Overview of Financial Markets

An Introduction
Impact of Studying Financial
Markets and Institutions to:
• Financial Managers - operate
• Investors - Individuals or Corporation -
invest
• Government and Corporation - finance
Primary vs. Secondary Markets
• The Primary Market
Primary vs. Secondary Markets
• The Primary Market
Primary vs. Secondary Markets
• The Primary Market
– markets in which corporations raise funds through
new issues of securities
• Initial Public Offerings or IPO
Primary vs. Secondary Markets
• Secondary Markets
Primary vs. Secondary Markets
• Secondary Markets
–USA has NYSE and NASDAQ
–Philippines has PSE
Primary vs. Secondary Markets
• Secondary Markets
Primary vs. Secondary Markets
• Secondary Market Brokers
Primary vs. Secondary Markets
• Secondary Market Brokers
Primary vs. Secondary Markets
• Secondary Markets can:
–provide quick access to buy and sell stocks
–offer liquidity to buyers and sellers
–give information about the prices or value of the
stocks
 Money vs. Capital Markets
• Money Markets
–trade debt securities or instruments with
maturities of one year or less
–transactions involving money markets are said
to be over-the-counter(OTC) markets
 Money vs. Capital Markets
• Capital Markets
–trade equity(stocks) and debt(bond) instruments
with maturities of more than one year
–capital markets have wider price fluctuations,
while money markets' fluctuations are quite
small
Examples of Money Market
Instruments
Examples of Capital Market
Instruments
 Foreign Exchange Markets
–markets in which cash flows from the sale of
products or assets denominated in a foreign
currency
• The “spot” FX transaction involves the immediate
exchange of currencies at the current exchange rate
• The “forward” FX transaction involves the exchange of
currencies at a specified date in the future and at a
specified exchange rate
 Derivative Security Markets

– markets in which derivative securities trade

 Derivative Security

– an agreement between two parties to exchange a

standard quantity of an asset at a predetermined price
on a specified date in the future
 Derivative Security
• Two purposes of derivatives:
1. To hedge risk
2. Speculation
 Financial Institutions
–these are entities that perform essential
functions of channeling funds from those with
surplus funds to those with shortages of funds
 Types of Financial Institutions
• Commercial banks
–depository institutions whose major assets
are loans and major liabilities are deposits
• Thrifts
–depository institutions in the form of
savings and loans, credit unions
 Types of Financial Institutions
• Insurance companies
–financial institutions that protect individuals
and corporations from adverse events
• Securities firms and investment banks
–financial institutions that underwrite securities
and engage in securities brokerage and trading
 Types of Financial Institutions
• Finance companies
– financial institutions that make loans to individuals and
businesses
• Mutual Funds
– financial institutions that pool financial resources and
invest in diversified portfolios
• Pension Funds
– financial institutions that offer savings plans for
retirement
 Direct Transfer
Financial Claims
(Equity and debt
instruments)
Users of Suppliers of
Funds Funds
(Corporations) Cash (Households)
 Functions of Financial institutions
Benefits to Suppliers of Funds
• Monitoring Costs
• Liquidity and Price Risk
• Transaction Cost Services
• Maturity Intermediation
• Denomination Intermediation
 Functions of Financial institutions
Benefits to Suppliers of Funds
• Monitoring Costs - Aggregation of funds in an FI
provides greater incentive to collect a firm’s
information and monitor actions. The relatively large
size of the FI allows this collection of information to
be accomplished at a lower average cost (economies
of scale).
 Functions of Financial institutions
Benefits to Suppliers of Funds
• Liquidity and price risk —FIs provide financial
claims to household savers with superior liquidity
attributes and with lower price risk.
 Functions of Financial institutions
Benefits to Suppliers of Funds
• Transaction cost services —Similar to economies of
scale in information production costs, an FI’s size can
result in economies of scale in transaction costs.
 Functions of Financial institutions
Benefits to Suppliers of Funds
• Maturity intermediation —FIs can better bear the
risk of mismatching the maturities of their assets and
liabilities.
 Functions of Financial institutions
Benefits to Suppliers of Funds
• Denomination intermediation —FIs such as mutual
funds allow small investors to overcome constraints
to buying assets imposed by large minimum
denomination size.
 Functions of Financial institutions
Benefits to Economy as a Whole
• Money Supply Transmission
• Credit Allocation
• Intergenerational Wealth Transfers
• Payment Services
 Functions of Financial institutions
Benefits to Economy as a Whole
• Money supply transmission —Depository institutions
are the conduit through which monetary policy
actions impact the rest of the financial system and the
economy in general.
 Functions of Financial institutions
Benefits to Economy as a Whole
• Credit allocation —FIs are often viewed as the major,
and sometimes only, source of financing for a
particular sector of the economy, such as farming
and residential real estate.
 Functions of Financial institutions
Benefits to Economy as a Whole
• Intergenerational wealth transfers —FIs, especially
life insurance companies and pension funds, provide
savers with the ability to transfer wealth from one
generation to the next.
 Functions of Financial institutions
Benefits to Economy as a Whole
• Payment services —The efficiency with which
depository institutions provide payment services
directly benefits the economy.
 Risks Faced by Financial
Institutions
• Interest Rate Risk • Off-Balance-Sheet Risk
• Foreign Exchange Risk • Technology Risk
• Market Risk • Operational Risk
• Credit Risk • Country or Sovereign
• Liquidity Risk Risk
• Insolvency Risk
 Look for the definition of:
• Liquidity Asset transformers
• Price Risk Diversify
• Agency Cost Economies of scale
• Bid-ask risk E-trade
• Delegated monitor