Primary vs. Secondary Markets
s
PRIMARY
q
s
SECONDARY
q
New Issue of Securities
Trading Previously Issued Securities No New Funds for Issuer
q
Exchange of Funds for Financial Claim Funds for Borrower; an IOU for Lender
Types of Depository Financial Institutions
Savings Institutions $1.3 Trillion Total Assets Credit Unions $.5 Trillion Total Assets
Commercial Banks $5 Trillion Total Assets
x
Prevent Inflation--Monetary policy Prevent Excessive Risk Taking by Financial Institutions
x
Financial Market Regulation
Why Government Regulation?
q To
q
q
q
Provides Liquidity for Seller
Money vs. Capital Markets
s
Money
q
s
Capital
q
Short-Term, < 1 Year High Quality Issuers Debt Only Primary Market Focus Liquidity Market--Low Returns
q Increased
Role of Financial Institutions in Financial Markets
Information processing s Serve special needs of lenders (liabilities) and borrowers (assets)
Provide Consumer Protection
x Provide
adequate disclosure x Set rules for business conduct
q To
Pursue Social Policies
x Transfer
income and wealth x Allocate saving to socially desirable areas
s
q By
denomination and term q By risk and return
Lower transaction cost s Serve to resolve problems of market imperfection
s
Role of Financial Institutions in Financial Markets
Firm Specific Information
Exhibit 1.3
Financial Market Efficiency
s
Security prices reflect available information New information is quickly included in security prices Investors balance liquidity, risk, and return needs
s
Role of Nondepository Financial Institutions
Focused on capital market s Longer-term, higher risk intermediation s Less focus on liquidity s Less regulation s Greater focus on equity investments
Debt vs. Equity Securities
Debt Securities: Contractual obligations (IOU) of Debtor (borrower) to Creditor (lender)
x Investor
receives interest x Capital gain/loss when sold x Maturity date
s
Derivative Securities
q q
Financial contracts whose value is derived from the values of underlying assets Used for hedging (risk reduction) and speculation (risk seeking)
s
s
Financial Market Regulation
Why Government Regulation?
q To
Promote Efficiency
level of competition payments mechanism
x High
x Efficient
x Low
cost risk management contracts
© 2003 South-Western/Thomson Learning
Chapter Objectives
s
Describe the types of financial markets Describe the role of financial institutions with financial markets Identify the types of financial institutions that facilitate transactions
Financial Market Regulation
Why Government Regulation?
q
To Maintain Financial Market Stability
x
Prevent market crashes
s s
Circuit breakers Federal Reserve discount window
Types of Nondepository Financial Institutions
Insurance companies s Mutual funds s Pension funds s Securities companies s Finance companies s Security pools
Valuation of Securities
s
Value a function of:
q Future
cash flows q When cash flows are received q Risk of cash flows
Present value of cash flows discounted at the market required rate of return s Value determined by market demand/supply s Value changes with new information
Listed
q New
York Stock Exchange
q All
Securities Traded in Financial Markets
s
Money Market Securities
q
Debt securities Only
s
Capital market securities
q
Debt and equity securities
s
s
Overview of Financial Markets
Financial Market: a market in which financial assets (securities) such as stocks and bonds can be purchased or sold
s
s s
PowerPoint Slides for:
Financial Markets and Institutions 6th Edition
By Jeff Madura Prepared by David R. Durst The University of Akron
CHAPTER
Role of Financial Markets and Institutions
s
Investor Assessment of New Information
Economic Conditions
Industry Conditions
Impact of Future Cash Flows
Evaluation of Security Pricing
Investor Decision to Trade
s s
Housing Student loans
Financial Market Globalization
s
Increased international funds flow
disclosure of information q Reduced transaction costs q Reduced foreign regulation on capital flows q Increased privatization Results: Increased financial integration--capital flows to highest expected risk-adjusted return