Chapter 1: Introduction and Overview of FINANCIAL MARKETS

University of San Carlos Department of Accountancy

Marga May Mancelita 11.16.11

Why study financial markets and institutions?

BRING YOUR FRIENDS CLOSE, BUT YOUR ENEMIES CLOSER!

RISK

analysis of the FINANCIAL SYSTEM in which financial managers operate. understanding the FLOW OF FUNDS throughout the economy as well as the operation and structure of domestic and international financial markets. analysis of the RISKS faced by investors and savers. development of STRATEGIES to control and manage risks.

FINANCIAL MARKETS
-are structures through which funds flow.
Two types of financial markets Money markets Capital markets Primary market Secondary market

Two types of financial markets

Money market- a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames; overthe-counter markets; e.g. Treasury bills, commercial paper, bankers' acceptances, certificates of deposit, federal funds, and short-lived mortgage- and asset-backed securities. Capital market- a market in which money is provided for periods longer than a year.

Capital Market: PRIMARY market vs SECONDARY market

PRIMARY MARKET
Markets in which users of funds raise funds through new issues of financial instruments ( stocks and bonds). Purpose: to raise additional funds. Issue stocks and bonds in exchange for money. Through INVESTMENT BANKS who serve as intermediaries between fund users and fund suppliers. Investment banks provide the funds user with advice on the securities issue (price, # of securities to issue) and attract the fund suppliers to purchase.
Benefit: save risk and cost of creating a market for the fund users securities

SECONDARY MARKET
Once financial instruments are issued in primary markets, they are then traded (resold and rebought) in secondary markets. Buyers: economic agents with excess funds Sellers: economic agents in need of funds. Benefits: centralized marketplace where economic agents know they can transact quickly and efficiently. The user of fund is not usually involved in the transaction. Offers buyers and sellers liquidity (the ability to turn an assets into cash quickly). ILLUSTRATION: PRIMARY market vs SECONDARY market

How are securities sold?

Primary Market: How are securities sold?

PUBLIC OFFERING An offer of sale to the investment public at large. PRIVATE PLACEMENT The fund users seek to find an institutional buyer (pension fund) or group of buyers to purchase the whole issue.

Primary Market: financial instruments sold

Stocks of an already publicly traded firm Bonds of an already publicly traded firm initial Public Offerings- first-time issues of firms initially going public. BACK: Secondary Market

ILLUSTRATION
FUND USERS INVESTMENT BANK PRIMARY MARKET (newly-issued financial instruments)

FUND SUPPLIERS FINANCIAL MARKETS SECURITIES BROKERS OTHER FUND SUPPLIERS

SECONDARY MARKET (already-issued financial instruments)

Foreign Exchange Markets

Cash flows from the sale of securities denominated in a foreign currency expose local fund users and fund suppliers to risk. =FOREIGN EXCHANGE RISK DERIVATIVE SECURITY MARKETS- the markets in which derivative securties trade. What is a derivative?

FINANCIAL INSTITUTIONS
Types of Financial Institutions: Commercial banks Thrifts Insurance Companies Securities firms and investment banks Finance companies Mutual Funds Pension Funds
What are these? How are they different from one another? Examples?

FINANCIAL INSTITUTIONS
Assignment For oral recitation NEXT meeting

TRANSFER OF FUNDS
Two Types: Direct transfer- from suppliers of funds to users of funds; NO FINANCIAL INSTITUTIONS INVOLVED! Disadvantages: investors need to monitor the use of their funds which is costly; price risk; liquidity costs Indirect transfer- an alternative and indirect way for investors o channel funds to users of funds; via FINANCIAL INSTITUTIONS!
Due to the costs of monitoring, liquidity risk, and rice risk, fund suppliers often prefer to hold the financial claims issued by FIs rather than those directly issued by the ultimate users of funds.

Services Performed by FIs

Services Benefiting Suppliers of Funds Monitoring costs Liquidity and Price Risk Transaction Cost Services Maturity Intermediation Denomination Intermediation Services Benefiting the Overall Economy Money Supply Transmission Credit Allocation Intergenerational Wealth Transfers Payment Services ASSIGNMENT: Define and explain each.

Risks Faced by FIs

Credit Risk Foreign Exchange Risk Country or Sovereign Risk Interest Rate Risk Market Risk Off-Balance-Sheet Risk Liquidity Risk Technology Risk Operational Risk Insolvency Risk

END
NEXT MEETING: Chapter 2 on DETERMINANTS OF INTEREST RATES -Prepare for a 10-item quiz.