Name: Argie G.

Catambacan Class Code: FIN 3153 (3-156)

Answer the following Guide Questions:

1. Why do we study Financial Markets and Institutions?

- We study Financial Markets and Institutions because both are important

to economic growth and stability, for financial markets play a critical role in the
accumulation of capital and the production of goods and services and help
efficiently direct the flow of savings and investment in the economy. The
combination of well-developed financial markets and institutions and a diverse
array of financial products and instruments suits the needs of borrowers and
lenders and, therefore, the overall economy. As noted by Demirgüç-Kunt and
Levine, together financial markets and financial institutions contribute to
economic growth; the relative mix of the two does not appear to be an
essential factor in growth or development.

2. What is the difference between primary and secondary markets, money

markets and capital markets?

- According to Brian Beers (2020), the primary market is where securities are
created. It is in this market that firms sell (float) new stocks and bonds to the
public for the first time. An initial public offering, or IPO, is an example of a
primary market. These trades provide an opportunity for investors to buy
securities from the bank that did the initial underwriting for a particular stock. An
IPO occurs when a private company issues stock to the public for the first time.
While the secondary market is where those securities are traded by investors.
The secondary market is basically the “stock market”. This includes the New
York Stock Exchange (NYSE), Nasdaq, and all major exchanges around the
world. The defining characteristic of the secondary market is that investors
trade among themselves.

- According to Christina Majaski (2021), the money market is a short-term

lending system. It is a good place for individuals, banks, other companies,
and governments to park cash for a short period of time, usually one year
or less. It exists so that businesses and governments that need cash to operate
can get it quickly at a reasonable cost, and so that businesses that have more
cash than they need can put it to use. Capital market, on the other hand, is
 geared toward long-term investing. It encompasses the trade in both
stocks and bonds.

The overriding goal of the companies’ institutions that enter the capital
markets is to raise money for their long-term purposes, which usually
come down to expanding their businesses and increasing their revenues.
They do this by issuing stock shares and by selling corporate bonds. In other
words, money market is less risky than the capital market while the capital
market is potentially more rewarding.
MM- low risk - low return
CM - high risk - high return

3. What are the risks faced by financial institutions?

- The risks faced by financial institutions are.

 Credit
- also known as default risk—is the danger associated with borrowing
money. It is the risk that the promised cash flows from loans and
securities held by FIs may not be paid in full.
 Foreign exchange risk
- is the risk that exchange rate changes can affect the value of an FI’s
assets and liabilities denominated in foreign currencies.
 Country or sovereign risk
- is the risk that repayments from foreign borrowers may be interrupted
because of interference from foreign governments.
 Interest rate risk
- is the risk incurred by an FI when the maturities of its assets and
liabilities are mismatched and interest rates are volatile
 Market risk
- is the risk incurred in trading assets and liabilities due to changes in
interest rates, exchange rates, and other asset prices – closely related
to interest rate and foreign exchange risk
 Off-balance-sheet (OBS) risk
- is the risk incurred by an FI as the result of activities related to
contingent assets and liabilities. OBS activity can increase FIs’ interest
rate risk, credit risk, and foreign exchange risk.
 Liquidity risk
- Liquidity risk comes in two flavors for investors to fear. The first
involves securities and assets that cannot be purchased or sold quickly
enough to cut losses in a volatile market. Known as market liquidity
risk this is a situation where there are few buyers but many sellers. The
second risk is funding or cash flow liquidity risk. Funding liquidity risk is
 the possibility that a corporation will not have the capital to pay its debt,
forcing it to default, and harming stakeholders.

 Technology risk
- Technology risk and operational risk are closely related. Technology
risk is the risk incurred by an FI when its technological investments do
not produce anticipated cost savings.
 Operational risk
- is the risk that existing technology or support systems may
malfunction or break down
- Businesses can experience operational risk when they have poor
management or flawed financial reasoning. Based on internal factors,
this is the risk of failing to succeed in its undertakings.
 Insolvency risk
- is the risk that an FI may not have enough capital to offset a sudden
decline in the value of its assets relative to its liabilities. Insolvency risk
is a consequence or an outcome of one or more of the risks previously
described: • interest rate, market, credit, OBS, technological, foreign
exchange, sovereign, and/or liquidity risk.

4. Why is financial institutions need to be regulated?

- Financial institutions need to be regulated for regulations helps make sure

that banks have good management and so they don’t make bad investments
or are too risky. Regulation also makes banks hold shock absorbers to help
deal with bad investments. These shock absorbers are referred to as capital.
Apart from that, having regulation and strong supervision can help
stop banks making similar mistakes in the future. And it helps to reduce many
of the problems that could get a bank into financial difficulty. For poorly
regulated financial institutions have the potential to undermine the stability of
the financial system, harm consumers and can damage the prospects for the
economy. That’s why strong financial regulation is important – to put rules in
place to stop things from going wrong, and to safeguard the wider financial
system and protect consumers if they do go wrong.
References
Adam Hayes (2021), Financial Risk.
https://www.investopedia.com/terms/f/financialrisk.asp
Allehs Voo (2013), Risks in financial institutions.
https://www.slideshare.net/BibieVoo/risks-in-financial-institutions
Brian Beers (2020), A Look at Primary and Secondary Markets.
https://www.investopedia.com/investing/primary-and-secondary-markets/
Christina Majaski (2021), Money Market Vs. Capital Market: What's the Difference?
https://www.investopedia.com/articles/investing/052313/financial-markets-capital-vs-
money-markets.asp
Please explain how financial markets may affect economic performance. January 2005.
https://www.frbsf.org/education/publications/doctor econ/2005/january/financial-
markets-economic-performance/
What is financial regulation and why does it matter?
https://www.centralbank.ie/consumer-hub/explainers/what-is-financial-regulation-and-
why-does-it-matter
Why do we regulate banks? https://www.bankofengland.co.uk/knowledgebank/why-do-
we-regulate-banks