©2009, the mcgraw-hill companies, all rights reserved 2.week introduction to financial markets,...
TRANSCRIPT
©2009, The McGraw-Hill Companies, All Rights Reserved
2.WEEK
INTRODUCTION TO FINANCIAL MARKETS, INSTITUTIONS AND
INSTRUMENTS
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Why study Financial Markets and Institutions?
Prudent investment and financing requires a full understanding of the structure of domestic and international
markets the flow of funds through domestic and
international markets the strategies used to manage risks faced by
investors and savers
Prudent investment and financing requires a full understanding of the structure of domestic and international
markets the flow of funds through domestic and
international markets the strategies used to manage risks faced by
investors and savers
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FINANCIAL SYSTEM
Financial markets Financial institutions & İndividuals Financial assets (instruments, securities) Rules and regulations
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Financial Markets
Financial markets are structures through which funds flow.
Financial markets consist of
- fund suppliers or lenders
- fund demanders or borrowers
- financials instruments (fin assets, securities)
- financial institutions (intermediaries)
Financial markets are structures through which funds flow.
Financial markets consist of
- fund suppliers or lenders
- fund demanders or borrowers
- financials instruments (fin assets, securities)
- financial institutions (intermediaries)
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Types of Financial Markets
Money market Foreign exchange market Stock market Bonds and bills market Derivatives market Gold market
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Types of Fınancıal Markets cont.
Financial markets can be distinguished along three dimensions primary versus secondary markets money versus capital markets organized versus over the counter
markets
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Primary versus Secondary Markets
Primary markets markets in which users of funds (e.g.,
corporations and governments) raise funds by issuing financial instruments (e.g., stocks and bonds)
Secondary markets markets where financial instruments are
traded among investors (e.g., NYSE and Nasdaq)
Primary markets markets in which users of funds (e.g.,
corporations and governments) raise funds by issuing financial instruments (e.g., stocks and bonds)
Secondary markets markets where financial instruments are
traded among investors (e.g., NYSE and Nasdaq)
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Money versus Capital Markets
Money markets markets that trade debt securities with
maturities of one year or less (e.g., CDs and U.S. Treasury bills)
Capital markets markets that trade debt (bonds) and equity
(stock) instruments with maturities of more than one year
Money markets markets that trade debt securities with
maturities of one year or less (e.g., CDs and U.S. Treasury bills)
Capital markets markets that trade debt (bonds) and equity
(stock) instruments with maturities of more than one year
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Organized versus Over the Counter (OTC) Markets
Organized markets- Have a central physical
location- Commission- Registration is required- Controlling system: Formal- Customers’ orders provide
liquidity- Listing
Organized markets- Have a central physical
location- Commission- Registration is required- Controlling system: Formal- Customers’ orders provide
liquidity- Listing
OTC markets- No physical location- No commission- No need for registration- Any controlling system:
Informal- Dealers- No listing (except
NASDAQ)
OTC markets- No physical location- No commission- No need for registration- Any controlling system:
Informal- Dealers- No listing (except
NASDAQ)
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Money Market Instruments Outstanding, ($Bn)
0
500
1000
1500
2000
2500
3000
1990q4 2000q4 2007q1
Fed funds and repos Commercial paper Negotiable CDs
U.S. Treasury bills Banker's accept.
0
500
1000
1500
2000
2500
3000
1990q4 2000q4 2007q1
Fed funds and repos Commercial paper Negotiable CDs
U.S. Treasury bills Banker's accept.
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Capital Market Instruments Outstanding, ($Bn)
0
5000
10000
15000
20000
25000
1990q4 2000q4 2007q1
Corporate stocks Mortgages Corporate bonds
U.S. gov't agencies Treasury securities State & local gov't bonds
Bank and consumer loans
0
5000
10000
15000
20000
25000
1990q4 2000q4 2007q1
Corporate stocks Mortgages Corporate bonds
U.S. gov't agencies Treasury securities State & local gov't bonds
Bank and consumer loans
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Foreign Exchange (FX) Markets
FX markets trading one currency for another (e.g., dollar for yen)
Spot FX the immediate exchange of currencies at current
exchange rates Forward FX
the exchange of currencies in the future on a specific date and at a pre-specified exchange rate
FX markets trading one currency for another (e.g., dollar for yen)
Spot FX the immediate exchange of currencies at current
exchange rates Forward FX
the exchange of currencies in the future on a specific date and at a pre-specified exchange rate
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Derivative Security Markets
Derivative security a financial security whose payoff is linked to
(i.e., “derived” from) another security or commodity
generally an agreement between two parties to exchange a standard quantity of assets at a predetermined price on a specific date in the future
Derivative security a financial security whose payoff is linked to
(i.e., “derived” from) another security or commodity
generally an agreement between two parties to exchange a standard quantity of assets at a predetermined price on a specific date in the future
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The Role (Economic Functions)of Financial Markets
1. They provide a mechanism for determinig the price of financial assets: Price discovery process, Efficiency of Financial Markets.
2. They make assets more liquid.
3. They reduce cost of exchanging assets: Search costs, Information costs.
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Financial Institutions (FIs)
Financial Institutions institutions through which suppliers channel
money to users of funds Financial Institutions are distinguished by
whether they accept deposits depository versus non-depository financial
institutions
Financial Institutions institutions through which suppliers channel
money to users of funds Financial Institutions are distinguished by
whether they accept deposits depository versus non-depository financial
institutions
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Depository versus Non-Depository FIs
Depository institutions commercial banks, savings associations,
savings banks, credit unions Non-depository institutions
insurance companies, securities firms and investment banks, mutual funds, pension funds
Depository institutions commercial banks, savings associations,
savings banks, credit unions Non-depository institutions
insurance companies, securities firms and investment banks, mutual funds, pension funds
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Users of Funds(corporations)
Suppliers of Funds
(households)
Financial Claims(equity and debt
instruments)
Cash
Flow of Funds in a World without FIs: Direct Transfer
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Users of FundsFIs
(brokers)
FIs(asset
transformers)
Suppliers of Funds
Financial Claims(equity and debt securities)
Financial Claims(deposits and insurance policies)
Cash Cash
Flow of Funds in a World with FIs
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Services that are provided by FIs
1. Transform fin. assets acquired into assets that are more attractive to the public. (Fin. Intermediaries)
2. Exchange fin. Assets on the behalf of others (Brokers)3. Exchange fin. Assets for their own. (Dealers)4. Assists in the creation of fin. assets for their customers and
then sell these fin. assets to others.(underwriting)5. Provide inv. advices6. Provide portfolio management
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FIs Benefit Suppliers of Funds
Reduce monitoring costs Increase liquidity and lower price risk Reduce transaction costs Provide maturity intermediation Provide denomination intermediation
Reduce monitoring costs Increase liquidity and lower price risk Reduce transaction costs Provide maturity intermediation Provide denomination intermediation
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FIs Benefit the Overall Economy
Conduit through which Federal Reserve conducts monetary policy
Provides efficient credit allocation Provide for intergenerational wealth
transfers Provide payment services
Conduit through which Federal Reserve conducts monetary policy
Provides efficient credit allocation Provide for intergenerational wealth
transfers Provide payment services
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Risks Faced by Financial Institutions
Credit Foreign exchange Country or
sovereign Interest rate Market
Credit Foreign exchange Country or
sovereign Interest rate Market
Off-balance-sheet Liquidity Technology Operational Insolvency
Off-balance-sheet Liquidity Technology Operational Insolvency
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Financial Assets
An asset is any possession that has value in exchange.
Tangible-intangible assets Financial assets= Financial
Instruments=Securities are intangible assets. Issuer: The entitiy that agrees to make future
cash payments. Investor: The owner of the financial asset.
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Examples of Fin. Assets
The bond issed by the Turkish governmnet The bond issued by Koç Holding An automibile loan. A home mortgage. Common Stock issued by a company.
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Debt vs Equity Claims
Debt Claims (Debt Instruments)= Fixed Income securities= Bonds
Equity Claims (Residual claims)=Common Stock
There are also preferred stock, convertible bonds.
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The Role of Financial Assets
Fin Assets has two economic functions;
1. Transfering of funds who have surplus of funds to those who need funds to invest in tangible assets.
2. Transferring funds in such a way that redistributes the unavoidable risk associated with the CF generated by the tangible assets among those seeking and those providing the funds.
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Regulation of Financial Institutions
FIs are heavily regulated to protect society at large from market failures
Regulations impose a burden on FIs and recent U.S. regulatory changes have been deregulatory in nature
Regulators attempt to maximize social welfare while minimizing the burden imposed by regulation
FIs are heavily regulated to protect society at large from market failures
Regulations impose a burden on FIs and recent U.S. regulatory changes have been deregulatory in nature
Regulators attempt to maximize social welfare while minimizing the burden imposed by regulation
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Globalization of Financial Markets and Institutions
The pool of savings from foreign investors is increasing and investors look to diversify globally now more than ever before
Information on foreign markets and investments is becoming readily accessible and deregulation across the globe is allowing even greater access
International mutual funds allow diversified foreign investment with low transactions costs
The pool of savings from foreign investors is increasing and investors look to diversify globally now more than ever before
Information on foreign markets and investments is becoming readily accessible and deregulation across the globe is allowing even greater access
International mutual funds allow diversified foreign investment with low transactions costs
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Globalization of Financial Markets and Institutions cont.
Foreign Markets: Foreigners can issue securities in other country markets, subject to national regulations. For example, Japanese firms can issue dollar-dominated securities in the United States but they must follow U.S. regulations, which apply to nationals and foreigners alike.
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Globalization of Financial Markets and Institutions cont.
International (Off shore or Euro) Market: Securities are issued outside the jurisdiction of any
country. The motivation for foreign and Eurodollar is that
many underdeveloped nations simply do not have a sizable capital market to meet their funds needs. Also Eurodollar loans are often less expensive since institutions holding such funds are not hampered by regulations.
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Financial Innovation
Categorizations of Financial Innovation;- Market-broadening Instruments- Risk management instruments,- Arbitraging instruments
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Motivation for Financial Innovation
1. Increased volatility of interest rates, inflation, equity prices, exchange rates.
2. Advances in computer&telecomminication technologies.
3. Greater sophistication and educational training among professional market participants.
4. Financial intermediary competition.5. Incentives to get around existing regulation and tax
laws.6. Changing global patterns of financial wealth
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Asset Securitization
It involves tha collection or pooling of loans and sale of securities backed by those loans.