Money market3ce Ch02


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Money market3ce Ch02

  1. 1. Chapter 2 An Overview of the Financial System
  2. 2. An Overview of the Financial System <ul><li>Primary Function of the Financial System is Financial Intermediation </li></ul><ul><li>The channeling of funds from households, firms and governments who have surplus funds (savers) to those who have a shortage of funds (borrowers). </li></ul>
  3. 3. An Overview of the Financial System
  4. 4. Classifications of Financial Markets <ul><li>Debt Markets </li></ul><ul><li>Short-term (maturity < 1 year) – the Money Market </li></ul><ul><li>Long-term (maturity > 10 year) – the Capital Market </li></ul><ul><li>Medium-term (maturity >1 and < 10 years) </li></ul>
  5. 5. Classifications of Financial Markets <ul><li>Equity Markets - Common stocks </li></ul><ul><li>Primary Market - New security issues sold to initial buyers </li></ul><ul><li>Secondary Market - Securities previously issued are bought and sold </li></ul>
  6. 6. Classifications of Financial Markets (Cont’d) <ul><li>Secondary Markets </li></ul><ul><li>Exchanges </li></ul><ul><li>Trades conducted in central locations (e.g., Toronto Stock Exchange and New York Stock Exchange) </li></ul><ul><li>Over-the-Counter Markets </li></ul><ul><li>Dealers at different locations buy and sell </li></ul>
  7. 7. Financial Market Instruments
  8. 8. Financial Market Instruments (Cont’d) <ul><li>Other Money Market Instruments </li></ul><ul><li>Certificates of deposit </li></ul><ul><li>Repurchase agreements </li></ul><ul><li>Overnight funds </li></ul>
  9. 9. Financial Market Instruments (Cont’d)
  10. 10. Financial Market Instruments (Cont’d) <ul><li>Other Capital Market Instruments </li></ul><ul><li>Canada savings bonds </li></ul><ul><li>Provincial and municipal bonds </li></ul><ul><li>Government agencies securities </li></ul>
  11. 11. Internationalization of Financial Markets <ul><li>International Bond Market </li></ul><ul><li>Foreign bonds - sold in a foreign country and denominated in that country </li></ul><ul><li>Eurobonds – denominated in a currency other than the country in which it is sold </li></ul><ul><li>Eurocurrencies – foreign currencies deposited in banks outside the home country </li></ul>
  12. 12. World Stock Markets
  13. 13. Function of Financial Intermediaries <ul><li>Financial Intermediaries </li></ul><ul><li>Engage in process of indirect finance </li></ul><ul><li>Are needed because of transactions costs and </li></ul><ul><li>asymmetric information </li></ul>
  14. 14. Function of Financial Intermediaries (Cont’d) <ul><li>Transactions Costs </li></ul><ul><li>1. Financial intermediaries make profits by </li></ul><ul><li>reducing transactions costs. </li></ul><ul><li>2. They reduce transactions costs by developing </li></ul><ul><li>expertise and taking advantage of </li></ul><ul><li>economies of scale. </li></ul>
  15. 15. Function of Financial Intermediaries (Cont’d) <ul><li>Risk Sharing </li></ul><ul><li>Create and sell assets with low risk characteristics and then use the funds to buy assets with more risk (also called asset transformation) </li></ul><ul><li>Lower risk by helping people to diversify portfolios </li></ul>
  16. 16. Asymmetric Information <ul><li>Adverse Selection </li></ul><ul><li>Before transaction occurs </li></ul><ul><li>Potential borrowers most likely to produce adverse outcomes are ones most likely to seek loans and be selected </li></ul>
  17. 17. Asymmetric Information (Cont’d) <ul><li>Moral Hazard </li></ul><ul><li>After transaction occurs </li></ul><ul><li>Hazard that borrower has incentives to engage in undesirable activities making it more likely that loan won’t be paid back </li></ul>
  18. 18. Financial Intermediaries
  19. 19. Size of Financial Intermediaries
  20. 20. Regulation of Financial Markets
  21. 21. Regulation of Financial Markets <ul><li>Primary Reasons for Regulation </li></ul><ul><li>Increase information to investors </li></ul><ul><ul><li>- Decreases adverse selection and moral hazard problems </li></ul></ul><ul><ul><li>- Securities commissions force corporations to disclose information </li></ul></ul>
  22. 22. Regulation of Financial Markets (Cont’d) <ul><li>Primary Reasons for Regulation (continued) </li></ul><ul><li>2. Ensuring the soundness of intermediaries </li></ul><ul><ul><li>Prevents financial panics </li></ul></ul><ul><ul><li>Restrictions on entry/assets/activities, disclosure, deposit insurance, limits on competition </li></ul></ul>