financial market and institution ch 1
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financial market and institution ch 1TRANSCRIPT
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Financial Markets and Institutions6th Edition
PowerPoint Slides for:PowerPoint Slides for:
By Jeff Madura
Prepared by
David R. Durst
The University of Akron
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CHAPTER
11Role of Financial Markets and Institutions
© 2003 South-Western/Thomson Learning
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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
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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
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� 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
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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
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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
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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
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� 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
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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
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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
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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
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Investor Assessment of New InformationInvestor Assessment of New Information
Exhibit 1.3
Economic Condit ions
Industry Condit ions
Firm Specif ic Information
Impact of Future
Cash Flows
Evaluation of Security
Pricing
Investor Decision to
Trade
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� 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
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Financial Market RegulationFinancial Market Regulation
� To Promote Efficiency
� High level of competition
� Efficient payments mechanism
� Low cost risk management contracts
Why Government Regulation?
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� 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?
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� 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?
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Financial Market GlobalizationFinancial 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
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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
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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
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Types of Nondepository Financial Types of Nondepository Financial InstitutionsInstitutions
� Insurance companies� Mutual funds� Pension funds� Securities companies� Finance companies� Security pools
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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
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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
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Global Expansion by Financial Global Expansion by Financial InstitutionsInstitutions
� International expansion� International mergers� Impact of the single European currency� Emerging markets