Function of Financial Markets

1. Allows transfers of funds from

person or business without investment
opportunities to one who has them
2.Improves economic efficiency
3.Transfer funds over life horizon

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Direct and Indirect Finance

• Direct finance: lenders hold direct claims on

borrowers’ assets or future income.
• Indirect finance: Lenders hold claims on financial
intermediary, which in turn hold claims on
borrowers. (q)

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Classifications of Financial Markets I
By Financial Instruments
1. Debt Markets
Short-term (maturity < 1 year)
Long-term (maturity > 10 year)
2. Equity Markets
Common stocks (owner a residual claimant)
Securities are assets for holders, but liabilities for issuers. (q)
The value of debt instruments was $20 trillion in 2002 while
the value of equity was $11 trillion.

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Classifications of Financial Markets II

• 1. Primary Market (often behind closed doors)

New security issues sold to initial buyers
• 2. Secondary Market
Securities previously issued are bought and sold
• Investment Bank.
• Role of Brokers and Dealers. (q)
• Liquidity and Valuation Provided by the
Secondary Market.

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Classifications of Financial Markets III

By Organization of Secondary Market

• 1. Exchanges
Trades conducted in central locations (NYSE,ASE)
• 2. Over-the-Counter (OTC) Markets
Dealers at different locations buy and sell
• U.S. Gov’t Bond Market Organized as an OTC
market with 40 or so dealers.

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Classifications of Financial Markets IV

By Maturity

1. Money Market (< 1 year debt instruments)

2. Capital Market (longer term debt and equity)
.

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