FM19 Chap 1

PowerPoint Slides for:
Financial Markets
and Institutions
6th Edition
By Jeff Madura
Prepared by
Dr. Dale Talaboc
CHAPTER
1
Role of Financial
Markets and
Institutions
© 2003 South-Western/Thomson Learning

Chapter Objectives
 Describe the types of financial markets
 Describe the role of financial institutions with

financial markets
 Identify the types of financial institutions that

facilitate transactions
Overview of Financial Markets
Financial Market: a market in which financial

assets (securities) such as stocks and bonds
can be purchased or sold
 Financial markets provide for financial intermediation--
financial savings (Surplus Units) to investment (Deficit Units)
 Financial markets provide payments system
 Financial markets provide means to manage risk
Overview of Financial Markets
 Broad Classifications of Financial Markets
Money versus Capital Markets
Primary versus Secondary Markets
Organized versus Over-the-Counter Markets

Primary vs. Secondary Markets
 PRIMARY  SECONDARY
 New Issue of Securities  Trading Previously Issued
Securities
 Exchange of Funds for  No New Funds for Issuer

Financial Claim
 Funds for Borrower; an  Provides Liquidity for

IOU for Lender Seller
Money vs. Capital Markets
 Money  Capital
 Short-Term, < 1 Year  Long-Term, >1Yr
 High Quality Issuers  Range of Issuer Quality
 Debt Only  Debt and Equity
 Primary Market Focus  Secondary Market Focus
 Liquidity Market--Low  Financing Investment--

Returns Higher Returns
Organized vs. Over-the-Counter
Markets
 Organized  OTC
 Visible Marketplace  Wired Network of
Dealers
 Members Trade
 No Central, Physical
Location
 Securities Listed
 All Securities Traded
 New York Stock off the Exchanges
Exchange
Securities Traded in Financial Markets
 Money Market Securities
 Debt securities Only
 Capital market securities

 Debt and equity securities
 Derivative Securities
 Financial contracts whose value is derived from the values of
underlying assets
 Used for hedging (risk reduction) and speculation (risk seeking)
Debt vs. Equity Securities
Debt Securities: Contractual obligations (IOU) of Debtor

(borrower) to Creditor (lender)
 Investor receives interest
 Capital gain/loss when sold
 Maturity date
Debt vs. Equity Securities
Equity Securities: Claim with ownership rights and

responsibilities
 Investor receives dividends if declared
 Capital gain/loss when sold
 No maturity date—need market to sell
Valuation of Securities
 Value a function of:

 Future cash flows
 When cash flows are received
 Risk of cash flows
 Present value of cash flows discounted at the

market required rate of return
 Value determined by market demand/supply
 Value changes with new information
Investor Assessment of New Information
Economic Conditions
Industry
Conditions Impact of Evaluation Investor
Future Cash of Security Decision to
Flows Pricing Trade
Firm Specific
Information Exhibit 1.3
Financial Market Efficiency
 Security prices reflect available information
 New information is quickly included in

security prices
 Investors balance liquidity, risk, and return

needs
Financial Market Regulation
Why Government Regulation?
 To Promote Efficiency
 High level of competition
 Efficient payments mechanism
 Low cost risk management contracts

 To Maintain Financial Market Stability

 Prevent market crashes
 Circuit breakers
 Federal Reserve discount window
 Prevent Inflation--Monetary policy
 Prevent Excessive Risk Taking by Financial Institutions

 To Provide Consumer Protection

 Provide adequate disclosure
 Set rules for business conduct
 To Pursue Social Policies
 Transfer income and wealth
 Allocate saving to socially desirable areas
 Housing
 Student loans
Financial Market Globalization
 Increased international funds flow

 Increased disclosure of information
 Reduced transaction costs
 Reduced foreign regulation on capital flows
 Increased privatization
Results: Increased financial integration--capital

flows to highest expected risk-adjusted return
Role of Financial Institutions in Financial
Markets
 Information processing
 Serve special needs of lenders (liabilities) and
borrowers (assets)
 By denomination and term
 By risk and return
 Lower transaction cost

 Serve to resolve problems of market
imperfection
Role of Financial Institutions in
Financial Markets
Types of Depository Financial Institutions
Savings Credit Unions

Institutions $.5 Trillion
$1.3 Trillion Total Assets
Commercial
Banks Total Assets
$5 Trillion
Total Assets
Types of Nondepository Financial
Institutions
 Insurance companies
 Mutual funds
 Pension funds
 Securities companies
 Finance companies
 Security pools
Role of Nondepository Financial
Institutions
 Focused on capital market

 Longer-term, higher risk intermediation
 Less focus on liquidity
 Less regulation
 Greater focus on equity investments
Trends in Financial Institutions
 Rapid growth of mutual funds and pension

funds
 Increased consolidation of financial
institutions via mergers
 Increased competition between financial
Institutions
 Growth of financial conglomerates
Global Expansion by Financial
Institutions
 International expansion
 International mergers
 Impact of the single European currency
 Emerging markets

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PowerPoint Slides for:

© 2003 South-Western/Thomson Learning

 Describe the types of financial markets

 Describe the role of financial institutions with

 Identify the types of financial institutions that

Financial Market: a market in which financial

 Broad Classifications of Financial Markets

Money versus Capital Markets

Primary versus Secondary Markets

Organized versus Over-the-Counter Markets

 Exchange of Funds for  No New Funds for Issuer

 Funds for Borrower; an  Provides Liquidity for

 High Quality Issuers  Range of Issuer Quality

 Debt Only  Debt and Equity

 Primary Market Focus  Secondary Market Focus

 Liquidity Market--Low  Financing Investment--

 Capital market securities

Debt Securities: Contractual obligations (IOU) of Debtor

Equity Securities: Claim with ownership rights and

 Value a function of:

 Present value of cash flows discounted at the

 Security prices reflect available information

 New information is quickly included in

 Investors balance liquidity, risk, and return

Why Government Regulation?

 High level of competition

 Efficient payments mechanism

 Low cost risk management contracts

Why Government Regulation?

 To Maintain Financial Market Stability

 Prevent Inflation--Monetary policy

 Prevent Excessive Risk Taking by Financial Institutions

Why Government Regulation?

 To Provide Consumer Protection

 Increased international funds flow

Results: Increased financial integration--capital

 Lower transaction cost

Types of Depository Financial Institutions

Savings Credit Unions

 Focused on capital market

 Rapid growth of mutual funds and pension

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