Financial Markets

Why Study Financial Markets?

Why Study Financial Markets?

• Financial markets channel funds from savers to investors, thereby, promoting economic efficiency.

• Financial markets also affect personal wealth and the behavior of business firms.

Overview of the Financial System

Borrowers-SpendersBusinesses

GovernmentHouseholdsForeigners

Lenders-SaversHouseholdsBusinesses

GovernmentForeigners

INDIRECT FINANCE

DIRECT FINANCE

Financial Intermediaries

Financial Markets

FUNDS

FUNDS

FUNDS FUNDS

FUNDS

Functions of the Financial System

• The financial system– Allows transfers of funds from a person or a

business without investment opportunities to one who has them.

– Improves economic efficiency.

Classification of Financial Markets

• Debt markets– Short-term (maturity < 1 year) Money Market

• U.S. Treasury bills, negotiable bank certificates of deposit (large denomination), commercial paper, etc.

– Long-term (maturity > 10 years) Capital Market• Residential mortgages, corporate bonds, U.S. government

securities, State and local bonds, bank commercial loans, etc.

• Equity markets– Long-term------Corporate stocks

Classification of Financial Markets

• Primary market– New security issues sold to initial buyers.

• Secondary market– Securities previously issued bought and sold.

• Exchanges– Trades conducted in central locations.

• Over-the-counter markets– Dealers at different locations buy and sell.

Internationalization of Financial Markets

• International Bond Market– Foreign bonds– Eurobonds

• Bond denominated in a currency other than the one of the country in which it is sold.

– Eurocurrencies• Foreign currencies deposited in banks outside the

home country.

• World Stock Markets

Some Regulatory Agencies• Securities and Exchange Commission

– Requires disclosure of information, restricts insider trading

• Office of the Comptroller of the Currency– Charters and examines the books of federally chartered

commercial banks and imposes restrictions on the assets they can hold.

• Federal Reserve– Examines the books of commercial banks that are members of the

system, sets reserve requirements.

• State Banking and Insurance Commissions– Charter and examine books of state chartered firms.

Regulation of Financial Markets

• Three Main Reasons for Regulation:– Increase information to investors

• SEC forces corporations to disclose information.– Decrease adverse selection and moral hazard problems.

– Ensure the soundness of financial intermediaries• Chartering, reporting requirements, restrictions on

assets and activities, deposit insurance– Prevents financial panics

– Improve monetary control