Mc GrawHillIrwin Chapter One Introduction Mc GrawHillIrwin 2

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Mc. Graw-Hill/Irwin

Mc. Graw-Hill/Irwin

Chapter One Introduction Mc. Graw-Hill/Irwin 2 © 2007, The Mc. Graw-Hill Companies, All Rights

Chapter One Introduction Mc. Graw-Hill/Irwin 2 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Why study Financial Markets and Institutions? • They are the cornerstones of the overall

Why study Financial Markets and Institutions? • They are the cornerstones of the overall financial system in which financial managers operate • Individuals use both for investing • Corporations and governments use both for financing Mc. Graw-Hill/Irwin 3 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Overview of Financial Markets • Primary Markets versus Secondary Markets • Money Markets versus

Overview of Financial Markets • Primary Markets versus Secondary Markets • Money Markets versus Capital Markets • Foreign Exchange Markets Mc. Graw-Hill/Irwin 4 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Primary Markets versus Secondary Markets • Primary Markets – markets in which users of

Primary Markets versus Secondary Markets • Primary Markets – markets in which users of funds (e. g. corporations, governments) raise funds by issuing financial instruments (e. g. stocks and bonds) • Secondary Markets – markets where financial instruments are traded among investors (e. g. NYSE, NASDAQ) Mc. Graw-Hill/Irwin 5 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Money Markets versus Capital Markets • Money Markets – markets that trade debt securities

Money Markets versus Capital Markets • Money Markets – markets that trade debt securities with maturities of one year or less (e. g. CD’s, U. S. Treasury bills) • Capital Markets – markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year Mc. Graw-Hill/Irwin 6 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Money Market Instruments Outstanding, 1990 -2004 ($Bn) Mc. Graw-Hill/Irwin 7 © 2007, The Mc.

Money Market Instruments Outstanding, 1990 -2004 ($Bn) Mc. Graw-Hill/Irwin 7 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Capital Market Instruments Outstanding, 1990 -2004 ($Bn) Mc. Graw-Hill/Irwin 8 © 2007, The Mc.

Capital Market Instruments Outstanding, 1990 -2004 ($Bn) Mc. Graw-Hill/Irwin 8 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Foreign Exchange Markets • “FX” markets deal in trading one currency for another (e.

Foreign Exchange Markets • “FX” markets deal in trading one currency for another (e. g. dollar for yen) • 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 Mc. Graw-Hill/Irwin 9 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Derivative Security Markets • The markets in which derivative securities trade. • Derivative Security

Derivative Security Markets • The 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. Mc. Graw-Hill/Irwin 10 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Overview of Financial Institutions • Institutions that perform the essential function of channeling funds

Overview of Financial Institutions • Institutions that perform the essential function of channeling funds from those with surplus funds to those with shortages of funds (e. g. banks, thrifts, insurance companies, securities firms and investment banks, finance companies, mutual funds, pension funds) Mc. Graw-Hill/Irwin 11 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Flow of Funds in a World without FIs: Direct Transfer Financial Claims (Equity and

Flow of Funds in a World without FIs: Direct Transfer Financial Claims (Equity and debt instruments) Users of Funds (Corporations) Suppliers of Funds (Households) Cash Example: A firm sells shares directly to investors without going through a financial institution. Mc. Graw-Hill/Irwin 12 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Flow of Funds in a world with FIs: Indirect transfer FI (Brokers) Users of

Flow of Funds in a world with FIs: Indirect transfer FI (Brokers) Users of Funds Cash FI (Asset transformers) Financial Claims (Equity and debt securities) Mc. Graw-Hill/Irwin Suppliers of Funds Cash Financial Claims (Deposits and insurance policies) 13 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Types of FIs • Commercial banks – depository institutions whose major assets are loans

Types of FIs • 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 • Insurance companies – financial institutions that protect individuals and corporations from adverse events (continued) Mc. Graw-Hill/Irwin 14 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

• Securities firms and investment banks – financial institutions that underwrite securities and

• Securities firms and investment banks – financial institutions that underwrite securities and engage in securities brokerage and trading • 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 Mc. Graw-Hill/Irwin 15 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Services Performed by Financial Intermediaries • • • Monitoring Costs Liquidity and Price Risk

Services Performed by Financial Intermediaries • • • Monitoring Costs Liquidity and Price Risk Transaction Cost Services Maturity Intermediation Denomination Intermediation Mc. Graw-Hill/Irwin 16 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Services Provided by FIs Benefiting the Overall Economy • • Money Supply Transmission Credit

Services Provided by FIs Benefiting the Overall Economy • • Money Supply Transmission Credit Allocation Intergenerational Wealth Transfers Payment Services Mc. Graw-Hill/Irwin 17 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Risks Faced by Financial Institutions • • • Interest Rate Risk Foreign Exchange Risk

Risks Faced by Financial Institutions • • • Interest Rate Risk Foreign Exchange Risk Market Risk Credit Risk Liquidity Risk Off-Balance-Sheet Risk Technology Risk Operational Risk Country or Sovereign Risk Insolvency Risk Mc. Graw-Hill/Irwin 18 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Regulation of Financial Institutions • FIs provide vital financial services to all sectors of

Regulation of Financial Institutions • FIs provide vital financial services to all sectors of the economy; therefore, their regulation is in the public interest • In an attempt to prevent their failure and the failure of financial markets overall Mc. Graw-Hill/Irwin 19 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Globalization of Financial Markets and Institutions • Financial Markets became more global as the

Globalization of Financial Markets and Institutions • Financial Markets became more global as the value of stocks traded in foreign markets soared • Foreign bond markets have served as a major source of international capital • Globalization also evident in the derivative securities market Mc. Graw-Hill/Irwin 20 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

Factors Leading to Significant Growth in Foreign Markets • The pool of savings from

Factors Leading to Significant Growth in Foreign Markets • The pool of savings from foreign investors has increased • International investors have turned to U. S. and other markets to expand their investment opportunities • Information on foreign investments and markets is now more accessible (e. g. internet) • Some mutual funds allow ability to invest in foreign securities with low transaction costs • Deregulation has enhanced globalization of capital flows Mc. Graw-Hill/Irwin 21 © 2007, The Mc. Graw-Hill Companies, All Rights Reserved

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