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CHAPTER 1 An Overview of Financial Markets and Institutions CHAPTER 1 An Overview of Financial Markets and Institutions

Basic components of the financial system: Markets and institutions. 2 Basic components of the financial system: Markets and institutions. 2

All Economic units can be classified in to : All Economic units can be classified in to :

Thus the Budget positions of any economic unit can be : Surplus or deficit Thus the Budget positions of any economic unit can be : Surplus or deficit or balanced in a given budget period

Financial claims arise as SSUs lend to DSUs. Financial claims arise as SSUs lend to DSUs.

Method s of Financing 1. Direct Financing: The simplest way for funds to flow. Method s of Financing 1. Direct Financing: The simplest way for funds to flow.

Direct Financing: efficient for large transactions if preferences match. Direct Financing: efficient for large transactions if preferences match.

Common arrangements in direct finance. An important player in direct finance is investment bankers(firms Common arrangements in direct finance. An important player in direct finance is investment bankers(firms that help the companies sell new debt or equity).

Investment banks services: Investment banks services:

Once the financial claim is issued Brokers and dealers facilitates secondary market transactions. Once the financial claim is issued Brokers and dealers facilitates secondary market transactions.

Problem with direct financing: DSUs and SSUs cannot always match preferences. Problem with direct financing: DSUs and SSUs cannot always match preferences.

2. Indirect Financing (“Financial Intermediation”): 2. Indirect Financing (“Financial Intermediation”):

Financial intermediaries transform claims Financial intermediaries transform claims

Comparative advantage of financial intermediaries Comparative advantage of financial intermediaries

Intermediaries perform 5 basic services as they transform claims. Intermediaries perform 5 basic services as they transform claims.

Intermediation Services, cont. Intermediation Services, cont.

Benefits of financial intermediation are a primary rationale for the financial system. Benefits of financial intermediation are a primary rationale for the financial system.

4 Major types of financial intermediaries transform claims to meet various needs. 4 Major types of financial intermediaries transform claims to meet various needs.

1. Depository Institutions take deposits and make loans. 1. Depository Institutions take deposits and make loans.

1. 1 Commercial Banks 1. 1 Commercial Banks

1. 2 Thrift Institutions 1. 2 Thrift Institutions

1. 3 Credit Unions: Unique Characteristics 1. 3 Credit Unions: Unique Characteristics

2. Contractual Institutions bring long-term savers and borrowers together. 2. Contractual Institutions bring long-term savers and borrowers together.

2. 1 Life Insurance Companies insure against lost income at death. 2. 1 Life Insurance Companies insure against lost income at death.

2. 2 Casualty Insurance Companies cover property against loss or damage. 2. 2 Casualty Insurance Companies cover property against loss or damage.

2. 3 Pension Funds help workers plan for retirement. 2. 3 Pension Funds help workers plan for retirement.

3. Investment Funds : Help small investors share the benefits of large investments and 3. Investment Funds : Help small investors share the benefits of large investments and provide them denomination flexibility and default risk intermediations.

4. “Other” Financial Institutions 4. “Other” Financial Institutions

Financial Markets are classified in several ways. Financial Markets are classified in several ways.

Primary and Secondary Markets Primary and Secondary Markets

Organized and Over-the-Counter Markets Organized and Over-the-Counter Markets

Spot and Futures Markets Spot and Futures Markets

Option Markets Option Markets

Foreign Exchange Markets(FOREX) Foreign Exchange Markets(FOREX)

International and Domestic Markets International and Domestic Markets

Money and Capital Markets Money and Capital Markets

Money Markets Money Markets

Examples of Major Money Market Instruments Examples of Major Money Market Instruments

Capital Markets Capital Markets

Examples of Major Capital Market Instruments Examples of Major Capital Market Instruments

Efficiency in financial markets Efficiency in financial markets

Risks of Financial Institutions Risks of Financial Institutions

Risks of Financial Institutions, cont. Risks of Financial Institutions, cont.