Professional Documents
Culture Documents
and Institutions
Required Reading: Mishkin, Chapter 1 and
Chapter 2
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CONTENTS
FINANCIAL MARKETS
FINANCIAL INSTITUTIONS
FINANCIAL REGULATIONS
AN OVERVIEW OF FINANCIAL
SYSTEM
I. AN OVERVIEW OF FINANCIAL
MARKETS
Debt vs Equity
Debt titles are the most commonly traded security. In these arrangements,
the issuer of the title (borrower) earns some initial amount of money
(such as the price of a bond) and the holder (lender) subsequently receives
a fixed amount of payments over a specified period of time, known as
the maturity of a debt title.
Debt titles can be issued on short term (maturity < 1 yr.), long term
(maturity >10 yrs.) and intermediate terms (1 yr. < maturity < 10 yrs.).
The holder of a debt title does not achieve ownership of the borrowers
enterprise.
Debt vs Equity
Equity titles are somewhat different from bonds. The most common
equity title is (common) stock.
Equity titles do not expire and their maturity is, thus, infinite. Hence
they are considered long term securities.
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Money markets are markets in which only short term debt titles
are traded.
Capital markets are markets in which longer term debt and equity
instruments are traded.
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Source: Miskin
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Source: Miskin
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Valuing a Bond
C1
C2
1,000 CN
PV
...
1
2
N
(1 r) (1 r)
(1 r)
Price of a bond is the sum of the discounted future cash flows.
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Valuing a Bond
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Valuing a Bond
as bond maturity.
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Interest Rates
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4.
Interest rates
Coupon and Maturity
Credit ratings, (Moodys, S&P etc.)
Economic Environment
Flight to quality?
1.
2.
3.
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Price Determination
Risk Sharing
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Liquidity
Efficiency
II.FINANCIAL INSTITUTIONS
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Financial intermediaries are firms that collect the funds from lenders and
channel those funds to borrowers (Mishkin)
Financial intermediaries are firms whose primary business is to provide
customers with financial products and services that can not be obtained
more efficiently by transacting directly in securities markets (Z.Bodie
&Merton)
Financial intermediaries
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Brokers are agents who match buyers with sellers for a desired
transaction.
A broker does not take position in the assets she/he trades (i.e. does not
maintain inventories of those assets)
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Investment Banks
Investment banks assist in the initial sale of newly issued securities (e.g.
IPOs)
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Financial Intermediaries
Even in the United States and Canada, enterprises tend to obtain funds
through financial intermediaries rather than through securities
markets.
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Economies of scale
Liquidity services
Since transaction costs are reduced, financial intermediaries are able to provide customers
with additional liquidity services, such as checking accounts which can be used as
methods of payment or deposits which can be liquidated any time while still bearing some
interest.
Reduce Risk
Through the process of asset transformation not only maturities, but also the risk of an
asset can change: A financial intermediary uses funds it acquires (e.g. through
deposits) and often turns them into a more risky asset (e.g. a larger loan). The risk then
is spread out between various borrowers and the financial intermediary itself.
The process of risk sharing is further augmented through diversification of assets
(portfolio-choice), which involves spreading out funds over a portfolio of assets with
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different types of risk.
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II.3TYPES OF FINANCIAL
INTERMEDIARIES
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Commercial Bank
Savings and Loans Associations (S&L)
Depository
Institutions
Financial
Intermed
iaries
Contractual
savings
Institutions
Insurance Companies
Pension Funds
Finance Companies
Investment
Intermedarie
s
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Examples of some recent panics are the crises in the Asian Tiger states,
Argentina or Russia. The United States, while spared for most of the
second half of 20th century, has a long tradition of financial crises
throughout the 19th century up to the Great Depression.
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Restrictions on entry
Disclosure
Restrictions on Assets and Activities
Deposit Insurance
Limits on Competition
Restrictions on Interest Rates
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Financial regulation
Limits to Competition
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Financial regulation
Restriction of interest rates
The experience of the Great Depression in the U.S. has led to the
widespread belief that interest rate competition paid on deposits
might facilitate bank failure and to strong regulation of interest
rates on bank deposits
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