the financial markets
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What is a Financial Market?
A mechanism by which borrowers (those with a need for funds) and lenders (those with excess fund) get together.
The primary role of financial markets is to facilitate the flow of funds from those who have surplus funds to those who have needs for funds in excess of their current income.
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Flow of Funds
Three financial phasesYoung adults borrow
Older working adults save
Retired adults use savings
Funds transferred from savers to borrowersDirect transfer
Investment banking house
Financial intermediary
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Transfer of Funds
Securities (stocks or bonds)
Dollars
Borrower(Business)
Saver(Investor)
Direct Transfers
Borrower(Business)
Indirect Transfers through an Investment Banker
Saver(Investor)Investment Banker
Securities Securities
Dollars Dollars
Indirect Transfers through a Financial IntermediaryBorrower(Business)
Saver(Investor)
Financial Intermediary
BusinessSecurities
Dollars(Loans)
Dollars(Deposits)
IntermediarySecurities
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Market Efficiency
Economic Efficiency—funds are allocated to their optimal use at the lowest costs
Informational Efficiency—investment prices are adjusted quickly to reflect current informationWeak-form—all information contained in past price
movements is reflected in current market prices
Semistrong-form—current prices reflect all publicly available information
Strong-form form—current prices reflect all pertinent information, both public and private
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Types of Financial Markets
Money versus capital markets
Debt versus equity markets
Primary versus secondary markets
Derivatives markets
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General Stock Market Activities
The secondary market—trading of outstanding, previously issued shares of stock
The primary market—new shares of stock sold by companies to raise funds
Initial Public Offering (IPO) market—privately/closely held firms go public for the first time
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Stock MarketsPhysical stock exchanges NYSE, AMEX, and regional exchanges
Exchange membersFloor brokers
• House broker• Independent broker
Specialists
Listing requirements
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Stock Markets
Over-the-Counter Markets and the NasdaqNetwork of brokers and dealers
Auction market
Organized Investment Network
Electronic Communications Networks
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Regulation of Securities Markets
Securities and Exchange Commission (SEC)Jurisdiction over most interstate offerings of
new securities to the general public
Regulation of national securities exchanges
Power to prohibit manipulation of securities’ prices
Control over stock trades by corporate insiders
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The Investment Banking Process
Investment BankerHelps corporations design securities
attractive to investors
Buys these securities from the corporation
Resells the securities to investors
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The Investment Banking Process
Raising Capital: Stage I DecisionsDollars to be raised
Type of securities used
Competitive bid versus negotiated deal
Selection of an investment banker
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The Investment Banking Process
Raising Capital: Stage II Decisions• Reevaluating the initial decisions• Best efforts or underwritten issues
• Underwritten Arrangement—investment bank guarantees the sale by purchasing the securities from the issuer
• Best Effort Arrangement—investment bank gives no guarantee that the securities will be sold
• Issuance (flotation) Costs
• Setting the offering price
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The Investment Banking ProcessSelling ProceduresUnderwriting Syndicate—to spread riskLead Underwriter—manages the distributionSelling Group—network of brokerage firms
Shelf Registration—approved by the SEC, but held for sale at a later date
Maintenance of the Secondary Market—investment banker wants to “make a market” for the issue (especially for an IPO)
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International Stock Markets
U.S. stock marketsLess than 40% of the total value worldwideStill dominate the international stock
markets
U.S. investors can participate in international markets by through American Depository Receipts (ADR)
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Types of Financial Intermediaries
Commercial banks
Credit unions
Savings and loan associations
Mutual funds
Whole life insurance companies
Pension funds
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The Roles of Financial Intermediaries
Facilitate the transfer of funds from those who have funds (savers) to those who need funds (borrowers)
Manufacture a variety of financial products
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Benefits of Financial Intermediaries
Improved standard of living
Reduced costs
Risk/diversification
Funds divisibility/pooling
Financial flexibility
Related services
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Financial Organizations in Other Parts of the World
U.S. financial institutions are more heavily regulated than foreign institutions
U.S. financial institutions face greater limitations on branching, services, and relationships with non-financial businesses than foreign institutions