Upload
dora-blankenship
View
227
Download
2
Tags:
Embed Size (px)
Citation preview
Chap. 1The Study of Financial Markets
• Financial Markets – A Definition:– Markets in which funds are transferred between
savers (investors) and borrowers– Funds are transferred from Surplus Units (Savers,
Investors) to Deficit Units (Borrowers)– Examples of Each:
• Surplus Units = Households and Investment Groups• Deficit Units = Financial, Non-Fin. Corps. and Individuals
– This promotes greater market efficiency (i.e. lowers transaction and search cost)
Chap. 1The Study of Financial Markets
• Debt Markets and Interest Rates– Financial Instruments (Securities)• A Claim on the Issuers Future Income and or
Assets• Financial claims are also called financial assets/
liabilities, securities, loans, and investments
– Assets• An Owned Financial Claim or Piece of Property• For every financial asset, there is an offsetting
financial liability
Chap. 1The Study of Financial Markets
• Debt Markets and Interest Rates– Bond Markets (Debt Markets)• Bond – A debt security promising to make
payments over a specified period of time
– The Rate of Interest• Interest Rate – The price or cost of borrowing
money expressed as a percentage
• Interest rates are determined in the Bond/Debt Markets
Chap. 1The Study of Financial Markets
• Interest Rates and Financial Institutions– Interest Rates directly effect the
performance of Financial Institutions– Example:• If a bank issues short term CD’s during a period
of rising interest rates what might happen to the bank’s cash flow assuming that assets are constant or declining?
– Int. Rates can differ b/w Time to Maturity
Chap. 1The Study of Financial Markets
• The Stock Market– Stock: A security representing a claim of
ownership in a corporations earnings and assets
– Primary Market• Initial Public Offering (IPO)• Seasoned Equity Offering (SEO)
– Secondary Market• NYSE, AMEX, NASDAQ
Chap. 1The Study of Financial Markets
• The Foreign Exchange Market– Allows funds from one country to be
transferred to another country– Implicit in this definition is the conversion of
one currency for another (i.e. Euros to Dollars)
• Foreign Exchange Rate– The price of one country’s currency relative to
another country’s (Can$ 1.5416 per 1 US)
Chap. 1The Study of Financial Markets
• The Foreign Exchange Market– Fluctuation in exchange rates between
currency’s lead to a variety of economic impacts
– Example:• When the US Dollar is strong (expensive) relative
to other currencies, American Consumers can buy abroad cheaper than they can domestically. However US firms may suffer as exports decline.
Chap. 1The Study of Financial Markets
• Financial Institutions– Central Banks• The government or quasi-government agency
tasked with managing monetary policy• In the US this agency is known as the Federal
Reserve System (or the Fed)
–Monetary Policy• Management of interest rates and the money
supply (M1, M2, M3, MZM)
Chap. 1The Study of Financial Markets
• Financial Institutions– Banks – An institution that accepts deposits
and makes loans– Types of Banking Institutions• Commercial Banks
• Savings and Loan Associations
• Mutual Savings Banks
• Credit Unions
Chap. 1The Study of Financial Markets
FINANCIAL ASSET HOLDINGS OF DEPOSIT-TYPE INTERMEDIARIES (1998)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
CommercialBanks
ThriftInstitutions
Credit Unions
Pe
rce
nt
of
To
tal F
ina
nc
ial A
ss
ets
U.S. Governmentsecurities
Municipal bonds
Corporate and foreignbonds
Consumer loans
Business loans
Real estate loans
Other financial assets
FINANCIAL ASSET HOLDINGS OF DEPOSIT-TYPE INTERMEDIARIES (1998)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
CommercialBanks
ThriftInstitutions
Credit Unions
Per
cen
t o
f T
ota
l F
inan
cial
Ass
ets
U.S. Governmentsecurities
Municipal bonds
Corporate and foreignbonds
Consumer loans
Business loans
Real estate loans
Other financial assets
Chap. 1The Study of Financial Markets
• Financial Institutions– Other Types of Financial Institutions• Investment Banks
• Mutual Funds
• Pension Funds
• Insurance Companies
• Finance Companies
• Government Agencies (HUD, Dept. Ag.)
Chap. 1The Study of Financial Markets
FINANCIAL ASSET HOLDINGS OF CONTRACTUAL SAVINGS INSTITUTIONS (1998)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Life InsuranceCompanies
Casualty InsuranceCompanies
Private PensionFunds
State and LocalGov. Pension
Funds
Pe
rce
nt
of
To
tal F
ina
nc
ial A
ss
ets
U.S. Government securities
Municipal bonds
Corporate and foreign bonds
Real estate loans
Corporate equities
Other financial assets
Chap. 1The Study of Financial Markets
FINANCIAL ASSET HOLDINGS OF INVESTMENT FUNDS (1998)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Money Market Mutual Funds Mutual Funds
Pe
rce
nt
of
To
tal F
ina
nc
ial A
ss
ets
U.S. Government securities
Municipal bonds
Corporate and foreign bonds
Corporate equities
Commercial Bank CDs
Commercial Paper
Other financial assets
Chap. 1The Study of Financial Markets
• Financial Intermediation– A financial "intermediary" writes a separate
contract with the Investor (bank depositor) and Borrower (auto loan)
– Financial intermediaries hold direct claims on Borrowers as financial assets and issue indirect financial claims to Investors as liabilities
Chap. 1The Study of Financial Markets
• Advantages of Financial Intermediation– Economies of scale from specialization– Transaction and search costs are lowered– Financial intermediaries may be able to
gather borrower information more effectively and discreetly
Chap. 1The Study of Financial Markets
• Services of Financial Intermediation– Denomination Divisibility - Issue varying
sized contracts of assets and liabilities– Currency Transformation - buying and
selling financial claims denominated in various currencies
– Maturity Flexibility - Offer contracts with varying maturities to suit both Borrowers and Investors
Chap. 1The Study of Financial Markets
• Services of Financial Intermediation– Credit Risk Diversification - Assume credit
risks of Borrowers and keep the risks manageable by spreading the risk over many varied types of Borrowers (loan portfolios)
– Liquidity - Provide a place to store liquidity for Investors (deposits); a place to find (borrow) liquidity for Borrowers
Chap. 1The Study of Financial Markets
0%
20%
40%
60%
80%
100%
1955 1965 1975 1985 1990 1995 1998
Pe
rce
nt
of
To
tal F
ina
nc
ial A
ss
ets
Finance Companies
Mutual Funds
Money Market Mutual Funds
State and Local Gov. PensionFunds
Private Pension Funds
Casualty InsuranceCompanies
Life Insurance Companies
Credit Unions
Thrift Institutions
Commercial Banks
Chap. 1The Study of Financial Markets
• Financial Innovation– The Advent of Electronic Banking/Investing• ATM’s• Smart Cards and Point of Sale Transactions• Telephone Banking• Web Bill Payment & Account Access• Electronic/Internet Securities Trading
– Can lead to higher profits for FI’s and lower costs for Investors and Borrowers
Chap. 1The Study of Financial Markets
Managing Risk in Financial Institutions• Types of Risk– Credit or default risk - the risk that a borrower will
not pay as agreed, thus affecting the rate of return on a loan or security
– Interest rate risk - the risk of fluctuations in a security's price or reinvestment income caused by changes in market interest rates
– Liquidity risk - the risk that a financial institution will be unable to generate sufficient cash flow to meet required cash outflows
Chap. 1The Study of Financial Markets
Managing Risk in Financial Institutions
• Types of Risk (Cont’d)– Foreign exchange risk -the risk that foreign
exchange rates will vary in the future affecting the profit of a financial institution
– Political risk - the cost or variation in returns caused by actions of governments or regulators