Chapter RATIONALE IN STUDYING FINANCIAL MARKETS AND INSTITUTIONS Expected Learning Outcomes After studying the chapter, you should be able to 1. Understand the importance of studying a. Financial Markets b. Financial Institutions 2. Explain briefly the role of the a. Financial Markets b, Financial Institutions 3. Know the effective approach in studying financial markets and institutions QUgZsCHAPTER 1 RATIONALE IN STUDYING FINANCIAL MARKETS AND INSTITUTIONS THE NEED TO STUDY FINANCIAL MARKETS In a market system, businesses of all types face risks, and many businesses fail. Economists and policy makers are particularly concerned about the risk and potential failure that financial institutions (bank and non-bank) face because they play a vital role in the Financial markets and institutions not only influence your everyday life but also involve huge flows of funds — trillions of dollars — throughout the world economy which is turn affect business profits, the production of goods and services and the economic well-being of the countries around the world. The study of financial markets and institutions will reward you with an understanding of many exciting issues such as how funds are transferred from people who have an excess of available funds to people who have a shortage. Indeed, well-functioning financial markets are a key factor in producing high economic growth and poorly performing financial markets are one reason that many countries in the world remain desperately poor, Activities in financial markets also have direct effects on personal wealth, the behavior of business and. consumers and the cyclical performance of the economy. On the evening television news, you have just heard that the bond market has been booming. In the business section of a local newspaper, you read that the Euro is slightly higher against the yen. A European airline loses millions of dollars with derivatives. The Dow Jones Industrial Average is off 18 points in active trading. Another local newspaper reported that “with inflation slowing again in June, 2019, the Bangko Sentral ng Pilipinas (BSP) Governor has sounded off on potential rate cuts in the near term. There was even a hint that the overnight borrowing rate cut will likely come before the last installment of the latest reserve requirement reduction scheduled at the end of July, 2019 which was implemented by the BSP in early May, 2019, will occur,4 Chapter 1 Does this mean that interest rates will fall so that it is easier for you to finance the purchase of a new computer system for your small retail business? Will the economy improve in the future so that it is a good time to build a new factory building or add to the one you are in? Should you try to raise funds by issuing stocks or bonds or instead go to the bank for a loan? If you import goods from abroad, should you be worried that that they will become more expensive? All these events are examples of Financial Markets at work. That markets exercise enormous influence over modern life comes is not news. But although people around the word speak glibly of “Wall Street”, the “stock market” and the “currency marks”, the meanings they attach to these time-worn phrases are often unclear and out-of-date. This book explains the purposes that different financial markets serve and clarifies the way they work. It cannot tell you whether your investment portfolio is likely to rise or fall in value. But it may help you understand how its value is determined and how the different securities or financial instruments in it are created and traded. This book provides answers to the businessmen’s questions by examining how financial markets (such as those for stocks, bond and foreign currency exchange) and financial institutions (such as banks, insurance companies, mutual funds and other institution) work. The word “market” usually conjures up an image of the bustling, paper-strewn floor of the New York Stock Exchange and of Philippine Stock Exchange and of traders motioning frantically in the “futures” cubicles of Chicago. These images are out-of-date as almost all the dealings are now handled computer to computer. often with minimal human intervention. Financial Markets have been around ever since mankind settled down to growing crops and trading them with others. The independent decisions of all of those farmers constituted a basic financial market, and that market fulfilled may be the same purposes as financial markets do today Financial Markets are comprehensively discussed in Unit IllRationale in Studying Financial Markets and Institutions _ 5. THE NEED TO STUDY FINANCIAL INSTITUTIONS Direct funds transfers are common among individuals and small businesses and in economies where financial markets and institutions are less developed. But large businesses in developed economies generally find it more efficient to enlist the services of a financial institution when the time comes to raise capital. Financial institutions are what make financial market work. Without them, financial markets would not be able to move funds from people who save to people who have productive investment opportunities. Thus, they also have important effects on the performance of the economy as a whole. Finaricial institutions are financial by purchasing securities or making loan. They play on important role in the financial system because they reduce allow sharing and solve problems created by adverse relation and moral hazard. As a result, financial institutions thereby increasing the efficiency of the economy. The field of financial markets and institutions is indeed an exciting one. Not only will one learn materials that affect the life of the individual directly but also gain a clearer understanding of events in financial markets and institutions that we hear about in the news media. Understanding how financial institutions are them. Cases provided in this textbook which provide specific analytic tools are useful if one makes his/her career at a financial institution and also give him/her a feel of what a job as a manager of a financial institution is all about. Another reason for studying financial institutions is that they are among the largest employers in the country and frequently pay very high salaries. Hence some of you have a very practical reason for studying financial institutions: It may help you get a good job in the financial sector. Even if your interests lie elsewhere, you should still care about how financial institutions are run because there will be many times in your life, as an individual, an employee, or the owner of a business, when you will interact with these institutions. tba rom tem orion dds thm wih fads,6 Chapter 1 APPROACH IN STUDYING FINANCIAL MARKETS AND INSTITUTIONS The framework underlying all discussions in this text has three levels, namely, a) Understanding Students learn to understand@conomie analysis) that is, students develop b) Evaluating Students learn to evaluateCurrent developments)and the financial news) Students learn to | ©) Predicting Students learn to This book stresses a unifying, analytic framework to study financial markets and institutions. This framework uses a few basic concepts to keep organize your thinking about the determination of asset prices, the structure of financial markets, | and the The Ee em Grn gyn ene asl behavior in the financial markets, the Gearch for profits) and an approach to @inancial structurébased on transaction costs and asymmetric information. The framework also provides the in the financial market place and in variables such asinterest rates undéxchange rates) This text also emphasizes the ‘data in order to expose the reader to real-life events and data. And to function better in the real world outside the classroom, it is recommended that one must get into the lifelong habit of regularly following the financial news that appears in leading financial publications or read the financial / business section of the newspapers. Lastly, the World Wide Web has become an extremely valuable and convenient resource for financial research. These sites contain additional information and are updated frequently. Visit these sites to further explore topics that one finds of particular interest.Rationale in Studying Financial Markets and Institutions _7 This chapter offers a preliminary overview of the fascinating study of financial markets and institutions. We will return to a more detailed treatment of the regulation, structure and evaluation of financial markets and institutions in the succeeding chapters. REVIEW QUESTIONS Questions 1 Why is there a need to understand how monetary policy is conducted by central banks worldwide? What crucial role do banks and other financial institutions play? Why is understanding how financial institutions are managed important to your life? Give three important reasons why is there a need to study Financial Markets. What is the most significant role that financial markets play? Explain briefly the three levels of the framework that underlie the study of financial markets and institutions.