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CHAPTER

Role of Financial
Markets and
Institutions
Copyright 2002 Thomson Publishing. All rights reserved.
Overview of Financial Markets
Financial markets provide for financial
intermediation--financial savings (Surplus Units) to
investment (Deficit Units)
Financial markets provide payments system
Financial markets provide means to manage risk

Financial Market: a market in which financial
assets (securities) such as stocks and bonds
can be purchased or sold

Copyright 2002 Thomson Publishing. All rights reserved.
Broad Classifications of Financial Markets

Money versus Capital Markets

Primary versus Secondary Markets

Organized versus Over-the-Counter Markets
Overview of Financial Markets
Copyright 2002 Thomson Publishing. All rights reserved.
Primary vs. Secondary Markets
PRIMARY
New Issue of Securities


Exchange of Funds for
Financial Claim

Funds for Borrower;
SECONDARY
Trading Previously Issued
Securities

No New Funds for Issuer


Provides Liquidity for
Seller
Copyright 2002 Thomson Publishing. All rights reserved.
Money vs. Capital Markets
Money
Short-Term, < 1 Year

High Quality Issuers

Debt Only

Primary Market Focus

Liquidity Market--Low
Returns
Capital
Long-Term, >1Yr

Range of Issuer Quality

Debt and Equity

Secondary Market Focus

Financing Investment--
Higher Returns
Copyright 2002 Thomson Publishing. All rights reserved.
Organized vs. Over-the-Counter
Markets
Organized
Visible Marketplace

Members Trade

Securities Listed

New York Stock
Exchange
OTC
Wired Network of
Dealers

No Central, Physical
Location

All Securities Traded
off the Exchanges
Copyright 2002 Thomson Publishing. All rights reserved.
Investor Assessment of New Information
Exhibit 1.3
Economic Conditions
Industry
Conditions
Firm Specific
Information
Impact of
Future Cash
Flows
Evaluation
of Security
Pricing
Investor
Decision to
Trade
Copyright 2002 Thomson Publishing. All rights reserved.
Financial Market Regulation



To Promote Efficiency

High level of competition

Efficient payments mechanism

Low cost risk management contracts
Why Government Regulation?
Copyright 2002 Thomson Publishing. All rights reserved.



To Maintain Financial Market Stability
Prevent market crashes
Prevent Inflation--Monetary policy
Prevent Excessive Risk Taking by Financial Institutions


Financial Market Regulation
Why Government Regulation?
Copyright 2002 Thomson Publishing. All rights reserved.



To Provide Consumer Protection
Provide adequate disclosure
Set rules for business conduct
To Pursue Social Policies
Transfer income and wealth
Allocate saving to socially desirable areas
Housing
Student loans
Financial Market Regulation
Why Government Regulation?