Download Chapter 3 Function of Financial Markets Financial Intermediaries

Chapter 3
Financial
Instruments,
Financial Markets,
and Financial
Institutions
McGraw-Hill/Irwin
Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Function of Financial Markets
1. Allows transfers of funds from
person or business without investment
opportunities to one who has them
2. Improves economic efficiency
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Financial Intermediaries
Indirect Finance
• An Institution stands between lender and
borrower.
Direct Finance
• Borrowers and lenders deal directly with each
other (usually between government and
corporations).
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Financial and Economic
Development
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Financial Instruments
• A financial instrument is the written
legal obligation of one party to
transfer something of value –
usually money – to another party at
some future date, under certain
conditions, such as stocks, loans,
or insurance.
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Financial Instruments
Serve as a:
Means of payment (Like Money)
Store of Value (Like Money)
allow for the trading of risk
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2
Financial Instruments
Characteristics
•
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Standardization
Communicate Information
Classes of Financial Instruments
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Primary – underlying Instruments
Derivative Instruments
• Value derived from the behavior of Underlying instruments.
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Examples of Financial
Instruments
Primarily Stores of Value
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Bank Loans
Bonds
Home Mortgages
Stocks
Asset-backed securities
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Examples of Financial
Instruments
Primarily to transfer risk
• Insurance
• Futures Contracts
• Options
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Financial Markets
Financial Markets are the places where
financial instruments are bought and sold.
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Financial Markets
Role of Financial Markets.
• Offer liquidity to borrowers and savers.
• Pool and communicate Information.
• Allow risk sharing
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Classifications of Financial Markets
1. Debt Markets
Short-term (maturity < 1 year) Money Market
Long-term (maturity > 1 year) Capital Market
2. Equity Markets
Common stocks
1. Primary Market
New security issues sold to initial buyers
2. Secondary Market
Securities previously issued are bought and sold
1. Exchanges
Trades conducted in central locations (e.g., New York Stock Exchange)
2. Over-the-Counter Markets
Dealers at different locations buy and sell
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4
Financial Institutions
Role of Financial Institutions
• Reduce transactions cost by specializing in
the issuance of standardized securities
• Reduce information costs of screening and
monitoring borrowers.
• Issue short term liabilities and purchase longterm loans.
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Financial Institutions
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Financial Institutions
The structure of the financial industry
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Depository Institutions
Insurance Companies
Pension Funds
Security Firms
Finance Companies
Government Sponsored Enterprises
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5
Financial Intermediaries
3-16
Size of Financial Intermediaries
3-17
Regulatory Agencies
3-18
6
Regulatory Agencies
3-19
Chapter 3
End of Chapter
McGraw-Hill/Irwin
Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
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