Download CHAPTER 4 The Financial Environment: Markets, Institutions, and

CHAPTER 2
Financial Markets and
Institutions:
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Financial markets
Financial institutions
The stock market
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The Capital Flow Process
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In a well-functioning economy, capital flows
efficiently from those who supply capital to
those who demand it.
Suppliers of capital – individuals and
institutions with “excess funds.” These
groups are saving money and looking for a
rate of return on their investment.
Demanders or users of capital – individuals
and institutions who need to raise funds to
finance their investment opportunities.
These groups are willing to pay a rate of
return(interest) on the capital they borrow.
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Three ways capital flow from savers to
borrowers?
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Direct transfer
Investment Bank
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Securities pass through the investment
bank
Financial intermediary
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Intermediary create new securities for
savers.
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What is a market
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Market: A place/venue where goods
and services are exchanged
FM: A place where funds/financial
assets are traded.
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Types of financial markets
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Money vs. Capital
Primary vs. Secondary
Spot vs. Futures
Public vs. Private
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FM
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F Asset /F instruments: contracts specifying borrowing/lending terms,
claims on real assets
i.
Money M (borrowed for less than 1 Y) and Capital M (1 Y or
longer)
ii.
Primary M and secondary M
1.
PM: Corporations raise capital by issuing new securites
2.
SM: outstanding issues traded among investors
iii.
Private M vs. Public
1.
Private: transactions between two parties
2.
Public: standardized contracts traded on exchanges.
iv. Spot M vs. Future M
1. SM: transaction “on-the-spot”
2. FM: Contract specifying terms of future trading
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Types of Financial Institutions
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Banks
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Commercial banks
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Investment banks
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Middleman between savers and borrowers
An organization that helps to sell new investment
securities (bonds, stocks).
Financial services corporations
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A firm that offers a wide range of financial
services, including investment banking,
commercial banking, brokerage and insurances.
Citi, B of A, JPM
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Types of Financial Institutions
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Funds-pool money to invest
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Mutual funds
Pension funds-retirement plans
Hedge funds; largely unregulated, target high net
worth, might hedge risk or have even higher risk
Exchange traded funds-ETF
Private equity: borrows money to invest/mange
the whole company
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Types of Financial Institutions
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Life Insurance companies: Collect
premiums and invest. Now offers taxdeferred saving and investing
plans
Tax benefits
 Return & Risk
 Flexibility
 High initial cost
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4-9
The stock market
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Types of stock market transactions
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The secondary market
The primary market:
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IPO market: Initial Public Offering
additional new shares
4-10
Where can you find a stock quote, and what does
one look like?
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Stock quotes can be found in a variety of print sources
(The Wall Street Journal and online sources
(Yahoo!Finance, CNNMoney, or MSN MoneyCentral).
Stock Quote for Twitter, Inc.,
June 3, 2014
Source: Twiter, Inc. (TWTR), finance.yahoo.com.
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4-11
S&P 500 Index, Total Returns: Dividend Yield + Capital
Gain or Loss, 1968-2013
Source: Data taken from various issues of The Wall
Street Journal “Investment Scoreboard” section.
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Returns of the stock market
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Historical average return about 10%
Real return (adjusted for inflation)
about 6-7%
Real value double every 10 years
Future might not look like the past
Stocks for the Long Run by Jeremy
Siegel
4-13
Stock market efficiency
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The Efficient Market Hypothesis(EMH):
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Stock price has reflected all available
information
Market prices are close to intrinsic values
Why: competitions in the market,
inefficiency (undervaluation or
overvaluation) will be traded away
Implication: buy the market(index)
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Behavioral finance
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Misprices can not be all traded away
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Investors are irrational
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Too much risk
Short sell restrictions and risk
Overconfidence
Loss aversion
Evidence
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Obviously overvalued or undervalued
market and individual stock, from
hindsight.
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