Capital Markets
- Are markets that trade equity
(stocks) and debt (bonds)
instruments with maturities of more
than one year.
Capital Market Instruments
1. Corporate stock – the fundamental
ownership claim in a public
corporation.
2. Mortgages – loans to individuals or
business to purchase a home, land,
or other real property.
3. Corporate bonds – long-term bonds
issued by corporations.
4. Treasury bonds – long-term bonds
issued by the U.S Treasury.
5. State and local government bonds –
long-term bonds issued by state and
local governments.
6. U.S government agencies – long
term bonds collateralized by a pool
of assets and issued by agencies of
the U.S government
7. Bank and consumer loans – loans to
commercial banks and individuals.
Derivative security markets
- The markets in which derivative
securities trade.
Derivative security
- Financial security (such as a futures
contract, option contract, swap
contract, or mortgage-backed
security) whose payoff is linked to
another, previously issued security
such as security traded in the capital
or foreign exchange markets.
Financial Institutions
- Commercial and savings bank,
credit unions, insurance companies,
mutual funds) perform the essential
function of challenging finds from
those with surplus funds (suppliers
of funds) to those with shortages of
funds (users of funds)
Type of Financial Institutions
Commercial banks —depository institutions
whose major assets are loans and whose
major liabilities are deposits. Commercial
banks’ loans are broader in range, including
consumer, commercial, and real estate
loans, than are those of other depository
institutions. Commercial banks’ liabilities
include more nondeposit sources of funds,
such as subordinate notes and debentures,
than do those of other depository
institutions.
Thrifts —depository institutions in the form
of savings associations, savings banks, and
credit unions. Thrifts generally perform
services similar to commercial banks, but
they tend to concentrate their loans in one
segment, such as real estate loans or
consumer loans.
Insurance companies —financial
institutions that protect individuals and
corporations (policyholders) from adverse
events. Life insurance companies provide
protection in the event of untimely death,
illness, and retirement. Property casualty
insurance protects against personal injury
and liability due to accidents, theft, fire, and
so on.
Securities firms and investment banks —
financial institutions that help firms issue
securities and engage in related activities
such as securities brokerage and securities
trading.
Finance companies —financial Price risk - The risk that an asset’s sale
intermediaries that make loans to both price will be lower than its purchase price.
individuals and businesses. Unlike
depository institutions, finance companies
do not accept deposits but instead rely on
short- and long-term debt for funding.
Mutual funds —financial institutions that
pool financial resources of individuals and
companies and invest those resources in
diversified portfolios of assets.
Hedge funds —financial institutions that
pool funds from a limited number (e.g., less Services Benefiting Suppliers of Funds:
than 100) of wealthy (e.g., annual incomes
Monitoring costs —Aggregation of funds in
of more than $200,000 or net worth
an FI provides greater incentive to collect a
exceeding $1 million) individuals and other
firm’s information and monitor actions. The
investors (e.g., commercial banks) and
relatively large size of the FI allows this
invest these funds on their behalf, usually
collection of information to be
keeping a large proportion (commonly 20
accomplished at a lower average cost
percent) of any upside return and charging a
(economies of scale).
fee (2%) on the amount invested.
Liquidity and price risk —FIs provide
Pension funds —financial institutions that
financial claims to household savers with
offer savings plans through which fund
superior liquidity attributes and with lower
participants accumulate savings during their
price risk.
working years before withdrawing them
during their retirement years. Funds Transaction cost services —Similar to
originally invested in and accumulated in a economies of scale in information
pension fund are exempt from current production costs, an FI’s size can result in
taxation. economies of scale in transaction costs.
Direct transfer - a corporation sells its stock Maturity intermediation —FIs can better
or debt directly to investors without going bear the risk of mismatching the maturities
through a financial institution of their assets and liabilities.
Denomination intermediation —FIs such as
mutual funds allow small investors to
overcome constraints to buying assets
imposed by large minimum denomination
size.
Services Benefiting the Overall Economy:
Liquidity - The ease with which an asset
can be converted into cash at its fair market Money supply transmission —Depository
value. institutions are the conduit through which
monetary policy actions impact the rest of
the financial system and the economy in
general.
Credit allocation —FIs are often viewed as
the major, and sometimes only, source of
financing for a particular sector of the
economy, such as farming and residential
real estate.
Intergenerational wealth transfers —FIs,
especially life insurance companies and
pension funds, provide savers with the
ability to transfer wealth from one
generation to the next.
Payment services —The efficiency with
which depository institutions provide
payment services directly benefits the
economy.
2 important payment services:
1. Check-clearing
2. Wire transfer services