direct f inance - borrowers borrow f unds directly f orm

lenders in f inancial markets by selling them securities.

indirect f inance - borrowers borrow f unds through a third-

party, such as a f inancial intermediary.

channeling f unds f rom people surplus of f unds to people

shortage of f unds 

f unction
f lows of f unds through the f inancial system

promotes economic ef f iciency by producing an ef f icient

allocation of capital, which increases production 

directly improve the well-being of consumers by allowing

them to time purchases better 

f ixed f inancial market income securities are bought and

sold

debt holder

Debt holders are considered as a creditor to the company

debt - a company’s borrowed capital
T he returns are comparatively less

T he market is less volatile

lower transaction costs (time and money spent in carrying T here is a guarantee of f ixed returns most of the time
our f inancial transactions)
Debt vs Equity markets 
financial markets 
Place where stocks of a company are bought and sold
reduce the exposure of investors to risk 

f unctions shareholders
adverse selection - a situation where one party of ten does
not know enough about the other party to make accurate
decisions Shareholders are considered as owners of the company
equity - a company’s owned capital
moral hazard - a situation where the borrower might deal with asymmetric inf ormation problems T he returns are comparatively high
engage in activities that are undesirable f rom the lender’s
point of view because they make it less likely that the loan
will be paid back.  T he market is more volatile

commercial banks  T here is no guaranty of f ixed returns on a regular basis

saving and loan associations  financial institutions  primary - investment banks underwrite securities in primary
depository institutions (banks) markets  
mutual savings banks
secondary - the previously issued securities will be sold in
the secondary market  
credit unions 

lif e insurance companies 

structure 

Primary vs Secondary markets 

f ire and casually insurance companies contractual savings institutions 
types 

pension f unds, government retirement f unds

f inance companies 

mutual f unds 
Overview of the financial system

money market mutual f unds  investment intermediaries 

1 central location standardized
exchanges - NYSE, NASDAQ, HNX, HSX, ..
hedge f unds
A stock in the Exchange market has one price only.
Exchanges vs OT C markets 
investment banks 
network of dealers and brokers 
OT C - Foreign exchange, Federal f unds
reduce adverse selection and moral hazard problems A stock has dif f erent prices in the OT C market.
to increase the inf ormation available to investors
reduce insider trading (SEC) money markets - short term debt instruments 
Money vs Capital markets 
restrictions on entry (chartering process) f unctions  capital markets - long term debt instruments 
regulations
restrictions on assets and activities (control holding of risky
assets) U.S. T reasury bills
to ensure the soundness of f inancial intermediaries

deposit insurance (avoid bank runs) negotiable bank certif icates of deposits 

limits on competition money market instruments commercial papers

f ed f unds

repurchase agreements 

stocks 
financial instruments
mortgages and mortgage-backed securities 

corporate bonds 

capital market instruments  U.S. government securities 

U.S. government agency securities 

state and local government bonds

consumer and bank commercial loans