This document outlines the key learning outcomes and content covered in a course on modern financial markets and institutions. The learning outcomes include outlining important financial markets and instruments, explaining the roles of financial products/markets/institutions, and describing changes in financial services. The content sections cover bond markets, equity markets, money markets, foreign exchange markets, derivatives, banking, financial centers, and the roles of various financial institutions. Diagrams and exhibits are included to illustrate concepts.

1. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.1
LEARNING OUTCOMES
• Outline the character and importance of the main financial
markets and instruments
• Explain the key roles played in a modern society by the
financial products, markets and institutions
• Describe the relative standing of the major financial centres
• Discuss the changes that have taken place in the way
financial services are provided
• Define and illustrate some key financial terms, such as
primary market and over-the-counter.

2. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.2
Bond markets
• Companies often need to borrow money
• A bond, states that the company will
pay interest for, say, ten years and a capital sum at the end
• Can sell it to other investors
• Government bonds (UK government bonds are called gilts)
• Corporate bonds.

3. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.3
Exhibit 1.1 Yields on corporate bonds issued in pounds and euros, and yields on
Greek government debt, 2001–2011
Source: Financial Times, 11 March 2011, p. 20. Reprinted with permission.

4. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.4
Equity markets
• Limited liability for companies
• Shares (also called equity and stock)
• Owners of the company and can vote directors on or off the
board to try to appoint a team
• Various savings schemes
• Share markets.

5. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.5
Exhibit 1.2 UK and US share market price movements, 1990–2011 (with the US S&P
500 index rebased to the UK FTSE 100 in 1991)
Source: DATASTREAM.

6. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.6
Money markets
• Allow companies, etc. to issue instruments that promise to
pay a sum of money after, say, 30 days if the buyer pays an
amount now for owning that right
• Wholesale markets
• Borrowing for less than one year
• Banks are particularly active
• Large corporations, local government bodies and non-
banking financial institutions also lend
• Largest borrowers in these markets are usually
governments
– Treasury bills.

7. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.7
Exhibit 1.3 The interest rate the UK government offered investors in its various three-
month Treasury bills issued each month 1991–2011
Source: DATASTREAM.

8. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.8
Foreign exchange markets
• Transactions worth $4,000 billion taking place every day
• Manuel borrowed €300,000 to buy an apartment in London
early in 2006
• £1 for every €1.50, so he could buy a £200,000 apartment
• In 2009 he needed to sell his apartment
• At 2009 exchange rates (€1.10 to £1) he could obtain only
€220,000
• An €80,000 loss.

9. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.9
Exhibit 1.4 The exchange rate between euros and UK pounds, 2001–2011
Source: DATASTREAM.

10. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.10
Foreign exchange (forex, FX) markets
• Markets in which one currency is exchanged for another
• Spot market, currencies are bought and sold for
‘immediate’ delivery
• Forward markets, the deal is agreed now to exchange
currencies at some fixed point in the future
• Futures and options and other forex derivatives are
employed to hedge (manage) risk and to speculate.

11. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.11
Derivative and commodity markets
• Cocoa farmer in Ghana
• Cadbury would also like to know the cost of its cocoa six
months from now
• Perhaps the farmer could sell a future in cocoa at, say,
$3,000 per tonne
• A future is a contract to undertake a transaction (e.g. sell
cocoa) at a point days, weeks or years from now, at a price
agreed now.

12. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.12
Exhibit 1.5 The futures price of cocoa, March 2009 to March 2011
Source: DATASTREAM.

13. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.13
A derivative
• A financial instrument whose value is derived from the
value of other financial securities or some other underlying
asset because it grants a right to undertake a transaction
• The right becomes a saleable derived financial instrument
• An option gives the purchaser the right, but not the
obligation, to buy or sell something at some point in the
future, at a price agreed now.

14. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.14
Banking
• Deposits
• Providing loans
• Allowing people and organisations to make payments to
each other
• Some borrowers may pose a low risk to the bank and so
may be charged, say, 2 per cent over the base rate.

15. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.15
Exhibit 1.6 UK bank base rates, 2001–2011
Source: DATASTREAM.

16. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.16
Importance of different financial centres
The five groups of instrumental factors for judging the quality
of a financial centre
• People
• Business environment
• Market access
• Infrastructure
• General competitiveness.

17. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.17
Exhibit 1.8 The top 20 global financial centres
Source: www.atlapedia.com.

18. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.18
Specific aspects of financial services
• Asset management (e.g. mutual funds, unit trusts, pension
funds):
– First – London
– Second – New York
– Third – Hong Kong
– Fourth – Singapore
• Banking:
– First – New York
– Second – Hong Kong
– Third – London
– Fourth – Singapore.

19. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.19
Specific aspects of financial services (Continued)
• Professional services (e.g. legal, accounting):
– First – London
– Second – New York
– Third – Hong Kong
– Fourth – Singapore
• Wealth management (advice and investing for wealthy
people):
– First – New York
– Second – Geneva
– Third – New York
– Fourth – Toronto.

20. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.20
Exhibit 1.10 Share of world financial market activity
Source: TheCityUK estimates.

21. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.21
World without money or financial institutions
• Barter-based system
• Money
– Something into which all goods and services received can
be converted
– Small and portable
– Hold its value over a long period of time
– General acceptability
• Financial intermediaries
– Put lenders and borrowers in touch with each other
– Vast sums of money accumulated from various lenders.

22. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.22
Exhibit 1.11 The flow of funds and financial intermediation

23. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.23
Financial intermediation
• Primary investors
• Ultimate borrowers
• Conflict of preferences.

24. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.24
Exhibit 1.12 Savings into investment in an economy without financial intermediaries

25. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.25
The introduction of financial intermediaries
• Brokers
• Asset transformers
• Risk transformation
• Maturity (liquidity) transformation
• Volume transformation.

26. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.26
Intermediaries’ economies of scale
• Efficiencies in gathering information on the riskiness of
lending to a particular firm
• Risk spreading
• Transaction costs - search, agreement and monitoring
costs.

27. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.27
Exhibit 1.13 Saving into investment in an economy with financial intermediaries and
financial markets

28. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.28
Payment mechanisms
• Transfer of money
• Coins and notes
• Cheques
• Debit or credit cards.

29. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.29
Financial markets
• Primary market
• Secondary market
• Ability to liquidate (turn into cash) a holding
• Reducing search, agreement and monitoring costs.

30. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.30
Growth in the financial services sector
• London
• Heart of the British Empire and the industrialised world
• Open for business when the rest of Europe is active and
when the Asian markets are still operating at the end of
their trading day and the US is starting its working day
• High income elasticity
• International comparative advantage.

31. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.31
Exhibit 1.14 City of London’s position in international finance and business services
Source: www.cityoflondon.gov.uk, 2010.

32. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.32
Exhibit 1.15 Innovation in the financial sector

33. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.33
Debt and equity capital
• Borrow either by taking out loans or by issuing bonds
• Interest being a tax-deductible expense
• Bonds often traded in an active secondary market
• Shares (equity)
• Own part of the company
• Returns in the form of dividends and capital gains
• Shares offered a higher return to investors.

34. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.34
Primary market
• Primary market
• Sales are managed by financial institutions
• New issue market (NIM)
• Initial public offering
• Flotation
• A rights issue.

35. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.35
Exchange-traded and OTC markets
• Exchange trading takes place on the myriad regulated
share markets and other security exchanges
• Publish prices
• Funded by a mixture of commission on trades, admission
fees and annual charges for listings
• Over-the-counter (OTC) market, off-exchange market,
trade in securities between two parties on a private basis
• More risky
• Little transparency in traded prices.

36. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.36
The banking sector
• Retail and wholesale banking
• Take (small) deposits from the public which are
repackaged and lent to businesses and households
• They also provide payment services
• Wholesale banking
• Clearing banks.

37. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.37
Investment banks
• Raising external finance for companies
• Broking and dealing
• Fund (asset) management
• Assistance in corporate restructuring
• Assisting risk management using derivatives.

38. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.38
International banks
• Foreign banking
• Eurocurrency banking.

39. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.39
Others banking-type organisation
• The mutuals
– Building societies
– Savings and loans
– Cooperative banks
• Finance houses
– Hire purchase agreements
– Leasing
– Factoring.

40. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.40
Long-term savings institutions
• Pension funds
• Insurance funds
• General insurance
• Life assurance
• Term assurance
– Whole-of-life policies
– Endowment policies
– Annuities
– Personal pensions.

41. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.41
The risk spreaders
• Unit trusts
– ‘Open-ended’ funds
• Mutual funds
• Investment trusts (investment companies)
– Closed-end funds
• Open-ended investment companies.

42. Glen Arnold, Modern Financial Markets and Institutions, 1st Edition, © Pearson Education Limited 2012
Slide 1.42
The risk takers
• Private equity funds
– Funds that invest in companies that do not have a stock
market trading quote for their shares
• Hedge funds
– Wide variety of financial strategies largely outside the
control of the regulators
– More freedom than unit trusts in ‘going short’
– Borrow many times the size of the fund.