This document is the first chapter of a textbook on financial markets and institutions. It introduces why students should study these topics. It discusses that financial markets like bond and stock markets channel funds from savers to investors, promoting economic efficiency. It also explains that the Fed, interest rates, and liquidity mentioned in news reports can impact personal wealth and businesses. The chapter then summarizes key topics that will be examined in the course, including debt markets, interest rates, the stock market, and foreign exchange markets. It also discusses the structure and risks of financial institutions. The objectives are for students to understand how these markets function and use models to analyze issues and consequences of events like financial crises.

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All rights reserved.
CHAPTER 1
Why Study
Financial Markets
and Institutions?

2. 1-1© 2012 Pearson Prentice Hall. All rights reserved.
Chapter Preview
The evening news features a segment
about interest rates, the Fed Chairman
Ben Bernanke, and liquidity in credit
markets.
What does all this mean? Do I care about
interest rates? What is “the Fed?” Will this
impact my firm’s ability to get a bank loan?

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Chapter Preview
These are good questions.
And this course will help you answer
these questions by addressing a variety of
topics ranging from the functioning of the
bond and sock markets to the behavior of
the Fed and banks.

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Why Study Financial Markets?
Financial markets, such as bond and stock
markets, are crucial in our economy.
1. These markets channel funds from savers to
investors, thereby promoting economic
efficiency.
2. Market activity affects personal wealth, the
behavior of business firms, and economy as a
whole

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Why Study Financial Markets?
▪ Well functioning financial markets, such
as the bond market, stock market, and
foreign exchange market, are key
factors in producing high economic
growth.
▪ We will briefly examine each of these
markets, key statistics, and how we will
examine them throughout this course.

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Why Study Financial Markets?
Debt Markets & Interest Rates
▪ Debt markets, or bond markets, allow
governments, corporations, and
individuals to borrow to finance activities.
▪ In this market, borrowers issue a
security, called a bond, that promises
the timely payment of interest and
principal over some specific time horizon.
▪ The interest rate is the cost of borrowing.

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Why Study Financial Markets?
Debt Markets & Interest Rates
▪ There are many different types of market
interest rates, including mortgage rates,
car loan rates, credit card rates, etc.
▪ The level of these rates are important.
For example, mortgage rates in the early
part of 1983 exceeded 13% vs near
4.5% over the past several years.

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Bond Market and Interest Rates

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Why Study Financial Markets?
The Stock Market
▪ The stock market is the market where
common stock (or just stock), representing
ownership in a company, are traded.
▪ Companies initially sell stock (in the primary
market) to raise money. But after that, the
stock is traded among investors (secondary
market).
▪ Of all the active markets, the stock market
receives the most attention from the Of all the
active markets, the stock market receives the
most attention from the media. Why?

10. Stock
Market
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Why Study Financial Markets?
The Foreign Exchange Market
▪ The foreign exchange market is where
international currencies trade and
exchange rates are set.
▪ Although most people know little about
this market, it has a daily volume
around
$1 trillion!

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Foreign Exchange Market

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Why Study Financial
Institutions?
We will also spend considerable time discussing
financial institutions—the corporations, organizations,
and networks that operate the so-called “marketplaces.”
1. Structure of the Financial System
─ Helps get funds from savers to investors
2. Financial Crises
─ The financial crises of 2007–2009 was the worst
financial crisis since the Great Depression. Why
did it happen?

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Why Study Financial
Institutions?
3. Banks and Other Financial Institutions
─ Includes the role of insurance companies, mutual
funds, pension funds, etc.
4. Financial Innovation
─ Focusing on the improvements in technology
and its impact on how financial products are
delivered
5. Managing Risk in Financial Institutions
─ Focusing on risk management in the
financial institution.

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Applied Managerial Perspective
▪ Financial institutions are among the
largest employers in the U.S. and often
pay high salaries.
▪ Knowing how financial institutions are
managed may help you better deal
with them.

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How We Study Financial
Markets and Institutions
Basic Analytic Framework
1. Simplified approach to demand for assets.
2. Basic supply & demand approach to
understanding behavior in financial
markets.

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How We Study Financial
Markets and Institutions
Basic Analytic Framework
3. Equilibrium forces & profit seeking
behavior
4. Transactions cost & asymmetric
information approach to financial structure

18. Learning Objectives
▪ You should be familiar with and able to
explain key elements of financial markets
and how they function, including
─ the basic theory of asset demand and
determination of asset prices,
─ the role of arbitrage and profit motive in
financial markets,
─ the role of information in financial markets,
─ and the causes and consequences of
financial crises.
1-17

19. Learning Objectives
▪ You should be able to use appropriate
models to analyze the issues listed
above, and to draw appropriate
conclusions about the effects of
economic developments and policy
interventions.
1-18

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Exploring the Web
Web Exercise
The next three slides (starting on page 10 in
the text) show you how to (1) find historical
interest rates from the Fed and save the
information, (2) how to import the data into
Excel, and (3) how to examine the information.

21. Exploring
the Web
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22. Exploring
the Web
1-21© 2012 Pearson Prentice Hall. All rights reserved.

23. Exploring
the Web
1-22© 2012 Pearson Prentice Hall. All rights reserved.