2. An Overview of the Financial System

2. An Overview of the Financial System

Overview

? Functions of financial markets ? Structure of financial markets ? Internationalization of financial markets ? Function of Financial Intermediaries ? Types of Financial Intermediaries ? Regulation of the Financial System ? Review questions

Copyright ? 2007 Pearson Addison-Wesley. All rights reserved.

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Function of Financial Markets

? Perform the essential function of channeling funds from economic players that have saved surplus funds to those that have a shortage of funds

? Promotes economic efficiency by producing an efficient allocation of capital, which increases production

? Directly improve the well-being of consumers by allowing them to time purchases better

They provide funds to young people to buy what they need and can eventually afford without forcing them to wait until they have saved up the entire purchase price.

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Structure of Financial Markets

? Debt and Equity Markets ? Primary and Secondary Markets

Investment Banks underwrite securities in primary markets Brokers and dealers work in secondary markets

? Exchanges and Over-the-Counter (OTC) Markets ? Money and Capital Markets

Money markets deal in short-term debt instruments Capital markets deal in longer-term debt and

equity instruments

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Debt an Equity Markets

? The are two ways to obtain funds in a financial market: debt and equity

? A debt instrument is a contractual agreement by the borrower to pay the holder of the instrument fixed amounts of money at regular intervals until a specified date (maturity date)

? Examples of debt instruments include bonds, treasury bills, mortgages

Copyright ? 2007 Pearson Addison-Wesley. All rights reserved.

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Debt and Equity Markets cont'd

? The date on which the final payment is be made is called the maturity date

? A debt instrument can either be short-term (Maturity < a year) or long-term (Maturity10 yrs or more)

? The second ways is to issue an equity such as common stock - which is a claim to share in the net income and assets of a business

? Equities often make periodic payments (dividends) to their holders and are considered long-term securities because they have no maturity date.

? In addition, owning stock means that you own a portion of the firm and have the right to vote on issues important to the firm and to elect its directors.

Copyright ? 2007 Pearson Addison-Wesley. All rights reserved.

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Primary and Secondary Markets

? Primary Market: a financial market in which new issues of a

security are sold to initial buyers by the corporation or

government agency borrowing the funds

? Secondary Market: a market in which securities that have been previously issued can be resold. (securities change hands).

Investment Banks underwrite (guarantees) securities in primary markets

Brokers and dealers work in secondary markets

? secondary markets serve two important functions.

First, they make it easier and quicker to sell these

financial instruments to raise cash; that is, they make the financial instruments more liquid.

Second, they determine the price of the security that the

issuing firm sells in the primary market

Copyright ? 2007 Pearson Addison-Wesl

ey. All rights reserved.

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