PowerPoint Slides for

Financial Markets and Institutions 5th Edition

By

Jeff Madura
Prepared by

Ann M. Hackert and Steve Byers

Idaho State University

2001 South-Western College Publishing Company

Chapter 1
Role of Financial Markets and Institutions

2001 South-Western College Publishing Company

Chapter 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 Markets

Financial Market: a market in which financial assets (securities) such as stocks and bonds can be purchased or sold Provide for financial intermediation--financial savings (Surplus Units) to investment (Deficit Units) Provide payments system Provide means to manage risk
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Overview of Financial Markets

Broad Classifications of Financial Markets Money versus Capital Markets Primary versus Secondary Markets Organized versus Over-the-Counter Markets

Overview of Financial Markets

Primary vs. Secondary Markets Primary Market New issue of securities Exchange of funds for financial claim Funds for borrower; an IOU(I owe you, ) for lender

Overview of Financial Markets

Primary vs. Secondary Markets Secondary Market Trading previously issued securities No new funds for issuer Provides liquidity for seller

Overview of Financial Markets

Money vs. Capital Markets Money Market Short-term, < 1 year High quality issuers Debt only Primary market focus Liquid market--low returns

Overview of Financial Markets

Money vs. Capital Markets Capital Market Long-term, >1Yr Range of issuer quality Debt and equity Secondary market focus Financing investment--higher returns

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Overview of Financial Markets

Organized vs. OTC Markets Organized Visible marketplace Members trade Securities listed Example: New York Stock Exchange Shanghai Stock Exchange Shenzhen Stock Exchange
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Overview of Financial Markets

Organized vs. OTC Markets OTC Market Wired network of dealers No central, physical location

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Securities Traded in Financial Markets

Money market securities Capital market securities Derivative securities Financial contracts whose value is derived from the values of underlying assets

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 Securities: Debt or Equity? Debt Securities: Contractual obligations (IOU) of Debtor (borrower) to Creditor (lender) Equity Securities: Claim with ownership rights and responsibilities

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Financial Market Efficiency

Security prices reflect available information New information is quickly included in security prices Investors balance liquidity, risk, and return needs

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Financial Market Regulation

Why Government Regulation? To Promote Efficiency High level of competition Efficient payments mechanism Low cost risk management contracts

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Financial Market Regulation

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
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Financial 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
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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

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Role of Financial Institutions in Financial Markets

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 Financial Markets

Depository Financial Institutions

TYPES OF DEPOSITORY FINANCIAL INSTITUTIONS

COMMERICIAL BANKS $$$ Total Assets

SAVINGS INSTITUTIONS $$$ Total Assets

CREDIT UNIONS $$ Total Assets

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Role of Financial Institutions in Financial Markets

Role of Depository Institutions Offer deposit accounts Repackage funds received from deposits to provide loans of size and maturity desired Accept the risk on the loans provided Expertise in evaluating creditworthiness Diversify loans among numerous borrowers

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Role of Financial Institutions in Financial Markets

Types of Nondepository Financial Institutions Finance Companies Mutual Funds Securities Companies Insurance Companies Pension Funds

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Role of Financial Institutions in Financial Markets

Role of Nondepository Financial Institutions Focused on capital market Longer-term, higher risk intermediation Less focus on liquidity Less regulation

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Comparison of Financial Institutions

Sources of funds Uses of funds Competition between financial institutions Consolidation of financial institutions

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Global Expansion by Financial Institutions

International expansion International mergers Impact of the single European currency Emerging markets

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