transferred from lenders to borrowers • Indirect finance – financial intermediaries receive funds from savers and lend them to borrowers Securities are assets for the holder and liabilities for the issuer
Debt instruments – contractual obligation to pay the holder fixed payments at specified dates (e.g., mortgages, bonds, car loans, student loans) Short-term debt instruments have a maturity of less than one year Intermediate-term debt instruments have a maturity between 1 and 10 years Long-term debt instruments have a maturity of ten or more years Equity – sale of ownership share (owners are residual claimants). Owners of stock may receive dividends
Primary market = financial market in which newly issued securities are sold. Secondary market = financial market in which previously owned securities are sold. Investment Banks underwrite securities in primary markets Brokers and dealers work in secondary markets • Broker – match buyers and sellers • Dealers – buy and sell securities
US treasury bills: 1-, 3-, 6-month maturities, discounted; no default risk Negotiable bank certificates of deposit (NCD): transferable in the secondary markets, large denominations Commercial paper (CP): issued by large banks or well-known corporations, growing fast, direct finance; largest instrument Banker’s Acceptances: can be resold in the secondary markets, use abroad in international trade Repurchase Agreements (repos): treasury bills are used to serve as collateral, <2 weeks Federal (Fed) funds: overnight loan b/w banks of their deposits at Fed
Stocks: largest instruments, hold by individuals (1/2), pensions, mutual funds, and insurance companies Mortgages: 3 government agencies, FNMA (Fannie Mae), GNMA (Ginnie Mae), FHLMC (Freddie Mac) Corporate bonds: convertible or non-convertible US government securities: issued by US Treasury, most liquid security US government agency securities: issued by other US gov’t agencies, e.g., FNMA, GNMA… State and local government bonds: also called municipal bonds, interest-exemption Consumer and bank commercial loans
• Foreign Bonds—sold in a foreign country and denominated
in that country’s currency • Foreign bonds may be used to avoid exchange-rate risk • Eurobond—bond denominated in a currency other than that of the country in which it is sold • Eurocurrencies—foreign currencies deposited in banks outside the home country Eurodollars—U.S. dollars deposited in foreign banks outside the U.S. or in foreign branches of U.S. banks • World Stock Markets London, Tokyo and other foreign stock exchanges have grown in importance
Two Main Reasons for Regulation (Financial sector is one
of the most heavily regulated sectors of the economy) • To increase the information available to investors: Reduce adverse selection and moral hazard problems SEC forces corporations to disclose information to reduce insider trading • To ensure the soundness of financial intermediaries: Restrictions on entry Disclosure Laws (SEC) Restrictions on Assets and Activities Deposit Insurance Limits on Competition Restrictions on Interest Rates (no longer in effect)