A. Baidoo fbaidoo@live.com

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Session Overview

• This session is designed to Introduce and orient students on

the financial market and institutions, stressing more on its

roles, and structure, as well as the regulatory confines

surrounding such market and institutional players.

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Session Learning Outcomes

At the end of the session, the student will

1. Understand the global and local financial systems

2. Appreciate what financial instruments are

3. Understand financial markets

4. Appreciate the regulatory frameworks governing

financial market operations.

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INTRODUCTION TO FINANCIAL

MARKETS & INSTITUTIONS

Financial Systems/Crises

Financial Markets

• Financial markets do not work well when we have a financial crisis

• Financial markets are important because they promote efficient resource allocation and economic growth (Finance/Growth literature)

• King, R. G., & Levine, R. (1993). Finance and growth: Schumpeter might be right. The quarterly journal of economics, 108(3), 717-737.

• Adjasi, C. K., & Biekpe, N. B. (2006). Stock market development and economic growth: The case of selected African countries. African Development Review, 18(1), 144-161.

History of Financial Crises

• https://www.youtube.com/watch?v=bx_LWm6_6tA

• http://www.economist.com/news/essays/21600451-finance-not-merely-prone-crises-it-shaped-them-five-historical-crises-show-how-aspects-today-s-fina

Some terms associated with the 2007/8 Financial Crises

• CDOs

• CDS

• Breaking the buck

• TED Spread

• Financial system has five components: – Money – as a medium of exchange and store of wealth

– Financial instruments – to transfer resources and risk

– Financial markets – allow trading in financial instruments

– Financial institutions – provide services, including access to financial markets

– Central banks – monitor and stabilise the economy

Overview of Financial System

• Financial instrument

– Is the legal obligation of one party to transfer something of value, usually money, to another party at some future date, under certain conditions, e.g. stocks, loans, insurance

– Uses of financial instruments include:

• Act as a means of payment

• Store of value

• Allow for the trading of risk

Financial Instruments

• Standardization – financial instruments are homogenous – loans and securitized loans

• Information – summarise essential information about issuer. Resolve problem of information asymmetry

• Akerlof, G. A. (1970). The market for" lemons": Quality uncertainty and the market mechanism. The quarterly journal of economics, 488-500.

• Examples of financial instruments: – Financial instruments used as store of value include: bank

loans, bonds, mortgages, stocks

– Financial instruments used to transfer risk include: insurance contracts, futures contracts, options, swaps

Characteristics of Financial Instruments

Overview 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 markets pool and communicate information about the issuers of financial instrument, summarising in the form of price

Financial Market: a market in which financial

assets (securities) such as stocks and bonds

can be purchased or sold

Role of Financial Intermediaries

• Providing maturity intermediation

• Pooling savings

• Reducing risk through diversification

• Reducing costs of contracting and information processing

• Providing a payments mechanism

• Providing liquidity

Services of Financial Institutions

n Transforming financial assets

l Deposits represent assets to customers but a liability of the financial

institution. These liabilities are transformed into loans

n Exchanging financial assets on behalf of customers

l Brokerage function

n Exchanging financial assets for own account

l Dealer function

n Assisting in the creation of financial assets

l Underwriting function

n Providing investment advice

n Managing portfolios

Function of Financial Markets 1. Allows transfers of funds from person or business without investment opportunities to one who has them

2. Improves economic efficiency

Role of Financial Intermediaries

• Transfer of funds from savers to investors – Types of Investments

– Direct Investment

• For example, purchasing a portfolio of stocks and bonds, investing in loans.

– Indirect Investment

• For example, purchasing an equity claim issued by an investment company, loan granted by a bank.

• Broad Classifications of Financial Markets

Money versus Capital Markets

Primary versus Secondary Markets

Organized versus Over-the-Counter Markets

Overview of Financial Markets

Money vs. Capital Markets

• Money

– Short-Term, < 1 Year

–High Quality Issuers

–Debt Only

–Primary Market Focus

– Liquidity Market--Low Returns

n Capital

l Long-Term, >1Yr

l Range of Issuer Quality

l Debt and Equity

l Secondary Market Focus

l Financing Investment--Higher Returns

Primary vs. Secondary Markets

• PRIMARY –New Issue of

Securities

– Exchange of Funds for Financial Claim

– Funds for Borrower; an IOU for Lender

• SECONDARY – Trading Previously

Issued Securities

–No New Funds for Issuer

–Provides Liquidity for Seller

Organized vs. Over-the-Counter Markets

• Organized

–Visible Marketplace

–Members Trade

– Securities Listed

–GSE, NYSE

• OTC

–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 Markets

Debt vs. Equity Securities

Debt Securities: Contractual obligations of Debtor (borrower) to Creditor (lender)

• Investor receives interest

• Capital gain/loss when sold

• Maturity date

Debt 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 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 Information

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 Efficiency

The Role of Govt. in Financial Markets

• Government acts as financial intermediary through its:

–Direct lending – provide credit on more favourable terms

–Guarantees – guarantee the payment of principal and interest in whole or in part, in the event that the borrower defaults

– Sponsored enterprises – govt. may sometimes provide capital for the formation of these firms

Financial Market Regulation

n To Maintain Financial Market Stability

u Prevent market crashes – using Central

Bank’s discount window

u Prevent Inflation--Monetary policy

u Prevent Excessive Risk Taking by

Financial Institutions

Financial Market Regulation

n To Promote Efficiency

u High level of competition

u Efficient payments mechanism

u Low cost risk management contracts

n To Provide Consumer Protection

n Provide adequate disclosure

n Set rules for business conduct

Financial Market Regulation

n To Pursue Social Policies

u Transfer income and wealth

u Allocate savings to socially desirable areas

n To restrict Foreign Activities in Domestic

markets

n To Control Level of Economic Activity

Forms of Regulation

• Disclosure Regulation

• Financial Activity Regulation

• Regulation of Financial Institutions

• Regulation of Foreign Participants

• Banking and Monetary Regulation

Reading Assignment – The Role of the Government in Financial Markets

• Stiglitz, J. E. (1993). The role of the state in financial markets. The World Bank Economic Review, 7(suppl 1), 19-52.

Financial Repression – Reading/Presentation

• What is financial repression?

– McKinnon and Shaw (1973) hypothesis on financial repression.

– http://www.investopedia.com/terms/f/financial-repression.asp

Financial Market Globalization

• Increased international funds flow

– Increased disclosure of information

–Reduced transaction costs

–Reduced foreign regulation on capital flows

– Increased privatization

Results: Increased financial integration--capital flows to highest expected risk-adjusted return

Reading Assignment

• Agbloyor, E. K., Abor, J. Y., Adjasi, C. K. D., & Yawson, A. (2014). Private capital flows and economic growth in Africa: The role of domestic financial markets. Journal of International Financial Markets, Institutions and Money, 30, 137-152.

Types of Depository Financial Institutions

Types of Depository Financial Institutions

Commercial

Banks

Savings

Institutions

Credit

Unions

Types of Non-depository Financial Institutions

• Insurance companies

• Mutual funds

• Pension funds

• Securities/Investment companies

• Finance companies

Role of Nondepository Financial Institutions

• Focused on capital market

• Longer-term, higher risk intermediation

• Less focus on liquidity

• Less regulation

• Greater focus on equity investments

Trends 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

References

• Abor, Joshua Y. (2016), Financial Markets and Institutions: A Frontier Market Perspective, Digibooks.

• Madura, Jeff, Financial Markets and Institutions, South-Western College Publishing. • Fabozzi, Frank J., Modigliani Franco and Michael G. Ferri, Foundations of Financial Markets

and Institutions. • Thygerson, Kenneth J., Financial Markets and Institutions: A Managerial Approach, Harper

Collins College Publishers • Mishkin, Frederic S., and Stanley G. Eakins, Financial Markets and Institutions, published by

Addison-Wesley. • Cecchetti, Stephen G. Money, Banking, and Financial Markets, McGraw-Hill, Irwin • Mensah, Sam, Securities Markets and Investments: A Ghanaian Primer, Smartline. • Ghana Fixed Income Market Manual • Ghana Stock Exchange (GSE) 25th Anniversary Lecture • Prospectus for Edendale Bond Issue • Greenwood, R., & Scharfstein, D. S. (2012). How to Make Finance Work (Digest

Summary). Harvard Business Review, 90(3), 104-110. • Merton, R. (2009). Making the Financial Markets Safe. Harvard Business Review. • Campbell, J. Y., Jackson, H. E., Madrian, B. C., & Tufano, P. (2011). Making Financial Markets

Work for Consumers (Digest Summary). Harvard Business Review, 89(7/8), 47-54.

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