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PPoowweerrPPooiinntt SSlliiddeess ffoorr:: 
Financial Markets 
and Institutions 
6th Edition 
By Jeff Madura 
Prepared by 
David R. Durst 
The University of Akron
CHAPTER 
11 Role of Financial 
Markets and 
Institutions 
© 2003 South-Western/Thomson Learning
CChhaapptteerr OObbjjeeccttiivveess 
 Describe the types of financial markets 
 Describe the role of financial institutions with 
financial markets 
 Identify the types of financial institutions that 
facilitate transactions
OOvveerrvviieeww ooff FFiinnaanncciiaall MMaarrkkeettss 
Financial Market: a market in which financial 
assets (securities) such as stocks and bonds 
can be purchased or sold 
 Financial markets provide for financial 
intermediation--financial savings (Surplus Units) to 
investment (Deficit Units) 
 Financial markets provide payments system 
 Financial markets provide means to manage risk
OOvveerrvviieeww ooff FFiinnaanncciiaall MMaarrkkeettss 
 Broad Classifications of Financial Markets 
Money versus Capital Markets 
Primary versus Secondary Markets 
Organized versus Over-the-Counter Markets
PPrriimmaarryy vvss.. SSeeccoonnddaarryy MMaarrkkeettss 
PPRRIIMMAARRYY 
 New Issue of Securities 
 Exchange of Funds for 
Financial Claim 
 Funds for Borrower; an 
IOU for Lender 
SSEECCOONNDDAARRYY 
 Trading Previously Issued 
Securities 
 No New Funds for Issuer 
 Provides Liquidity for 
Seller
Ad

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financial market and institution ch 1

  • 1. PPoowweerrPPooiinntt SSlliiddeess ffoorr:: Financial Markets and Institutions 6th Edition By Jeff Madura Prepared by David R. Durst The University of Akron
  • 2. CHAPTER 11 Role of Financial Markets and Institutions © 2003 South-Western/Thomson Learning
  • 3. CChhaapptteerr OObbjjeeccttiivveess Describe the types of financial markets Describe the role of financial institutions with financial markets Identify the types of financial institutions that facilitate transactions
  • 4. OOvveerrvviieeww ooff FFiinnaanncciiaall MMaarrkkeettss Financial Market: a market in which financial assets (securities) such as stocks and bonds can be purchased or sold Financial markets provide for financial intermediation--financial savings (Surplus Units) to investment (Deficit Units) Financial markets provide payments system Financial markets provide means to manage risk
  • 5. OOvveerrvviieeww ooff FFiinnaanncciiaall MMaarrkkeettss Broad Classifications of Financial Markets Money versus Capital Markets Primary versus Secondary Markets Organized versus Over-the-Counter Markets
  • 6. PPrriimmaarryy vvss.. SSeeccoonnddaarryy MMaarrkkeettss PPRRIIMMAARRYY New Issue of Securities Exchange of Funds for Financial Claim Funds for Borrower; an IOU for Lender SSEECCOONNDDAARRYY Trading Previously Issued Securities No New Funds for Issuer Provides Liquidity for Seller
  • 7. MMoonneeyy vvss.. CCaappiittaall MMaarrkkeettss MMoonneeyy Short-Term, 1 Year High Quality Issuers Debt Only Primary Market Focus Liquidity Market--Low Returns CCaappiittaall Long-Term, 1Yr Range of Issuer Quality Debt and Equity Secondary Market Focus Financing Investment-- Higher Returns
  • 8. OOrrggaanniizzeedd vvss.. OOvveerr--tthhee--CCoouunntteerr MMaarrkkeettss OOrrggaanniizzeedd Visible Marketplace Members Trade Securities Listed New York Stock Exchange OOTTCC Wired Network of Dealers No Central, Physical Location All Securities Traded off the Exchanges
  • 9. SSeeccuurriittiieess TTrraaddeedd iinn FFiinnaanncciiaall MMaarrkkeettss Money Market Securities Debt securities Only Capital market securities Debt and equity securities Derivative Securities Financial contracts whose value is derived from the values of underlying assets Used for hedging (risk reduction) and speculation (risk seeking)
  • 10. DDeebbtt vvss.. EEqquuiittyy SSeeccuurriittiieess Debt Securities: Contractual obligations (IOU) of Debtor (borrower) to Creditor (lender) Investor receives interest Capital gain/loss when sold Maturity date
  • 11. DDeebbtt vvss.. EEqquuiittyy SSeeccuurriittiieess Equity Securities: Claim with ownership rights and responsibilities Investor receives dividends if declared Capital gain/loss when sold No maturity date—need market to sell
  • 12. VVaalluuaattiioonn ooff SSeeccuurriittiieess Value a function of: Future cash flows When cash flows are received Risk of cash flows Present value of cash flows discounted at the market required rate of return Value determined by market demand/supply Value changes with new information
  • 13. IInnvveessttoorr AAsssseessssmmeenntt ooff NNeeww IInnffoorrmmaattiioonn Exhibit 1.3 Economic Conditions Industry Condition s Firm Specific Information Impact of Future Cash Flows Evaluation of Security Pricing Investor Decision to Trade
  • 14. FFiinnaanncciiaall MMaarrkkeett EEffffiicciieennccyy Security prices reflect available information New information is quickly included in security prices Investors balance liquidity, risk, and return needs
  • 15. FFiinnaanncciiaall MMaarrkkeett RReegguullaattiioonn Why Government Regulation? To Promote Efficiency High level of competition Efficient payments mechanism Low cost risk management contracts
  • 16. FFiinnaanncciiaall MMaarrkkeett RReegguullaattiioonn Why Government Regulation? To Maintain Financial Market Stability Prevent market crashes Circuit breakers Federal Reserve discount window Prevent Inflation--Monetary policy Prevent Excessive Risk Taking by Financial Institutions
  • 17. FFiinnaanncciiaall MMaarrkkeett RReegguullaattiioonn Why Government Regulation? To Provide Consumer Protection Provide adequate disclosure Set rules for business conduct To Pursue Social Policies Transfer income and wealth Allocate saving to socially desirable areas Housing Student loans
  • 18. FFiinnaanncciiaall MMaarrkkeett GGlloobbaalliizzaattiioonn Increased international funds flow Increased disclosure of information Reduced transaction costs Reduced foreign regulation on capital flows Increased privatization Results: Increased financial integration--capital flows to highest expected risk-adjusted return
  • 19. RRoollee ooff FFiinnaanncciiaall IInnssttiittuuttiioonnss iinn FFiinnaanncciiaall MMaarrkkeettss Information processing Serve special needs of lenders (liabilities) and borrowers (assets) By denomination and term By risk and return Lower transaction cost Serve to resolve problems of market imperfection
  • 20. RRoollee ooff FFiinnaanncciiaall IInnssttiittuuttiioonnss iinn FFiinnaanncciiaall MMaarrkkeettss Types of Depository Financial Institutions Commercial Banks $5 Trillion Total Assets Savings Institutions $1.3 Trillion Total Assets Credit Unions $.5 Trillion Total Assets
  • 21. TTyyppeess ooff NNoonnddeeppoossiittoorryy FFiinnaanncciiaall IInnssttiittuuttiioonnss Insurance companies Mutual funds Pension funds Securities companies Finance companies Security pools
  • 22. RRoollee ooff NNoonnddeeppoossiittoorryy FFiinnaanncciiaall IInnssttiittuuttiioonnss Focused on capital market Longer-term, higher risk intermediation Less focus on liquidity Less regulation Greater focus on equity investments
  • 23. TTrreennddss iinn FFiinnaanncciiaall IInnssttiittuuttiioonnss Rapid growth of mutual funds and pension funds Increased consolidation of financial institutions via mergers Increased competition between financial Institutions Growth of financial conglomerates
  • 24. GGlloobbaall EExxppaannssiioonn bbyy FFiinnaanncciiaall IInnssttiittuuttiioonnss International expansion International mergers Impact of the single European currency Emerging markets