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Why study Financial Markets and Institutions?

Prudent investment and financing requires a thorough understanding of The structure of domestic and international markets The flow of funds through domestic and international markets The strategies used to manage risks faced by investors and savers Financial Markets Financial markets are structures through which funds flow Financial markets can be distinguished along two dimensions primary versus secondary markets money versus capital markets

Primary versus Secondary Markets Primary markets markets in which users of funds (e.g., corporations and governments) raise funds by issuing financial instruments (e.g., stocks and bonds) Secondary markets markets where financial instruments are traded among investors (e.g., NYSE and Nasdaq

Money versus Capital Markets Money markets markets that trade debt securities with maturities of one year or less (e.g., CDs and U.S. Treasury bills) Capital markets markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year

Foreign Exchange (FX) Markets FX markets trading one currency for another (e.g., dollar for yen) Spot FX the immediate exchange of currencies at current exchange rates Forward FX the exchange of currencies in the future on a specific date and at a pre-specified exchange rate

Derivative Security Markets Derivative security

a financial security whose payoff is linked to (i.e., derived from) another security or commodity generally an agreement to exchange a standard quantity of assets at a set price on a specific date in the future

Financial Institutions (FIs) Financial Institutions institutions through which suppliers channel money to users of funds Financial Institutions are distinguished by whether they accept deposits depository versus non-depository financial institutions

Depository versus Non-Depository FIs Depository institutions commercial banks, savings associations, savings banks, credit unions Non-depository institutions insurance companies, securities firms and investment banks, mutual funds, pension funds

Financial Instruments:
A financial instrument can be define as any contract that gives raise to a financial assets of one entity and a financial liability or equity instrument of another entity Financial Asset: Financial asset is any asset that is (a) cash; (b) An equity instrument of another entity; (c) A contractual right: (I) to receive cash or another financial asset from another entity; or (ii) To exchange financial assets or financial liabilities with another entity Under conditions that are potentially favorable to the entity; or (d) A contract that will or may be settled in the entitys own equity instruments and is: (I) a non-derivative for which the entity is or may be obliged to receive a Variable number of the entitys own equity instruments; or (ii) A derivative that will or may be settled other than by the exchange of a

Fixed amount of cash or another financial asset for a fixed number of the entitys own equity instruments. For this purpose the entitys own equity Instruments do not include instruments that are themselves contracts for The future receipt or delivery of the entitys own equity instruments Financial Liability: A financial liability is any liability that is: (a) A contractual obligation: (I) to deliver cash or another financial asset to another entity; or (ii) To exchange financial assets or financial liabilities with another entity Under conditions that are potentially unfavorable to the entity; or (b) A contract that will or may be settled in the entitys own equity instruments and Is (I) a non-derivative for which the entity is or may be obliged to deliver a Variable number of the entitys own equity instruments; or (ii) A derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the Entitys own equity instruments. For this purpose the entitys own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entitys own equity instruments. Equity instrument: An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. Fair value: Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction. Types of financial instruments: There are the different types of the financial instruments: Equity Shares Preference Shares Debentures Treasury bills Commercial Paper Certificate of Deposits

Commercial bills Derivatives Mutual funds Government securities Treasury bills Most important segment of money market. They are negotiable securities. They are issued at discount. They are negotiable securities. No default risk It is issued by RBI on behalf of GOI to raise short-term finance. On-tap bill, ad hoc bill, auctioned bill Multiple price / uniform price auction Commercial paper It is issued by corporates, primary dealers and FI at discount. Minimum rating is required to issue CPs. It can be issued from 7 days to 1 year. It is issued in the multiple of Rs. 5 lakhs. It can be issued as a promissory note or in the demat form. Underwriting is not permitted in CPs. It is also issued at a discount as T-bill Commercial bills Types of bills Demand bill Usance bill Clean bill Documentary bill Inland bill Foreign bill Bill Market in India has remained under-developed. Certificate of Deposit CDs are short-term bearer instruments issued banks and DFIs. Differences between CDs and FDs. Minimum amount of CD is Rs. 1 lakh and multiple of Rs. 1 lakh thereafter. Banks can issue CD from 7 days to 1 year. CDs can be issued at discount. Physical CDs are freely transferable by endorsement and delivery Derivatives Derivatives means the value of which is derived from the underlying asset. Underlying asset can be equity, foreign exchange, interest bearing financial asset, commodities. It is a tool for financial risk management. There are four major types of derivatives: forward, future, option and swaps.

Forward It is the simplest and oldest type of derivative. It is a contract between two parties to buy and sell an asset at future date at agreed price. Each contract is custom design. They are bilateral contracts so they are exposed to counter party risk. Futures It is designed to remove the disadvantage of forward contracts. A future contract is a standardised contract which is traded in the future exchanges. There can be financial future or commodity future. Clearing house acts as an intermediary in the future contracts. Option It is an agreement in which a buyer has a right ( not obligation) to buy or sell an asset at a set price. The buyer pays the premium to seller for having the option. There are two types of option : Call option and Put option. Options are generally European or American. Swaps It is a derivative where two parties exchange on stream of cash flow against another. There are mainly interest rate swaps and currency swaps

Financial Institutions:
An establishment that focuses on dealing with financial transactions, such as investments, loans and deposits. Conventionally, financial institutions are composed of organizations such as banks, trust companies, insurance companies and investment dealers. Almost everyone has deal with a financial institution on a regular basis. Everything from depositing money to taking out loans and exchange currencies must be done through financial institutions Explanation; Since all people depend on the services provided by financial institutions, it is imperative that they are regulated highly by the federal government. For example, if a financial institution were to enter into bankruptcy as a result of controversial practices, this will no doubt cause wide-spread panic as people start to question the safety of their finances. Also, this loss of confidence can inflict further negative externalities upon the economy. Types of financial institutions;

Commercial Banks Credit Unions Stock Brokerage Firms Asset Management Firms Insurance Companies Finance Companies Building Societies Retailers Services Offered by Various Financial Institutions The services provided by the various types of financial institutions may vary from one institution to another. For example, The services offered by the commercial banks are insurance services, mortgages, loans and credit cards. The services provided by the brokerage firms, on the other hand, are different and they are insurance, securities, mortgages, loans, credit cards, money market and check writing. The insurance companies offer insurance services, securities, buying or selling service of the real estates, mortgages, loans, credit cards and check writing. The credit union is co-operative financial institution, which is usually controlled by the members of the union. The major difference between the credit unions and banks is that the credit unions are owned by the members having accounts in it. The stock brokerage firms are the other types of financial institutions that help both the corporations and individuals to invest in the stock market.

Another type of financial institution is the asset management firms. The prime functionality of these firms is to manage various securities and assets to meet the financial goals of the investors. The firms also offer fund management advice and decisions to the corporations and individuals. Role of Financial Institutions The various financial institutions generally act as an intermediary between the capital market and debt market. But the services provided by a particular institution depends on its type. The financial institutions are also responsible to transfer funds from investors to the companies. Typically, these are the key entities that control the flow of money in the economy. .