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Financial Markets and Institutions – BA 543 Tuesday Bexell 415 12: 00 noon to Financial Markets and Institutions – BA 543 Tuesday Bexell 415 12: 00 noon to 2: 50 p. m. 6: 00 p. m. to 8: 50 p. m.

Chapter 1 – Financial Markets n Types of Markets – Allocation of Economic Resources Chapter 1 – Financial Markets n Types of Markets – Allocation of Economic Resources through Prices n Product Markets n n n Factor Markets n n n Goods and Services Generally thought of as a consumption market Factors of production Generally thought of as labor and capital Financial Markets – One Part of Factor Market n n Market for financial assets (capital markets) Our focus for this course

Chapter 1 – Financial Assets n Define an asset… n Possession that has value Chapter 1 – Financial Assets n Define an asset… n Possession that has value in exchange n Tangible asset – value determined by its physical characteristics § Diamond – 4 Cs § Car – physical properties n Intangible asset – value determined by its legal claim to future benefits § Financial asset – aka financial instrument or security § Financial asset – claim to future cash flow n n Examples of Financial Assets on Page 2 Both tangible and Intangible can share one concept – expected to generate future cash flow

Chapter 1 – Financial Assets n Valuing (Pricing) a Financial Asset -- Timing and Chapter 1 – Financial Assets n Valuing (Pricing) a Financial Asset -- Timing and Amount of Future Cash Flow Known (both timing and amount) n Known (only timing and amount uncertain) n Known (only amount and timing uncertain) n Unknown amount and timing n n Risk of a Financial Asset n Inflation risk or purchasing power risk n Credit risk or default risk n Foreign-exchange risk

Chapter 1 – Financial Assets n Functions of Financial Assets n Invest (postpone consumption) Chapter 1 – Financial Assets n Functions of Financial Assets n Invest (postpone consumption) n n Borrow (accelerate consumption) n n We pay for moving up consumption Transfer Risk n n We demand a reward for postponing consumption Others can handle risk better (cheaper) than we can Rate of Return encompasses these functions n Price of a financial asset…model for discounted cash flow includes the timing and amount of the cash flow and the discount rate covers inflation, real return, and risk premiums

Chapter 1 – Financial Markets n Where Buyers and Sellers Meet n n In Chapter 1 – Financial Markets n Where Buyers and Sellers Meet n n In every transaction there is a buyer and a seller Both exchange the asset for a mutually agreed upon price n Function of Financial Markets n Buy or Sell financial assets n n Provide price discovery Provide liquidity Reduce transaction costs (search costs and information costs) Efficient Market place – operational and price

Chapter 1 – Financial Markets n Classification of Financial Markets n See Table 1 Chapter 1 – Financial Markets n Classification of Financial Markets n See Table 1 -1 on page 7 n n n n Claim Maturity Seasoning Delivery Structure Location Limitations of Participants n n Members Only Qualifications

Chapter 1 – Global Financial Markets n Access increasing due to technology n Classification Chapter 1 – Global Financial Markets n Access increasing due to technology n Classification by Issuer and Issue Place n n n Domestic – issuer domiciled in country where security is issued Foreign – issuer domiciled in foreign country but security issued in another country n Examples…Yankee market (foreign issuers sell securities in the U. S. ), Samurai market (foreign issuers sell in Japan), Matador market (foreign issuers sell in Spain)…etc. International (or off-shore or external or Euromarket) n Simultaneous selling in multiple countries and issued outside the jurisdiction of any one country

Chapter 1 – Financial Assets n Derivatives n Forward and Futures Contracts n n Chapter 1 – Financial Assets n Derivatives n Forward and Futures Contracts n n n Two parties agree to transact at a future date with the details of the transaction agreed upon today Large percentage of transactions are forward contracts Options Contracts – Calls and Puts n n Call is the right but not the obligation to buy in the future (at a pre-set price) Put is the right but not the obligation to sell in the future n One function is to transfer risk

Chapter 1 – Regulations of Markets n Why regulate? n Goal of a market…”competitive Chapter 1 – Regulations of Markets n Why regulate? n Goal of a market…”competitive market” n n n Regulate when (reach or maintain equilibrium) n n Efficiency Low-cost Markets cannot on their own attain competitive status Markets are too slow at reaching competitive status Markets cannot maintain competitive status Types of Regulation n n Disclosure - information available to all participants Allowed activity – for example, insider trading Institutions activity – Sub-Prime Housing Market Foreign participation – limitation on individuals or countries

Chapter 1 – Financial Innovation n Three Types of Innovation n Market Broadening Instruments Chapter 1 – Financial Innovation n Three Types of Innovation n Market Broadening Instruments n n Risk Instruments n n Increased liquidity (new borrowers or lenders) Transfer of risk Arbitrage Instruments n Reduce differences across markets n Motivation n Many reasons but the two strongest seems to be increase efficiency and risk sharing (hedging and speculating)