The document discusses three key elements of any financial system: financial instruments, financial markets, and financial institutions. It provides an overview of different types of financial markets, how they function, and how various financial assets are traded within these markets. The roles of financial institutions and how they facilitate activities in financial markets are also summarized.

1. Financial System
n Three elements of Financial System
 Financial Instruments
 Financial Markets
 Financial Institutions

2. Overview of Financial Markets
n Financial markets provide for financial
intermediation: from savers to users of funds
n Financial markets provide payments system
n Financial markets provide means to manage risk
Financial Market: a market in which financial
assets (securities) such as stocks and bonds
can be purchased or sold

3. n Broad Classifications of Financial Markets
Money versus Capital Markets
Primary versus Secondary Markets
Organized versus Over-the-Counter Markets
Overview of Financial Markets

4. Primary vs. Secondary Markets
n PRIMARY
l New Issue of Securities
l Exchange of Funds for
Financial Claim
l Funds for Borrower; an
IOU for Lender
n SECONDARY
l Trading Previously Issued
Securities
l No New Funds for Issuer
l Provides Liquidity for
Seller

5. Money vs. Capital Markets
n Money
l Short-Term, < 1 Year
l High Quality Issuers
l Debt Only
l Primary Market Focus
l Liquidity Market--Low
Returns
n Capital
l Long-Term, >1Yr
l Range of Issuer Quality
l Debt and Equity
l Secondary Market Focus
l Financing Investment--
Higher Returns

6. Organized vs. Over-the-Counter
Markets
n Organized
l Visible Marketplace
l Members Trade
l Securities Listed
l New York Stock
Exchange
n OTC
l Wired Network of
Dealers
l No Central, Physical
Location
l All Securities Traded
off the Exchanges

7. n Money Market Securities
l Debt securities Only
n Capital market securities
l Debt and equity securities
n Derivative Securities
l Financial contracts whose value is derived from the values of
underlying assets
l Used for hedging (risk reduction) and speculation (risk
seeking)
Securities Traded in Financial Markets

8. Debt vs. Equity Securities
Debt Securities: Contractual obligations (IOU) of Debtor
(borrower) to Creditor (lender)
u Investor receives interest
u Capital gain/loss when sold
u Maturity date

9. Debt vs. Equity Securities
Equity Securities: Claim with ownership rights and
responsibilities
u Investor receives dividends if declared
u Capital gain/loss when sold
u No maturity date—need market to sell

10. Valuation of Securities
n Value a function of:
l Future cash flows
l When cash flows are received
l Risk of cash flows
n Present value of cash flows discounted at the
market required rate of return
n Value changes with new information

11. n Security prices reflect available information
n New information is quickly included in
security prices
n Investors balance liquidity, risk, and return
needs
Financial Market Efficiency

12. Financial Market Regulation
l To Promote Efficiency
u High level of competition
u Efficient payments mechanism
u Increase Information to Investors
Why Government Regulation?

13. l To Maintain Financial Market Stability
u Prevent market crashes
n Circuit breakers
u Prevent Inflation--Monetary policy
u Prevent Excessive Risk Taking by Financial Institutions
Financial Market Regulation
Why Government Regulation?

14. l To Provide Consumer Protection
u Provide adequate disclosure
u Set rules for business conduct
l To Pursue Social Policies
u Transfer income and wealth
u Allocate saving to socially desirable areas
n Housing
n Student loans
Financial Market Regulation
Why Government Regulation?

15. Financial Market Globalization
n Increased international funds flow
l Increased disclosure of information
l Reduced transaction costs
l Reduced foreign regulation on capital flows
l Increased privatization
Results: Increased financial integration--capital
flows to highest expected risk-adjusted return

16. Role of Financial Institutions in Financial
Markets
n Information processing
n Serve special needs of lenders (liabilities) and
borrowers (assets)
l By denomination and term
l By risk and return
n Lower transaction cost
n Serve to resolve problems of market
imperfection

17. Role of Financial Institutions in
Financial Markets
Types of Depository Financial Institutions
Commercial
Banks
$5 Trillion
Total Assets
Savings
Institutions
$1.3 Trillion
Total Assets
Credit Unions
$.5 Trillion
Total Assets

18. Types of Nondepository Financial
Institutions
n Insurance companies
n Mutual funds
n Pension funds
n Securities companies

19. Role of Nondepository Financial
Institutions
n Focused on capital market
n Longer-term, higher risk intermediation
n Less focus on liquidity
n Less regulation
n Greater focus on equity investments

20. Trends in Financial Institutions
n Rapid growth of mutual funds and pension
funds
n Increased consolidation of financial
institutions via mergers (summit bank & Sindh
Bank, KASB & BIPL)
n Increased competition between financial
Institutions (banking Sector)
n Growth of financial conglomerates (nishat
group MCB)

21. Global Expansion by Financial
Institutions
n International expansion ( can buy US securities in
Pakistan)
n International mergers
n Impact of the single European currency
n Emerging markets (like china, Pakistan, india,
Indonesia, Turkey)