Upload
airo-ridho
View
217
Download
0
Embed Size (px)
Citation preview
8/3/2019 1 Overview of Financial Markets
1/35
Y
1February 17th , 2011
Financial Marketsand Institutions :An Overview
8/3/2019 1 Overview of Financial Markets
2/35
Objectives1. Explain the functions of financial markets2. Explain the types and categories of financial
markets that facilitate the flow of funds
3. Explain the internationalization of financial markets
4. Explain the functions of financial intermediaries5. Describe the main types of financial intermediaries
that facilitate transactions
8/3/2019 1 Overview of Financial Markets
3/35
Topics include: Function of Financial Markets
Structure of Financial Markets
Internationalization of Financial Markets
Function of Financial Intermediaries Financial Intermediaries
Regulation of the Financial System
Topics
8/3/2019 1 Overview of Financial Markets
4/35
1. Channels funds from savers toinvestors, thereby promoting economicefficiency.
2. Affects personal wealth and behaviorof business firms.
Well functioning financial markets, suchas the bond market, stock market, andforeign exchange market, are keyfactors in producing high economic
growth
Why Study Financial Markets?
8/3/2019 1 Overview of Financial Markets
5/35
1. Central Banks and the Conduct of Monetary Policy The role of the Fed and foreign counterparts
2. Structure of the Financial System Helps get funds from savers to investors
3. Banks and Other Financial Institutions Includes the role of insurance companies, mutual funds,
pension funds, etc.
4. Financial Innovation
Focusing on the improvements in technology and itsimpact on how financial products are delivered
5. Managing Risk in Financial Institutions Focusing on risk management in the financial
institution.
Why Study Financial Institutions?
8/3/2019 1 Overview of Financial Markets
6/35
Overview of Financial Markets (Madura,2010)
Financial markets provide for financialintermediation--financial savings (Surplus Units) toinvestment (Deficit Units)
Financial markets provide payments system Financial markets provide means to manage risk
Financial Market: a market in which financial
assets (securities) such as stocks and bonds
can be purchased or sold
8/3/2019 1 Overview of Financial Markets
7/35
Money versus Capital Markets
Primary versus Secondary Markets
Organized versus Over-the-Counter Markets
Broad Classifications of Financial Markets(Madura, 2010)
8/3/2019 1 Overview of Financial Markets
8/35
Money vs. Capital Markets
Money Short-Term, < 1 Year
High Quality Issuers
Debt Only
Primary Market Focus
Liquidity Market--LowReturns
Capital Long-Term, >1Yr
Range of Issuer Quality
Debt and Equity
Secondary Market Focus
Financing Investment--Higher Returns
Classifications of Financial Markets
8/3/2019 1 Overview of Financial Markets
9/35
Primary vs. Secondary Markets
PRIMARY
New Issue of Securities
Exchange of Funds forFinancial Claim
Funds for Borrower; an
IOU for Lender
SECONDARY
Trading Previously IssuedSecurities
No New Funds for Issuer
Provides Liquidity for
Seller
Classifications of Financial Markets
8/3/2019 1 Overview of Financial Markets
10/35
Organized vs. Over-the-Counter Markets
Organized
Visible Marketplace
Members Trade
Securities Listed
New York StockExchange
OTC
Wired Network ofDealers
No Central, PhysicalLocation
All Securities Tradedoff the Exchanges
Classifications of Financial Markets
8/3/2019 1 Overview of Financial Markets
11/35
Allows transfers of funds from person or businesswithout investment opportunities (i.e., Lender-Savers) to one who has them (i.e., Borrower-Spenders)
Improves economic efficiency
Functions of Financial Markets
Direct Finance : Borrowers borrow directly from lenders infinancial markets by selling financial instruments which
are claims on the borrowers future income or assetsIndirect Finance : Borrowers borrow indirectly from lendersvia financial intermediaries (established to source bothloanable funds and loan opportunities) by issuingfinancial instruments which are claims on the borrowers
future income or assets
Segments of Financial Markets
8/3/2019 1 Overview of Financial Markets
12/35
Figure 1 Flow of Funds Through the Financial System
Functions of Financial Markets
8/3/2019 1 Overview of Financial Markets
13/35
Internationalization of Financial Markets
International Bond Market Foreign bonds
Eurobonds (now larger than U.S. corporate bond market)
World Stock Markets
U.S. stock markets are no longer always the largestatone point, Japan's was larger
8/3/2019 1 Overview of Financial Markets
14/35
Function of Financial Intermediaries (FIs)
Financial Intermediaries1. Engage in process of indirect finance
2. More important source of finance than securitiesmarkets
3. Needed because of transactions costs andasymmetric information
Transactions Costs
1. Financial intermediaries make profits by reducingtransactions costs
2. Reduce transactions costs by developing expertiseand taking advantage of economies of scale
8/3/2019 1 Overview of Financial Markets
15/35
Function of Financial Intermediaries (cont.) A financial intermediarys low transaction costs mean
that it can provide its customers with liquidityservices, services that make it easier for customers toconduct transactions
1. Banks provide depositors with checking accounts that enable
them to pay their bills easily2. Depositors can earn interest on checking and savings
accounts and yet still convert them into goods and serviceswhenever necessary
Another benefit made possible by the FIs low transaction
costs is that they can help reduce the exposure ofinvestors to risk, through a process known as risksharing
FIs create and sell assets with lesser risk to oneparty in order to buy assets with greater risk from another party
This process is referred to as asset transformation, because in a
8/3/2019 1 Overview of Financial Markets
16/35
Copyright 2006 PearsonAddison-Wesley. All rights
2-16
Financial Intermediaries
8/3/2019 1 Overview of Financial Markets
17/35
Copyright 2006 PearsonAddison-Wesley. All rights
2-17
Size of Financial Intermediaries
8/3/2019 1 Overview of Financial Markets
18/35
Types of Financial Intermediaries Depository Institutions (Banks)
Commercial banks
Savings & Loan Associations (S&Ls)
Mutual Savings Banks
Contractual Savings Institutions (Non Depository) Life insurance companies Fire & casualty insurance companies
Pension funds, government retirement funds
Investment Intermediaries
Finance companies Mutual funds
Money market mutual funds
8/3/2019 1 Overview of Financial Markets
19/35
Depository Institutions (Banks) Commercial banks
Raise funds primarily by issuing checkable, savings, andtime deposits which are used to make commercial,consumer and mortgage loans
Collectively, these banks comprise the largest financialintermediary and have the most diversified asset portfolios
S&Ls, Mutual Savings Banks and Credit Unions Raise funds primarily by issuing savings, time, and
checkable deposits which are most often used to makemortgage and consumer loans, with commercial loans alsobecoming more prevalent at S&Ls and Mutual Savings
Banks Mutual savings banks and credit unions issue deposits asshares and are owned collectively by their depositors, mostof which at credit unions belong to a particular group, e.g., acompanys workers
8/3/2019 1 Overview of Financial Markets
20/35
Contractual Savings Institutions (CSIs) All CSIs acquire funds from clients at periodic
intervals on a contractual basis and have fairlypredictable future payout requirements. Life Insurance Companies receive funds from policy
premiums, can invest in less liquid corporate securities andmortgages,
since actual benefit pay outs are close to those predicted byactuarial analysis Fire and Casualty Insurance Companies receive funds
from policy premiums, must invest most in liquid governmentand corporate securities, since loss events are harder topredict
Pension and Government Retirement Funds hosted bycorporations and state and local governments acquire fundsthrough employee and employer payroll contributions, investin corporate securities, and provide retirement income via
annuities
8/3/2019 1 Overview of Financial Markets
21/35
Investment Intermediaries Finance Companies sell commercial paper (a
short-term debt instrument) and issue bonds andstocks to raise funds to lend to consumers to buydurable goods, and to small businesses foroperations
Mutual Funds acquire funds by selling shares toindividual investors (many of whose shares areheld in retirement accounts) and use theproceeds to purchase large, diversified portfoliosof stocks and bonds
Money MarketMutual Funds acquire funds byselling checkable deposit-like shares to individualinvestors and use the proceeds to purchasehighly liquid and safe short-term money marketinstruments
8/3/2019 1 Overview of Financial Markets
22/35
Regulation of Financial Markets
Three Main Reasons for Regulation1. Increase Information to Investors
2. Ensure the Soundness of Financial Intermediaries
3. Improve Monetary Control
8/3/2019 1 Overview of Financial Markets
23/35
Regulation Reason:
Increase Investor Information
Asymmetric information in financial markets means that
investors may be subject to adverse selection and moralhazard problems that may hinder the efficient operationof financial markets and may also keep investors awayfrom financial markets
The Securities and Exchange Commission (SEC)requires corporations issuing securities to disclosecertain information about their sales, assets, andearnings to the public and restricts trading by the largeststockholders (known as insiders) in the corporation
Such government regulation can reduce adverseselection and moral hazard problems in financial marketsand increase their efficiency by increasing the amount ofinformation available to investors
8/3/2019 1 Overview of Financial Markets
24/35
Regulation Reason: Ensure Soundnessof Financial Intermediaries Because providers of funds to financial
intermediaries may not be able to assesswhether the institutions holding their funds aresound or not, if they have doubts about theoverall health of financial intermediaries, theymay want to pull their funds out of both soundand unsound institutions, with the possibleoutcome of a financial panic that produces largelosses for the public and causes serious damage
to the economy
8/3/2019 1 Overview of Financial Markets
25/35
8/3/2019 1 Overview of Financial Markets
26/35
Regulation: Restriction on Entry
Restrictions on Entry Regulators have created very tight regulations as to
who is allowed to set up a financial intermediary
Individuals or groups that want to establish a
financial intermediary, such as a bank or an insurancecompany, must obtain a charter from the state or thefederal government
Only if they are upstanding citizens with impeccablecredentials and a large amount of initial funds will theybe given a charter.
8/3/2019 1 Overview of Financial Markets
27/35
Regulation: Disclosure
Disclosure Requirements There are stringent reporting requirements for
financial intermediaries Their bookkeeping must follow certain strict principles,
Their books are subject to periodic inspection,
They must make certain information available tothe public.
8/3/2019 1 Overview of Financial Markets
28/35
Regulation: Restriction on Assets andActivities
There are restrictions on what financialintermediaries are allowed to do and what assetsthey can hold
Before you put your funds into a bank or some other
such institution, you would want to know that yourfunds are safe and that the bank or other financialintermediary will be able to meet its obligations toyou
One way of doing this is to restrict the financialintermediary from engaging in certain risky activities
Another way is to restrict financial intermediaries fromholding certain risky assets, or at least from holding a
greater quantity of these risky assets than is prudent
8/3/2019 1 Overview of Financial Markets
29/35
Regulation: Deposit Insurance
The government can insure people providingfunds to a financial intermediary from anyfinancial loss if the financial intermediary shouldfail
The Federal Deposit Insurance Corporation(FDIC), insures each depositor at a commercialbank or mutual savings bank up to a loss of$100,000 per account
8/3/2019 1 Overview of Financial Markets
30/35
Regulation: Past Limits on Competition
Although the evidence that unbridled competitionamong financial intermediaries promotes failuresthat will harm the public is extremely weak, it hasnot stopped the state and federal governments
from imposing many restrictive regulations In the past, banks were not allowed to open up
branches in other states, and in some states
banks were restricted from openingadditional locations
8/3/2019 1 Overview of Financial Markets
31/35
Regulation: Past Restrictions on InterestRates Competition has also been inhibited by
regulations that impose restrictions on interestrates that can be paid on deposits
These regulations were instituted because of the
widespread belief that unrestricted interest-ratecompetition helped encourage bank failuresduring the Great Depression
Later evidence does not seem to support this
view, and restrictions on interest rates havebeen abolished
8/3/2019 1 Overview of Financial Markets
32/35
Regulation: Past Restrictionson Interest Rates Competition has also been inhibited by
regulations that impose restrictions on interestrates that can be paid on deposits
These regulations were instituted because of the
widespread belief that unrestricted interest-ratecompetition helped encourage bank failuresduring the Great Depression
Later evidence does not seem to support this
view, and restrictions on interest rates havebeen abolished
8/3/2019 1 Overview of Financial Markets
33/35
2-33
Regulation Reason: Improve MonetaryControl Because banks play a very important role in determining
the supply of money (which in turn affects many aspectsof the economy), much regulation of these financialintermediaries is intended to improve control over themoney supply
One such regulation is reserve requirements, whichmake it obligatory for all depository institutions to keep acertain fraction of their deposits in accounts with theFederal Reserve System (the Fed), the central bank inthe United States
Reserve requirements help the Fed exercise moreprecise control over the money supply
8/3/2019 1 Overview of Financial Markets
34/35
Financial Regulation Abroad
Those countries with similar economic systemsalso implement financial regulation consistentwith the U.S. model: Japan, Canada, andWestern Europe
Financial reporting for corporations is required Financial intermediaries are heavily regulated
However, U.S. banks are more regulated along
dimensions of branching and services than theirforeign counterparts.
8/3/2019 1 Overview of Financial Markets
35/35
Summary
Thank You
REFERENCE
Frederic S. Mishkin and Stanley G. Eakins (2006),Financial Markets + Institutions, 5ed, Addison-Wesley, Boston, MA. (MEA)
Jeff Madura (2006), Financial Institutions and Markets,7ed, Thomson South-Western, Mason, OH. (JEM)