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EGEE3313 ECONOMICS OF FINANCIAL MARKETS

I. INTRODUCTION
What is a Financial Systems? It contains 5 important elements: 1. Money 2. Financial instruments 3. Financial markets 4. Financial institutions 5. Central bank

Form and Operation of typical Financial System (refer to the diagram ) - Net Savers and Net Borrowers. - Financial market (Direct finance) - Financial intermediaries (Indirect finance) - Cash flow & Financial instruments flow. Types of Financial Markets i. Bond market ii. Stock market iii. Forex market iv. Derivatives market

The Financial System


Financial Intermediaries
In-direct Finance

Net Savers
- Household - Firms - Government - Foreign Sector

Net Borrowers
- Household - Firms - Government - Foreign Sector

Direct Finance

Financial Market
- Stock Market - Bond Market - Forex Market - Derivative Market
Flow of Fin. Instr.

Flow of Funds

Functions of a Financial Systems


i. Risk sharing. ii. Lowering the transaction cost. iii. To liquidate the financial instruments. iv. Disseminate information. Every asset when purchase contain 4 attributes: i. Return/yield. ii. Risk. iii. Liquidity. iv. Time pattern of the return. All participants in financial markets will have their own preference on those attributes!

THE STRUCTURE OF FINANCIAL MARKET

The financial markets is normally divided into 4 categories: i. Debt market vs Equity market ii. Primary market vs Secondary market iii. Exchange market vs OTC market iv. Money market vs capital market

1. Debt and Equity Market - Debt market refer to the issuing of debt instruments by fund demanders (Firms), ie. bond or mortgages. - Equity market refer to issuing of equity instrument by firms, ie. stock/share of the firm. - The classification of debt instruments depends on its maturity: a) short term (maturity <1 year) b) intermediate term (maturity 1-10 years) c) long term (maturity >10 years) - By differentiating these instruments by its maturity enable the instrument to be classified either into the money market instrument or into the capital market instrument.

2. Primary market and secondary market - Primary market issue new securities into the market. It can be a newly issues bond or share. - Secondary market refer to the market that trading the previously issued securities. - Transaction of shares in BURSA MALAYSIA, NYSE, NASDAQ, FT100, HANG SENG is done through brokers & dealers are the example of transaction on secondary market. - Should be noted that transaction conducted in secondary market doesn't affected the amount of fund already generated in the market.

Functions of secondary market: i. Facilitating buying and selling of financial instruments. ii. To liquidate the financial instruments. iii. Serve as an indicator whether there is a demand or not for a company to raise a fund through issuing a share. iv. As a pricing guide to the new security that is about to be issued into the market.

3. Exchange market and the OTC market - Exchange market is the organised market that form the transactions under one roof at fixed location (ie Bursa Malaysia, NYSE). - OTC market is where a dealers at different location that have an inventory of certain shares that wanted to sell to buyers at certain prices. - Or it could be done over the counter of a particular bank or financial institutions. - Transactions are normally done through on-line (ie at KLOFF and NASDAQ).

4. Money and Capital Market - Money market traded the SR debt instruments. - Capital market traded the medium to LR debt instruments. - Money market instruments normally have less risk due to the minimal price fluctuation. (Proffered by a commercial banks and corporations). - Capital market instruments are much riskier than money market instruments. (Normally preferred by financial intermediaries such as EPF and insurance companies).