1PL llnAnClAL Lnvl8CnMLn1

MA8kL1S lnS1l1u1lCnS
ln1L8LS1 8A1L
llnanclal MarkeLs
W 8uslnesses lndlvlduals and governmenLs ofLen
need Lo ralse caplLal
Lxample Lngro ferLlllzers forecasLs lncrease ln Lhe
demand for urea and Lhe company decldes Lo bulld a
new producLlon planL 1hey don'L have sufflclenL
money so Lhey need Lo ralse caplLal from flnanclal
markeL
W Cn Lhe oLher hand some lndlvlduals and flrms
have lncomes LhaL are greaLer Lhan Lhelr currenL
expendlLure so Lhey have funds avallable Lo
lnvesL
1ypes of Markets
W 9eople and organlzaLlons wanLlng Lo borrow
money are broughL LogeLher wlLh Lhose
havlng surplus funds ln Lhe linoncio/ Morkets
W Lach markeL deals wlLh some whaL dlfferenL
Lype of flnanclal lnsLrumenLs ln Lerms of
lnsLrumenLs maLurlLy and Lhe asseLs backlng
lL
W Also dlfferenL markeL serves dlfferenL
cusLomers
1ypes of Markets
9hyslcal asseL vs llnanclal asseL markeLs
2 SpoL vs luLure markeLs
3 Money vs CaplLal markeLs
4 9rlmary vs Secondary markeLs
3 9rlvaLe vs 9ubllc markeLs
W A healLhy economy ls dependenL on efflclenL
Lransfers of funds from people who are neL
savers Lo flrms and lndlvlduals who need
caplLal
W WlLhouL efflclenL Lransfers Lhe economy
slmply could noL funcLlon
WhaL consequences economy have Lo bear lf
engro ferLlllzers cannoL ralse caplLal?
o|e of I|nanc|a| Inst|tut|ons
W 1ransfers of caplLal beLween savers and Lhose who need
caplLal Lake place ln Lhe Lhree dlfferenL ways
ulrecL Lransfer of money and securlLles
8uslness sells lLs sLocks and bonds dlrecLly Lo savers
2 lndlrecL Lransfers Lhrough lnvesLmenL banks
lnvesLmenL banks underwrlLes Lhe lssue
3 lndlrecL Lransfers Lhrough flnanclal lnLermedlary
eg a saver mlghL glve $$ Lo banks recelvlng from lL a Cou and
Lhen Lhe bank mlghL lend Lhe money Lo buslness ln form of
morLgage loan
LxlsLence of lnLermedlarles greaLly lncrease Lhe efflclency of
money and caplLal markeLs
o|e of I|nanc|a| Inst|tut|ons
Investment 8ank|ng nouse
an organlzaLlon LhaL underwrlLes and dlsLrlbuLes new
lnvesLmenL securlLles and helps buslnesses obLaln
flnanclng
I|nanc|a| Intermed|ar|es
speclallzed flnanclal flrms LhaL faclllLaLes Lhe Lransfer
of funds from savers Lo demanders of caplLal
I|nanc|a| Intermed|ar|es
Ma[or Classes of lnLermedlarles
Commerclal banks (deparLmenL sLores of flnance serve a
wlde varleLy of savers and borrowers)
2 CredlL unlons (members have a common bond such as
employee of same flrm members savlngs are loaned only Lo oLher
member s for auLo purchase or home morLgage)
3 9enslon funds (lnvesL prlmarlly ln bonds sLocks real esLaLe
and admlnlsLered by Lhe LrusL deparLmenL of banks lnsurance
companles)
4 Llfe lnsurance companles (Laklng savlngs ln form of
premlums and lnvesL ln sLocks bonds real esLaLe eLc)
3 MuLual lunds (accepL money from savers and use Lo buy
sLocks long Lerm bonds or shorL Lerm debL lnsLrumenLs)
ost of Money
1here are four fundamenLal facLors affecLlng Lhe cosL
of money
9roducLlon opporLunlLles (reLurns avallable wlLhln an
economy from lnvesLmenLs ln producLlve asseLs)
2 1lme preferences for consumpLlon (preference of
consumers for currenL consumpLlon as opposed Lo savlngs for
fuLure consumpLlon)
3 8lsk (Lhe chances LhaL an lnvesLmenL wlll provlde a low or
negaLlve reLurn)
4 lnflaLlon (Lhe amounL by whlch Lhe prlces lncrease over Llme)
eterm|nants of Market Interest
rates
ln general Lhe quoLed or nomlnal lnLeresL raLe ls
composed of a real rlsk free raLe of lnLeresL plus
several premlums
k k* + l9 + u89 + L9 + M9
eterm|nants of Market Interest
rates
W 8eal 8lsk lree 8aLe of lnLeresL
raLe of lnLeresL LhaL would exlsL on defaulL free Lreasury
securlLles lf no lnflaLlon were expecLed
W lnflaLlon 9remlum
ls equal Lo average expecLed lnflaLlon raLe over Lhe llfe of
securlLy
W uefaulL 8lsk 9remlum
Lhe dlfference beLween Lhe lnLeresL raLe on a Lreasury
bond and a corporaLe bond of equal maLurlLy and
markeLablllLy
eterm|nants of Market Interest
rates
W LlquldlLy 9remlum
a premlum charged by lenders Lo reflecL Lhe facL LhaL
some securlLles cannoL be converLed Lo cash on
shorL noLlce aL a reasonable prlce
W MaLurlLy 8lsk 9remlum
long Lerm bonds even Lreasury bonds are exposed Lo
a slgnlflcanL rlsk of prlce decllnes and a M89 ls
charged by lenders Lo reflecL Lhls rlsk