• They are the

cornerstones of the
Introduction to Why study overall financial system
in which financial

Financial Markets Financial managers operate

• Individuals use both for
Markets and investing
• Corporations and
Prepared by: Ms. Ida
Institutions? governments use both
for financing

OVERVIEW OF FINANCIAL MARKETS Primary Markets versus Secondary Markets

Primary Markets Secondary Markets
markets in which users of markets where financial
PRIMARY MARKETS SECONDARY MARKETS
VS funds (e.g. corporations, instruments are traded
MONEY MARKETS CAPITAL MARKETS governments) raise funds among investors (e.g.
FOREIGN EXCHANGE MARKETS by issuing financial NYSE, NASDAQ)
instruments (e.g. stocks
and bonds)
 Money Markets versus Capital Markets Foreign Exchange Markets
Money Markets Capital Markets • “FX” markets deal in trading one currency for
markets that trade debt markets that trade debt another (e.g. dollar for yen)
securities with maturities (bonds) and equity (stock) • The “spot” FX transaction involves the immediate
of one year or less (e.g. instruments with exchange of currencies at the current exchange rate
CD’s, U.S. Treasury bills) maturities of more than • The “forward” FX transaction involves the
one year exchange of currencies at a specified date in the
future and at a specified exchange rate

Derivative Security Markets Overview of Financial Institutions

• The markets in which derivative securities
trade.
• Derivative Security
– An agreement between two parties to exchange a
standard quantity of an asset at a predetermined price
on a specified date in the future.
Institutions that 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).
 Flow of Funds in a World without FIs: Flow of Funds in a World without FIs:
Direct Transfer Direct Transfer
Users of Funds FI Suppliers of Funds
Financial Claims (Brokers)
(Equity and debt
instruments)
Suppliers of
Users of Funds
Funds FI
(Corporations) Cash Cash
(Households) (Asset
Cash transformers)
Financial Claims Financial Claims
Example: A firm sells shares directly to investors without (Equity and debt securities) (Deposits and insurance policies)
going through a financial institution.

McGraw-Hill/Irwin 10

Types of Financial Institutions Types of Financial Institutions

• Commercial banks • Insurance companies
– depository institutions whose major assets are loans – financial institutions that protect individuals and
and major liabilities are deposits corporations from adverse events
• Thrifts • Securities firms and investment banks
– depository institutions in the form of savings and – financial institutions that underwrite securities and
loans, credit unions engage in securities brokerage and trading
 Types of Financial Institutions Types of Financial Institutions
• Finance companies • Pension Funds
– financial institutions that make loans to individuals – financial institutions that offer savings plans for
and businesses retirement
• Mutual Funds
– financial institutions that pool financial resources
and invest in diversified portfolios

Services Performed by Financial Services Provided by FIs Benefiting the Overall

Intermediaries Economy

• Monitoring Costs • Money Supply Transmission

• Liquidity and Price Risk • Credit Allocation
• Transaction Cost Services
• Maturity Intermediation • Intergenerational Wealth Transfers
• Denomination Intermediation • Payment Services
 Risks Faced by Financial Institutions Regulation of Financial Institutions

• Interest Rate Risk • Off-Balance-Sheet Risk • FIs provide vital financial services to all
• Foreign Exchange Risk • Technology Risk sectors of the economy; therefore, their
• Market Risk • Operational Risk regulation is in the public interest
• Credit Risk • Country or Sovereign
Risk • In an attempt to prevent their failure and the
• Liquidity Risk • Insolvency Risk failure of financial markets overall

Factors Leading to Significant Growth in

Regulation of Financial Institutions
Foreign Markets

• Financial Markets became more global as the
value of stocks traded in foreign markets soared
• Foreign bond markets have served as a major
source of international capital
• Globalization also evident in the derivative
securities market
• The pool of savings from foreign investors has
increased
• International investors have turned to U.S. and other
markets to expand their investment opportunities
• Information on foreign investments and markets is
now more accessible (e.g. internet)