Financial Management

and Investment
Dr. Tamer Mohamed Shahwan
Professor of Financial Management,
Department of Management, Faculty of Commerce,
Zagazig University
English Section Coordinator, Faculty of Commerce,
Zagazig University
Ph.D. in Business Administration, Humboldt University of
Berlin, Germany

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY

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 Chapter 2:

The Financial Environment

By the end of this chapter, the students will be able to
understand:
 What is the financial environment?
 The main components of financial environment.
 The concept of financial markets.
 The concept of financial institutions.
 The main function of financial markets.
 The main function of financial institutions.
 Types of financial markets.
 Types of financial institutions.
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY
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What is the financial environment?

Firms that require funds from external sources

can obtain them in three ways:

1. through a financial institution

2. through financial markets

3. through private placements

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY

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Components of financial environment
(1)

 Financial Institutions
• Financial institutions are intermediaries that
channel the savings of individuals, businesses, and
governments into loans or investments.
• The key suppliers and demanders of funds are
individuals, businesses, and governments.
• In general, individuals are net suppliers of funds,
while businesses and governments are net
demanders of funds.
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-3
Components of financial environment
(2)
Financial Markets
• Financial markets are forums in which suppliers of funds
and demanders of funds can transact business directly.
• Transactions in short term marketable securities take
place in the money market while transactions in long-
term securities take place in the capital market.
• A private placement involves the sale of a new security
directly to an investor or group of investors.
• Most firms, however, raise money through a public
offering of securities, which is the sale of either bonds or
stocks to the general public.
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY
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PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-5
 Structure of Financial Markets

• Primary Markets versus Secondary

Markets
• Money Markets versus Capital Markets
• Foreign Exchange Markets
• Spot Markets versus Futures Markets
• Broker Markets versus Dealer Markets
• International Capital Markets
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY
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Primary Markets versus Secondary
Markets
• Primary Markets
• markets in which users of funds (e.g. corporations,
governments) raise funds by initially issuing financial
instruments (e.g. stocks and bonds).
• New security issues sold to initial buyers.
• Typically involves an investment bank who underwrites the
offering.
• Secondary Markets
• markets where financial instruments are traded among
investors (e.g. NYSE, NASDAQ).
• Securities previously issued are bought and sold.
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY
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 Money Markets versus Capital
Markets (1)
Money Markets
• markets that trade debt securities with maturities of one year or
less (e.g. CD’s, U.S. Treasury bills).
• Most money market transactions are made in marketable
securities which are short-term debt instruments, such as:
• U.S. Treasury bills issues by the federal government
• commercial paper issued by businesses
• negotiable certificates of deposit issued by financial
institutions
• Investors generally consider marketable securities to be among
the least risky investments available.
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-8
 Money Markets versus Capital
Markets (2)

The Money Market (cont.)

• The international equivalent of the domestic (U.S.) money
market is the Eurocurrency market.
• The Eurocurrency market is a market for short-term bank
deposits denominated in U.S. dollars or other marketable
currencies.
• The Eurocurrency market has grown rapidly mainly
because it is unregulated and because it meets the needs of
international borrowers and lenders.
• Nearly all Eurodollar deposits are time deposits.

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-9
 Money Markets versus Capital
Markets (3)

 The Capital Market is a market that enables

suppliers and demanders of long-term funds to make
transactions.
• The key capital market securities are bonds (long-term debt)
and both common and preferred stock (equity, or ownership).
– Bonds are long-term debt instruments used by businesses
and government to raise large sums of money, generally
from a diverse group of lenders.
– Common stock are units of ownership interest or equity in
a corporation.
– Preferred stock is a special form of ownership that has
features of both a bond and common stock.
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-10
Bond Market and Interest Rates

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 Foreign Exchange Markets

• “FX” markets deal in trading one currency

for another (e.g. dollar for yen)
• The “spot” FX transaction involves the
immediate exchange of currencies at the
current exchange rate
• The “forward” FX transaction involves the
exchange of currencies at a specified date in
the future and at a specified exchange rate
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-12
 Spot Markets versus Futures
Markets (1)
 Spot markets
The spot market or cash market is a public financial market in
which financial instruments or commodities are traded for
immediate delivery. It contrasts with a futures market, in which
delivery is due at a later date.
** While the official transfer of funds between the buyer and
seller may take time, such as T+2 in the stock market and in most
currency transactions, both parties agree to the trade “right now.

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-13
 Spot Markets versus Futures
Markets (2)

A futures market is an auction market in which

participants buy and sell commodity and futures contracts for delivery
on a specified future date at a price set today.

• Futures are exchange-traded derivatives contracts that lock in future

delivery of a commodity or security.

• Examples: New York Mercantile Exchange (NYMEX), the Kansas City

Board of Trade, the Chicago Mercantile Exchange (CME), the Chicago
Board of Trade (CBoT), Chicago Board Options Exchange (CBOE)
and the Minneapolis Grain Exchange.
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-14
 Broker Markets versus Dealer
Markets (1)

Broker markets are securities exchanges on

which the two sides of a transaction, the buyer
and seller, are brought together to trade
securities.

– Trading takes place on centralized trading

floors of national exchanges, such as NYSE
Euronext, as well as regional exchanges.

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-15
 Broker Markets versus Dealer
Markets (2)
• Dealer markets, such as Nasdaq, are
markets in which the buyer and seller are not
brought together directly but instead have
their orders executed by securities dealers
that “make markets” in the given security.
– The dealer market has no centralized trading floors.
Instead, it is made up of a large number of market
makers who are linked together via a mass-
telecommunications network.
• As compensation for executing orders, market
makers make money on the spread (bid price
– ask price).
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-16
International Capital Markets

• In the Eurobond market, corporations and

governments typically issue bonds
denominated in dollars and sell them to
investors located outside the United States.
• The foreign bond market is a market for bonds
issued by a foreign corporation or government
that is denominated in the investor ’ s home
currency and sold in the investor ’ s home
market.
• The international equity market allows
corporations to sell blocks of shares to
investors in a number of different countries
simultaneously.
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-17
 The Role of Capital Markets
• From a firm ’ s perspective, the role of capital
markets is to be a liquid market where firms can
interact with investors in order to obtain valuable
external financing resources.
• From investors’ perspectives, the role of capital
markets is to be an efficient market that
allocates funds to their most productive uses.
• An efficient market allocates funds to their most
productive uses as a result of competition among
wealth-maximizing investors and determines and
publicizes prices that are believed to be close to
their true value.

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-18
Overview of Financial Institutions
(FIs)

FIs perform the essential function of

channeling funds from those with surplus
funds to those with shortages of funds
(e.g. banks, thrifts, insurance companies,
securities firms and investment banks,
finance companies, mutual funds, pension
funds) indirectly.

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-19
Flow of Funds in a World without
FIs: Direct Transfer (1)

Financial Claims
(Equity and debt
instruments)
Suppliers of
Users of Funds
Funds
(Corporations)
(Households)
Cash

Example: A firm sells shares directly to investors without going

through a financial institution

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-20
 Flow of Funds in a World
without FIs: Direct Transfer (2)

• Without FIs: Low level of fund flows.

– Information costs:
• Economies of scale reduce costs for FIs to screen
and monitor borrowers
– Less liquidity
– Substantial price risk

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-21
Flow of Funds in a world with FIs:
Indirect transfer

FI
Users of Funds (Brokers) Suppliers of Funds

FI
(Asset
transformers)

Financial Claims Financial Claims

(Equity and debt securities) (Deposits and Insurance policies)

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-22
 Functions of FIs

– Acting as broker, that is, as an agent for

investors:
• Provide information and offer transaction services
• e.g. Merrill Lynch, Charles Schwab
• Reduce costs through economies of scale
• Encourages higher rate of savings
– Asset transformer:
• Purchase primary securities by selling financial claims
to households
• These secondary securities often more marketable

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-23
 Types of Financial Institutions
(Financial Intermediaries) (1)
 Commercial Banks
– depository institutions whose major assets are loans and major
liabilities are deposits
– provide savers with a secure place to invest their funds
– offer loans to individual and business borrowers.
 Thrifts
– depository institutions in the form of savings and loans, credit
unions, etc.,
 Insurance Companies
– financial institutions that protect individuals and corporations
from adverse events
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-24
 Types of Financial Institutions
(Financial Intermediaries) (2)
 Securities firms and investment banks
 financial institutions that underwrite securities and
engage in securities brokerage and trading
 assist companies in raising capital
 advise firms on major transactions such as mergers or
financial restructurings
 engage in trading and market making activities
Finance companies
 financial institutions that make loans to individuals
and businesses
PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-25
 Types of Financial Institutions
(Financial Intermediaries) (3)

 Mutual Funds
financial institutions that pool financial
resources and invest in diversified portfolios
 Pension Funds
financial institutions that offer savings plans
for retirement

PROF. DR. TAMER MOHAMED SHAHWAN, FACULTY OF COMMERCE, ZAGAZIG UNIVERSITY 8-26