Download Introduction to Financial Markets, Institutions, and Systems Learning

UNIT I STUDY GUIDE
Introduction to Financial Markets,
Institutions, and Systems
Learning Objectives
Reading
Assignment
Chapter 1:
Why Study Financial
Markets and Institutions?
Chapter 2:
Overview of the Financial
System
Upon completion of this unit, students should be able to:
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Describe the three major markets: bond, stock, and foreign exchange.
Summarize the reasons to study financial institutions.
Explain the structure of financial markets.
Identify roles of financial intermediaries within financial markets.
Describe the key points of risk management and moral hazard.
Discuss internationalization of financial markets and their investment
opportunities.
Written Lecture
Learning Activities
(Non-Graded)
Click here to access a
PDF of the Unit I Learning
Activities.
Key Terms
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Adverse selection
Asset
Asset transformation
Asymmetric
information
Banks
Bond
Brokers
Capital
Capital market
Central bank
Common stock (stock)
Conflicts of interest
Dealers
Diversification
Dividends
Economies of scale
e-finance
Equities
Eurobond
Eurocurrencies
Eurodollars
Exchanges
Federal Reserve
System (the Fed)
BBA 4201, Financial Institutions
In one form or another, financial markets and institutions are a part of our
everyday well-being. While there can be some significant “mystery” as to how
such markets function, this course will provide a basis for review and
understanding.
Taken at the most basic structure, there are three very important markets to
consider: (1) the bond market, where the setting of interest rates occurs; (2) the
stock market, where individuals, governments, and corporations trade
instruments and create wealth; and (3) the foreign exchange market, where
U.S. based initiatives can change due to fluctuations within the foreign
exchange.
Along with markets, we need to consider additional factors that can affect the
well-being of markets, including central banks (both from the U.S. and abroad),
channeling relationships (allocation methods to efficiently transfer wealth),
specific intermediaries and their role within the financing arena, and
governmental rules and regulations.
Bond Market
When reviewing the interest rate structure, we can see that “generally” interest
rates will “move in unison” with each other (Mishkin & Eakins, 2012, p. 2).
Figure 1.1 shows that there was a spike around the dates of 1980 to 1985. Why
did this occur? Did the Federal Reserve impact rates? Were we in an inflationary
period? Go to your favorite search engine, and search for the Federal Reserve
Bank of San Francisco. Click on the Education tab. Then, click on Ask Dr. Econ
under the Student Activities. Type in the question, “How did the Fed change its
approach to monetary policy in the late 1970s and early 1980s?” Click on the
Fire Away button. This will give you some information on monetary policy in the
late 1970s and early 1980s.
Stock Market
The stock market serves an important role for the allocation of capital necessary
for both individual and corporate growth. You can search for more information
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24. Financial crisis
25. Financial
Intermediaries
26. Financial
intermediation
27. Financial markets
28. Financial panic
29. Foreign bonds
30. Foreign exchange
market
31. Foreign exchange rate
32. Interest rate
33. Intermediate-term
34. Investment bank
35. Liabilities
36. Liquid
37. Liquidity services
38. Long-term
39. Maturity
40. Monetary policy
41. Money (money
supply)
42. Money market
43. Moral hazard
44. Over-the-counter
(OTC) market
45. Portfolio
46. Primary market
47. Risk
48. Risk sharing
49. Secondary market
50. Security
51. Short-term
52. Thrift Institutions
(thrifts)
53. Transaction costs
54. Underwriting
about the stock market on the Internet. You can also use the keywords “What
are stocks?”
Foreign Exchange
Simply put, foreign exchange is where the value of one country’s currency is
measured against another. The value of currency has significant impact on both
the domestic (internal) value of goods and services and foreign (external) value
of goods and services. You can search for more information about foreign
exchange market on the Internet.
Institutions
There are many different types of financial institutions that assist with financial
markets, including depository institutions, contractual savings institutions, and
investment intermediaries. Review Table 2.2. You will notice that the value of
assets has increased in each category of institution from 1980 to 2009. Also
review Table 2.3, which shows the different regulatory bodies that impact these
institutions, such as the Securities and Exchange Commission, the Federal
Deposit Insurance Corporation, and the Federal Reserve System.
In today’s environment, there is a specific need to monitor and regulate our
financial institutions (and markets). Due to the impact of the Great Recession,
there is a continual desire to improve both the operational effectiveness of
markets—along with ensuring that fairness and ethics play a key part in the
overall approach that financial institutions use when dealing within our society as
a whole.
Read the following article: Go to your favorite search engine, and search for
VoxEU. Then, search for the article “Financial regulation: Can we avoid another
great recession?” It touches on the ideas of moral hazard, liquidity, and risk
taking. These concepts will be discussed throughout the course.
Key Terms from the Article
Moral hazard: When thinking of a moral hazard, we can turn to recent events
where borrowers are “walking away” from loans. In some cases, they may be in
a position to pay back the loans—but simply choose not to. Since many homes
have financially become upside down (today’s value vs. the amount still owed on
the home), many borrowers are finding that they can purchase similar housing at
a fraction of what they had originally paid. Therefore, without regard to the
ethical/moral implication, they are consciously choosing to walk away from the
financial obligation. Additional examples of moral hazards are provided in the
textbook.
Liquidity: This idea deals with the overall acceptance of financial products. In
other words, the more “liquid” something is, the greater the desire from other
investors. For example, if we compare a house vs. a piece of gold—which is
more liquid? In this example, a piece of gold would be more liquid simply due to
the conditions found within the market. We see a greater desire for gold given its
appreciation—vs. housing, which is in a declining state. Both gold and housing
are less liquid than certain financial instruments, such as government bonds.
Therefore, liquidity is essentially ranked by how valuable (desirable) an asset
is vs. the amount of buyers and sellers willing to trade. More information on
liquid securities is provided in the textbook.
BBA 4201, Financial Institutions
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Risk: This concept simply means that the return expected contains some portion
of unknowns. In other words, nothing is guaranteed to be 100% risk free. The
percentage of expected risk affects the overall cost of the asset/investment.
See the section titled “Risk Sharing” in the textbook.
References
Mishkin, F. S., & Eakins, S. G. (2012). Financial markets and
institutions. (7th ed.). Upper Saddle River, NJ: Prentice Hall.
Reenen, J. V. (2010). Financial regulation: Can we avoid another great
recession? Retrieved from http://www.voxeu.org/index.php?q
=node/4988
BBA 4201, Financial Institutions
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