The document provides an overview of financial systems and their role in the economy. It discusses that financial systems channel funds from lenders to borrowers, create liquidity and money, provide payment mechanisms and financial services. Financial systems impact economic growth through capital accumulation and technological innovation by lowering costs and allowing risk diversification. Financial markets are crucial as they transfer funds from savers to borrowers, promoting economic efficiency.
The document provides an overview of financial systems and markets. It defines key terms like financial system, formal and informal financial sectors, components of a formal financial system including financial institutions, markets, instruments, services and currency. It describes the functions of a financial system like payments, savings, liquidity, risk management and government policy. It also discusses elements of a financial system such as lenders and borrowers, financial intermediaries, instruments, markets, money creation and price discovery. Finally, it provides details about the structure and classification of the Indian financial system.
A financial system consists of financial institutions, markets, instruments, and services that facilitate the transfer of funds between savers and investors. It plays a key role in allocating resources in the economy by channeling funds from savers to borrowers. A sound financial system is essential for capital formation and steady economic growth by mobilizing savings and efficiently directing those savings towards productive investments. It links those who have capital but do not want to engage directly in business with those who need capital to start or expand their business.
Topic 8_Money and Financial Markets (1).pdfamalik32
Financial markets transfer funds from those with excess funds to those with a shortage. They promote economic efficiency and growth. Interest rates are important as they affect consumers, businesses, and the overall economy. The bond market enables borrowing, and interest rates are determined here. Stocks represent ownership in corporations and trade in stock markets. The foreign exchange market determines currency exchange rates. Financial institutions like banks reduce transaction costs and risks by acting as intermediaries between lenders and borrowers. Money supply increases often lead to inflation as more money chases the same amount of goods and services. Central banks conduct monetary policy to manage money supply, interest rates, and inflation.
The document provides an overview of the financial system. It defines a financial system as consisting of financial markets, financial assets, and financial institutions. The financial system plays several key roles in the economy, including channeling funds from savers to borrowers, creating liquidity and money, providing payment mechanisms, and allowing for risk diversification. It discusses the components of the financial system, including financial assets/instruments, markets, and institutions. Financial assets are defined as providing expected cash flows rather than physical services, and having characteristics like fungibility and divisibility.
The document discusses the key components and functions of a financial system. It describes a financial system as a network that allows the exchange of funds between participants like lenders, borrowers, and investors. The main components include financial institutions, markets, instruments, services, and currency. Key functions of a financial system are to facilitate payments, savings, liquidity, risk management, and influence of government policies. Financial systems are important for economic development by channeling savings into investments.
Finance involves the management of money and funds. It includes activities like originating, marketing, and managing cash and other financial instruments. There are three main areas of finance: personal finance concerning individuals' finances, corporate finance concerning for-profit organizations' finances, and public finance concerning governments' financial affairs. Financial systems provide capital from investors to other individuals, firms, and governments through various financial instruments and markets.
Fiduciary or paper money is issued by the Central Bank on the basis of
computation of estimated demand for cash. Monetary policy guides the Central
Bank’s supply of money in order to achieve the objectives of price stability (or low
inflation rate), full employment, and growth in aggregate income.
The document provides an overview of financial systems and markets. It defines key terms like financial system, formal and informal financial sectors, components of a formal financial system including financial institutions, markets, instruments, services and currency. It describes the functions of a financial system like payments, savings, liquidity, risk management and government policy. It also discusses elements of a financial system such as lenders and borrowers, financial intermediaries, instruments, markets, money creation and price discovery. Finally, it provides details about the structure and classification of the Indian financial system.
A financial system consists of financial institutions, markets, instruments, and services that facilitate the transfer of funds between savers and investors. It plays a key role in allocating resources in the economy by channeling funds from savers to borrowers. A sound financial system is essential for capital formation and steady economic growth by mobilizing savings and efficiently directing those savings towards productive investments. It links those who have capital but do not want to engage directly in business with those who need capital to start or expand their business.
Topic 8_Money and Financial Markets (1).pdfamalik32
Financial markets transfer funds from those with excess funds to those with a shortage. They promote economic efficiency and growth. Interest rates are important as they affect consumers, businesses, and the overall economy. The bond market enables borrowing, and interest rates are determined here. Stocks represent ownership in corporations and trade in stock markets. The foreign exchange market determines currency exchange rates. Financial institutions like banks reduce transaction costs and risks by acting as intermediaries between lenders and borrowers. Money supply increases often lead to inflation as more money chases the same amount of goods and services. Central banks conduct monetary policy to manage money supply, interest rates, and inflation.
The document provides an overview of the financial system. It defines a financial system as consisting of financial markets, financial assets, and financial institutions. The financial system plays several key roles in the economy, including channeling funds from savers to borrowers, creating liquidity and money, providing payment mechanisms, and allowing for risk diversification. It discusses the components of the financial system, including financial assets/instruments, markets, and institutions. Financial assets are defined as providing expected cash flows rather than physical services, and having characteristics like fungibility and divisibility.
The document discusses the key components and functions of a financial system. It describes a financial system as a network that allows the exchange of funds between participants like lenders, borrowers, and investors. The main components include financial institutions, markets, instruments, services, and currency. Key functions of a financial system are to facilitate payments, savings, liquidity, risk management, and influence of government policies. Financial systems are important for economic development by channeling savings into investments.
Finance involves the management of money and funds. It includes activities like originating, marketing, and managing cash and other financial instruments. There are three main areas of finance: personal finance concerning individuals' finances, corporate finance concerning for-profit organizations' finances, and public finance concerning governments' financial affairs. Financial systems provide capital from investors to other individuals, firms, and governments through various financial instruments and markets.
Fiduciary or paper money is issued by the Central Bank on the basis of
computation of estimated demand for cash. Monetary policy guides the Central
Bank’s supply of money in order to achieve the objectives of price stability (or low
inflation rate), full employment, and growth in aggregate income.
The financial system channels funds from savers to borrowers through financial intermediation and markets. It improves economic efficiency by allocating capital to its most productive uses. The primary functions of the financial system are to transfer funds from lenders like households to borrowers like businesses, improve consumer well-being by allowing better timing of purchases, and produce an efficient allocation of capital contributing to higher economic production. Financial markets and intermediaries facilitate this process through direct financing in markets and indirect financing through intermediaries. Regulation aims to increase information to investors, ensure the soundness of intermediaries to prevent failures, and improve monetary control.
This document provides an overview of financial markets and institutions. It begins by defining key terms like financial systems and markets. It then describes different types of financial markets including capital markets, money markets, commodity markets, and more. It also outlines various financial institutions like commercial banks, investment banks, insurance companies, and others. The document discusses how funds flow through the financial system directly and indirectly. It also touches on important concepts like asymmetric information, free rider problems, and how financial development relates to economic growth. Finally, it introduces Minsky's financial instability hypothesis and how periods of stability can lead to increased risk-taking and potential financial crises.
Chapter 02_Overview of the Financial SystemRusman Mukhlis
This chapter provides an overview of the financial system, including the functions of financial markets and intermediaries in channeling funds from lenders to borrowers. It describes the structure of markets, such as debt versus equity, and primary versus secondary markets. It also discusses the internationalization of markets and the role of regulation in ensuring stability and transparency.
Week-1 Into to Money and Bankingand Basic Overview of U.S. Fin.docxalanfhall8953
Week-1 Into to Money and Banking
and Basic Overview of U.S. Financial System
Money and Banking Econ 311
Instructor: Thomas L. Thomas
Financial markets transfer funds from people who have excess available funds to people who have a shortage.
They promote grater economic efficiency by channeling funds from people who do not have a productive use for them to those who do.
Well functioning financial markets are a key factor in producing economic growth, where as, poor functioning financial markets are a major reason many countries in the world remain poor.
Financial Markets
A security or financial instrument is a claim on the issuer’s future income or assets.
A bond is a debt security (IOU) that promises to make payments periodically for a specified period of time.
The bond market is especially important economic activity because it enables businesses and the government to borrow and finance their activities and because it is where interest rates are determined.
An interest rate is the cost of borrowing money or the price to rent (use someone else’s) funds.
Because different interest rates tend to move in unison, economist frequently lump interest rates together and refer to the “interest rate”.
Interest rates are important on a number of levels:
High interest rates retard borrowing
High interest rates induce saving.
Lower interest rates induce borrowing
Lower Interest rates retard saving
Information Asymmetry and Information costs
Why Financial Intermediaries
In the neo-classical world economists have argued financial intermediaries are not necessary. Savers (investors) could manage their risks through diversification.
The logic rests on the perfect market assumption – that is investors can always through their own borrowing and lending compose their portfolios as they see fit, without costs. In such a world there are no bankruptcy costs.
In such a world if taken to the extreme, perfect and complete markets imply that there is no need for financial institutions to intermediate in the financial (capital markets) as every investor (saver) has complete information and can contract with the market at the same terms as banks. E.g. Information Asymmetry
Why Financial Intermediaries Bonds
A common stock (usually called stock) represents a share of ownership in a corporation.
It is usually a security that is a claim on the earnings and assets of the corporation.
Issuing stock and selling it to the public (called a public offering) is a way for corporations to raise the funds to finance their activities.
The stock market is the most widely followed financial market in almost every country that has one – that is why it is generally called the market – here “Wall Street.”
The stock market is also an important factor in business investment decisions, because the price of shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending. (Note impact examples..
financial status.com ndasbjd as d ansd nas dnaloganzeck02
Financial markets and institutions play important roles in the economy by facilitating transactions and the efficient allocation of resources. They consist of agents, brokers, and intermediaries that link investors and borrowers. Financial institutions act as intermediaries by collecting funds from savers and channeling them to borrowers. They perform important functions like managing payments, trading securities, modifying the terms of loans (transmutation), diversifying risk, and managing portfolios. This allows for the distribution of risk across the economy and a more efficient allocation of capital over time.
The document provides an overview of the financial system. It discusses the key components and functions of the financial system including financial instruments, markets, institutions, and regulators. The financial system works to channel funds from sectors with surplus to those with shortages. It also provides important services like risk sharing, liquidity, and information. However, the system faces problems of adverse selection and moral hazard due to asymmetric information between borrowers and lenders. Financial intermediaries help address these challenges by reducing transaction and information costs.
The document provides an introduction to financial systems, including definitions, key components, and functions. It discusses that a financial system consists of institutions, markets, instruments, and services that facilitate the transfer of funds. The main components are financial institutions like banks, markets where assets are traded, various financial services, and instruments/assets like stocks, bonds, and mutual funds. Financial systems play an important role in allocating resources and facilitating economic growth.
This document discusses the roles and functions of financial institutions (FIs). FIs connect borrowers and lenders by accepting funds from lenders and loaning them to borrowers. They serve as conduits between savers and users of funds by providing brokerage functions and transforming assets. Specifically, FIs issue securities like deposits that are attractive to savers and use the funds to purchase corporate securities, providing liquidity and reducing risk.
This document discusses investment avenues available in India. It describes the country's financial system, including financial institutions, markets, services and instruments. Various investment avenues are categorized as security forms, non-security forms, traditional forms and emerging avenues. Within security forms, money market securities like treasury bills are explained in detail. The document provides an overview of different savings and investment options for individuals and organizations in India.
This document provides an overview of the Indian financial system. It discusses key components such as financial institutions, financial markets, and financial instruments. It notes that the financial system comprises a variety of intermediaries and markets that transform savings into investments. It also outlines some functions of the financial system like facilitating payments, pooling funds, and managing risk. The document further describes different types of financial institutions, markets, and instruments as well as financial services in India. It concludes by identifying some weaknesses of the Indian financial system.
The financial system allows the flow of funds from savers (surplus spending units) to borrowers (deficit spending units) through financial institutions. It does this by facilitating financial claims like loans and equity investments between these units. The system also enables settlement of transactions through payment systems like banks, ATMs, and EFTPOS. Additionally, it provides information to market participants to make informed investment decisions through credit rating agencies, and allows risks to be transferred and managed through insurance and derivatives. Maintaining an efficient financial system is important for allocating funds to their highest uses and integrating economies, though some countries were less affected by the global financial crisis due to more calibrated financial liberalization.
This document provides an overview of financial institutions and markets. It begins with definitions of key terms like financial markets, debt/interest rates, stock markets, and foreign exchange markets. It then discusses causes of financial crises like banking crises, asset bubbles, international crises, and regulatory failures. The document concludes that financial markets have significant impacts on individuals, businesses, and the overall economy, so it is important to understand these systems and how monetary policy works.
Assignment 1 Discussion QuestionThe management of current asset.docxfredharris32
Assignment 1: Discussion Question
The management of current assets and current liabilities in the short run can lead to several challenges for the financial manager. What are some of the more common challenges or problems encountered by the firm in this regard, and what are the possible solutions? Explain your answers.
Assignment 2: Discussion Question
Financial mangers make decisions today that will affect the firm in the future. The dollars used for investment expenditures made today are different from the cash flows to be realized in the future. What are these differences? What are some of the techniques that can be used to adjust for these differences?
Assignment 3: Discussion Question
Valuation of a firm’s financial assets is said to be based on what is expected in the future, in terms of the future performance of the firm, the industry, and the economy. What types of value would you consider when assigning “value” to a firm’s stock or bond? What is the significance of each of the different types of value in the valuation process? Use examples to support your response.
Assignment 4: Discussion Question
The finance department of a large corporation has evaluated a possible capital project using the NPV method, the Payback Method, and the IRR method. The analysts are puzzled, since the NPV indicated rejection, but the IRR and Payback methods both indicated acceptance. Explain why this conflicting situation might occur and what conclusions the analyst should accept, indicating the shortcomings and the advantages of each method. Assuming the data is correct, which method will most likely provide the most accurate decisions and why?
Course Overview (1 of 3)
Defining Finance
Broadly defined, finance is the study of how people manage scarce resources in general, and money and other financial resources in particular. There are two important features that distinguish financial decisions from other types of decisions. The benefits and costs of financial decisions are spread out over time and usually shrouded in uncertainty.
These decisions are made in a financial environment that includes the financial system, institutions, markets, and participants such as individual households, businesses, and governments. It is important to note that a well developed and properly functioning financial system enables the economy to operate efficiently and contributes to the economic growth and development of the country.
Brief History of Finance
Finance emerged as a separate field of study in the U.S. in the early 1900s. At that time finance was taught primarily as a descriptive subject using anecdotes and rules of thumb. The focus at that time was on the formation of new firms, the various types of securities firms can issue to raise funds and the legal aspects of mergers and acquisitions. This continued to be the focus all through the 1920s.
However, during the 1930s the focus shifted to the study of bankruptcy and reorganization, corporate liqu ...
The document provides an introduction to financial management, including definitions of finance, financial intermediaries, and financial accounts. It discusses how finance deals with concepts like time, money, and risk. It also defines different types of financial intermediaries like insurance companies, mutual funds, investment brokers, and pension funds. Finally, it summarizes the key financial statements - the trading account, profit and loss account, and balance sheet - and explains the rules and objectives of financial accounting.
The Indian financial system consists of financial institutions, markets, instruments, and services that facilitate the flow of funds between savers and borrowers. It mobilizes savings and channels them into productive investments. The key components include commercial banks, insurance companies, stock and money markets. Financial institutions intermediate between surplus and deficit units, while markets allow trading of instruments like stocks, bonds, and currencies. Together they perform vital roles like maturity transformation and risk sharing. Over time, India's financial system has grown in strength, efficiency, and stability through measures like competition, consolidation, and regulation.
introduction to financial intermediaries
working of financial intermediaries
importance of financial intermediaries
for whom financial intermediaries are working?
The document discusses the role of financial systems and stock markets in economic development. It provides an overview of Pakistan's financial system, including the historical dominance of informal finance. While financial reforms in recent decades improved access to formal institutions, stock markets remain underdeveloped in Pakistan. The document analyzes constraints like low interest rates, weak regulation, and political instability that have limited stock market growth. It recommends further reforms like reducing corporate leverage, encouraging bond markets, and improving disclosure to strengthen Pakistan's financial system.
The document provides an overview of the financial system and its key components. It discusses how financial markets and institutions help channel funds from savers to borrowers, allowing for investment and economic growth. It then covers the major types of financial markets and instruments, including debt vs equity markets, primary vs secondary markets, money markets, capital markets, and derivatives. It also discusses the internationalization of financial markets through foreign bonds, Eurobonds, and Eurocurrencies.
This document provides an overview of the key components of the financial system. It discusses the six main parts of the financial system: money, financial instruments, financial markets, financial institutions, regulatory agencies, and central banks. It then describes the core principles of money and banking. Finally, it outlines the structure of the financial industry, including depository institutions like banks, and non-depository institutions like insurance companies, investment banks, and mutual funds.
Financial reporting for financial instruments and institutions is undergoing significant changes as standards have been implemented to improve transparency. These standards require more fair value accounting and enhanced disclosures of risks. To fully analyze financial instruments, users must understand how fair value accounting describes instruments while also considering sensitivity analyses and risk disclosures. Financial institutions provide useful contexts for learning to analyze a variety of financial instrument transactions and histories.
Unveiling the Dynamic Personalities, Key Dates, and Horoscope Insights: Gemin...my Pandit
Explore the fascinating world of the Gemini Zodiac Sign. Discover the unique personality traits, key dates, and horoscope insights of Gemini individuals. Learn how their sociable, communicative nature and boundless curiosity make them the dynamic explorers of the zodiac. Dive into the duality of the Gemini sign and understand their intellectual and adventurous spirit.
Cover Story - China's Investment Leader - Dr. Alyce SUmsthrill
In World Expo 2010 Shanghai – the most visited Expo in the World History
https://www.britannica.com/event/Expo-Shanghai-2010
China’s official organizer of the Expo, CCPIT (China Council for the Promotion of International Trade https://en.ccpit.org/) has chosen Dr. Alyce Su as the Cover Person with Cover Story, in the Expo’s official magazine distributed throughout the Expo, showcasing China’s New Generation of Leaders to the World.
The financial system channels funds from savers to borrowers through financial intermediation and markets. It improves economic efficiency by allocating capital to its most productive uses. The primary functions of the financial system are to transfer funds from lenders like households to borrowers like businesses, improve consumer well-being by allowing better timing of purchases, and produce an efficient allocation of capital contributing to higher economic production. Financial markets and intermediaries facilitate this process through direct financing in markets and indirect financing through intermediaries. Regulation aims to increase information to investors, ensure the soundness of intermediaries to prevent failures, and improve monetary control.
This document provides an overview of financial markets and institutions. It begins by defining key terms like financial systems and markets. It then describes different types of financial markets including capital markets, money markets, commodity markets, and more. It also outlines various financial institutions like commercial banks, investment banks, insurance companies, and others. The document discusses how funds flow through the financial system directly and indirectly. It also touches on important concepts like asymmetric information, free rider problems, and how financial development relates to economic growth. Finally, it introduces Minsky's financial instability hypothesis and how periods of stability can lead to increased risk-taking and potential financial crises.
Chapter 02_Overview of the Financial SystemRusman Mukhlis
This chapter provides an overview of the financial system, including the functions of financial markets and intermediaries in channeling funds from lenders to borrowers. It describes the structure of markets, such as debt versus equity, and primary versus secondary markets. It also discusses the internationalization of markets and the role of regulation in ensuring stability and transparency.
Week-1 Into to Money and Bankingand Basic Overview of U.S. Fin.docxalanfhall8953
Week-1 Into to Money and Banking
and Basic Overview of U.S. Financial System
Money and Banking Econ 311
Instructor: Thomas L. Thomas
Financial markets transfer funds from people who have excess available funds to people who have a shortage.
They promote grater economic efficiency by channeling funds from people who do not have a productive use for them to those who do.
Well functioning financial markets are a key factor in producing economic growth, where as, poor functioning financial markets are a major reason many countries in the world remain poor.
Financial Markets
A security or financial instrument is a claim on the issuer’s future income or assets.
A bond is a debt security (IOU) that promises to make payments periodically for a specified period of time.
The bond market is especially important economic activity because it enables businesses and the government to borrow and finance their activities and because it is where interest rates are determined.
An interest rate is the cost of borrowing money or the price to rent (use someone else’s) funds.
Because different interest rates tend to move in unison, economist frequently lump interest rates together and refer to the “interest rate”.
Interest rates are important on a number of levels:
High interest rates retard borrowing
High interest rates induce saving.
Lower interest rates induce borrowing
Lower Interest rates retard saving
Information Asymmetry and Information costs
Why Financial Intermediaries
In the neo-classical world economists have argued financial intermediaries are not necessary. Savers (investors) could manage their risks through diversification.
The logic rests on the perfect market assumption – that is investors can always through their own borrowing and lending compose their portfolios as they see fit, without costs. In such a world there are no bankruptcy costs.
In such a world if taken to the extreme, perfect and complete markets imply that there is no need for financial institutions to intermediate in the financial (capital markets) as every investor (saver) has complete information and can contract with the market at the same terms as banks. E.g. Information Asymmetry
Why Financial Intermediaries Bonds
A common stock (usually called stock) represents a share of ownership in a corporation.
It is usually a security that is a claim on the earnings and assets of the corporation.
Issuing stock and selling it to the public (called a public offering) is a way for corporations to raise the funds to finance their activities.
The stock market is the most widely followed financial market in almost every country that has one – that is why it is generally called the market – here “Wall Street.”
The stock market is also an important factor in business investment decisions, because the price of shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending. (Note impact examples..
financial status.com ndasbjd as d ansd nas dnaloganzeck02
Financial markets and institutions play important roles in the economy by facilitating transactions and the efficient allocation of resources. They consist of agents, brokers, and intermediaries that link investors and borrowers. Financial institutions act as intermediaries by collecting funds from savers and channeling them to borrowers. They perform important functions like managing payments, trading securities, modifying the terms of loans (transmutation), diversifying risk, and managing portfolios. This allows for the distribution of risk across the economy and a more efficient allocation of capital over time.
The document provides an overview of the financial system. It discusses the key components and functions of the financial system including financial instruments, markets, institutions, and regulators. The financial system works to channel funds from sectors with surplus to those with shortages. It also provides important services like risk sharing, liquidity, and information. However, the system faces problems of adverse selection and moral hazard due to asymmetric information between borrowers and lenders. Financial intermediaries help address these challenges by reducing transaction and information costs.
The document provides an introduction to financial systems, including definitions, key components, and functions. It discusses that a financial system consists of institutions, markets, instruments, and services that facilitate the transfer of funds. The main components are financial institutions like banks, markets where assets are traded, various financial services, and instruments/assets like stocks, bonds, and mutual funds. Financial systems play an important role in allocating resources and facilitating economic growth.
This document discusses the roles and functions of financial institutions (FIs). FIs connect borrowers and lenders by accepting funds from lenders and loaning them to borrowers. They serve as conduits between savers and users of funds by providing brokerage functions and transforming assets. Specifically, FIs issue securities like deposits that are attractive to savers and use the funds to purchase corporate securities, providing liquidity and reducing risk.
This document discusses investment avenues available in India. It describes the country's financial system, including financial institutions, markets, services and instruments. Various investment avenues are categorized as security forms, non-security forms, traditional forms and emerging avenues. Within security forms, money market securities like treasury bills are explained in detail. The document provides an overview of different savings and investment options for individuals and organizations in India.
This document provides an overview of the Indian financial system. It discusses key components such as financial institutions, financial markets, and financial instruments. It notes that the financial system comprises a variety of intermediaries and markets that transform savings into investments. It also outlines some functions of the financial system like facilitating payments, pooling funds, and managing risk. The document further describes different types of financial institutions, markets, and instruments as well as financial services in India. It concludes by identifying some weaknesses of the Indian financial system.
The financial system allows the flow of funds from savers (surplus spending units) to borrowers (deficit spending units) through financial institutions. It does this by facilitating financial claims like loans and equity investments between these units. The system also enables settlement of transactions through payment systems like banks, ATMs, and EFTPOS. Additionally, it provides information to market participants to make informed investment decisions through credit rating agencies, and allows risks to be transferred and managed through insurance and derivatives. Maintaining an efficient financial system is important for allocating funds to their highest uses and integrating economies, though some countries were less affected by the global financial crisis due to more calibrated financial liberalization.
This document provides an overview of financial institutions and markets. It begins with definitions of key terms like financial markets, debt/interest rates, stock markets, and foreign exchange markets. It then discusses causes of financial crises like banking crises, asset bubbles, international crises, and regulatory failures. The document concludes that financial markets have significant impacts on individuals, businesses, and the overall economy, so it is important to understand these systems and how monetary policy works.
Assignment 1 Discussion QuestionThe management of current asset.docxfredharris32
Assignment 1: Discussion Question
The management of current assets and current liabilities in the short run can lead to several challenges for the financial manager. What are some of the more common challenges or problems encountered by the firm in this regard, and what are the possible solutions? Explain your answers.
Assignment 2: Discussion Question
Financial mangers make decisions today that will affect the firm in the future. The dollars used for investment expenditures made today are different from the cash flows to be realized in the future. What are these differences? What are some of the techniques that can be used to adjust for these differences?
Assignment 3: Discussion Question
Valuation of a firm’s financial assets is said to be based on what is expected in the future, in terms of the future performance of the firm, the industry, and the economy. What types of value would you consider when assigning “value” to a firm’s stock or bond? What is the significance of each of the different types of value in the valuation process? Use examples to support your response.
Assignment 4: Discussion Question
The finance department of a large corporation has evaluated a possible capital project using the NPV method, the Payback Method, and the IRR method. The analysts are puzzled, since the NPV indicated rejection, but the IRR and Payback methods both indicated acceptance. Explain why this conflicting situation might occur and what conclusions the analyst should accept, indicating the shortcomings and the advantages of each method. Assuming the data is correct, which method will most likely provide the most accurate decisions and why?
Course Overview (1 of 3)
Defining Finance
Broadly defined, finance is the study of how people manage scarce resources in general, and money and other financial resources in particular. There are two important features that distinguish financial decisions from other types of decisions. The benefits and costs of financial decisions are spread out over time and usually shrouded in uncertainty.
These decisions are made in a financial environment that includes the financial system, institutions, markets, and participants such as individual households, businesses, and governments. It is important to note that a well developed and properly functioning financial system enables the economy to operate efficiently and contributes to the economic growth and development of the country.
Brief History of Finance
Finance emerged as a separate field of study in the U.S. in the early 1900s. At that time finance was taught primarily as a descriptive subject using anecdotes and rules of thumb. The focus at that time was on the formation of new firms, the various types of securities firms can issue to raise funds and the legal aspects of mergers and acquisitions. This continued to be the focus all through the 1920s.
However, during the 1930s the focus shifted to the study of bankruptcy and reorganization, corporate liqu ...
The document provides an introduction to financial management, including definitions of finance, financial intermediaries, and financial accounts. It discusses how finance deals with concepts like time, money, and risk. It also defines different types of financial intermediaries like insurance companies, mutual funds, investment brokers, and pension funds. Finally, it summarizes the key financial statements - the trading account, profit and loss account, and balance sheet - and explains the rules and objectives of financial accounting.
The Indian financial system consists of financial institutions, markets, instruments, and services that facilitate the flow of funds between savers and borrowers. It mobilizes savings and channels them into productive investments. The key components include commercial banks, insurance companies, stock and money markets. Financial institutions intermediate between surplus and deficit units, while markets allow trading of instruments like stocks, bonds, and currencies. Together they perform vital roles like maturity transformation and risk sharing. Over time, India's financial system has grown in strength, efficiency, and stability through measures like competition, consolidation, and regulation.
introduction to financial intermediaries
working of financial intermediaries
importance of financial intermediaries
for whom financial intermediaries are working?
The document discusses the role of financial systems and stock markets in economic development. It provides an overview of Pakistan's financial system, including the historical dominance of informal finance. While financial reforms in recent decades improved access to formal institutions, stock markets remain underdeveloped in Pakistan. The document analyzes constraints like low interest rates, weak regulation, and political instability that have limited stock market growth. It recommends further reforms like reducing corporate leverage, encouraging bond markets, and improving disclosure to strengthen Pakistan's financial system.
The document provides an overview of the financial system and its key components. It discusses how financial markets and institutions help channel funds from savers to borrowers, allowing for investment and economic growth. It then covers the major types of financial markets and instruments, including debt vs equity markets, primary vs secondary markets, money markets, capital markets, and derivatives. It also discusses the internationalization of financial markets through foreign bonds, Eurobonds, and Eurocurrencies.
This document provides an overview of the key components of the financial system. It discusses the six main parts of the financial system: money, financial instruments, financial markets, financial institutions, regulatory agencies, and central banks. It then describes the core principles of money and banking. Finally, it outlines the structure of the financial industry, including depository institutions like banks, and non-depository institutions like insurance companies, investment banks, and mutual funds.
Financial reporting for financial instruments and institutions is undergoing significant changes as standards have been implemented to improve transparency. These standards require more fair value accounting and enhanced disclosures of risks. To fully analyze financial instruments, users must understand how fair value accounting describes instruments while also considering sensitivity analyses and risk disclosures. Financial institutions provide useful contexts for learning to analyze a variety of financial instrument transactions and histories.
Unveiling the Dynamic Personalities, Key Dates, and Horoscope Insights: Gemin...my Pandit
Explore the fascinating world of the Gemini Zodiac Sign. Discover the unique personality traits, key dates, and horoscope insights of Gemini individuals. Learn how their sociable, communicative nature and boundless curiosity make them the dynamic explorers of the zodiac. Dive into the duality of the Gemini sign and understand their intellectual and adventurous spirit.
Cover Story - China's Investment Leader - Dr. Alyce SUmsthrill
In World Expo 2010 Shanghai – the most visited Expo in the World History
https://www.britannica.com/event/Expo-Shanghai-2010
China’s official organizer of the Expo, CCPIT (China Council for the Promotion of International Trade https://en.ccpit.org/) has chosen Dr. Alyce Su as the Cover Person with Cover Story, in the Expo’s official magazine distributed throughout the Expo, showcasing China’s New Generation of Leaders to the World.
The Most Inspiring Entrepreneurs to Follow in 2024.pdfthesiliconleaders
In a world where the potential of youth innovation remains vastly untouched, there emerges a guiding light in the form of Norm Goldstein, the Founder and CEO of EduNetwork Partners. His dedication to this cause has earned him recognition as a Congressional Leadership Award recipient.
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This PowerPoint compilation offers a comprehensive overview of 20 leading innovation management frameworks and methodologies, selected for their broad applicability across various industries and organizational contexts. These frameworks are valuable resources for a wide range of users, including business professionals, educators, and consultants.
Each framework is presented with visually engaging diagrams and templates, ensuring the content is both informative and appealing. While this compilation is thorough, please note that the slides are intended as supplementary resources and may not be sufficient for standalone instructional purposes.
This compilation is ideal for anyone looking to enhance their understanding of innovation management and drive meaningful change within their organization. Whether you aim to improve product development processes, enhance customer experiences, or drive digital transformation, these frameworks offer valuable insights and tools to help you achieve your goals.
INCLUDED FRAMEWORKS/MODELS:
1. Stanford’s Design Thinking
2. IDEO’s Human-Centered Design
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4. Lean Startup Methodology
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13. The Double Diamond
14. Lean Six Sigma DMAIC
15. TRIZ Problem-Solving Framework
16. Edward de Bono’s Six Thinking Hats
17. Stage-Gate Model
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19. Microsoft’s Digital Transformation Framework
20. Design for Six Sigma (DFSS)
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2. Beginning Quote
“The only certainty in financial
markets is uncertainty”
(Credit Swiss, August 16, 2007)
3. 1.1. What is Financial
Systems?
In this first chapter we want to find a preliminary
answer to two questions.
We want to know what is meant by the
expression the ‘financial system’ and we want
to know what such a system does.
For the purposes of this course, we shall define a
financial system fairly narrowly, to consist of a set
of markets, financial assets and institutions
which trade/traded in those markets and the
supervisory bodies responsible for their regulation
4. 1.1. What is Financial Systems?
The end-users of the system are people and firms
whose desire is to lend and to borrow.
Faced with a desire to lend or borrow, the end-
users of most financial systems have a choice
between three broad approaches:
Firstly, they may decide to deal directly with one
another, though this, as we shall see, is costly,
risky, inefficient and, consequently, not very likely.
5. 1.1. What is Financial
Systems?
Secondly, More typically they may decide to use
one or more of many organized markets.
In these markets, lenders buy the liabilities issued
by borrowers.
If the liability is newly issued, the issuer receives
funds directly from the lender.
More frequently, however, a lender will buy an
existing liability from another lender.
In effect, this refinances the original loan, though
the borrower is completely unaware of this
‘secondary’ transaction.
6. 1.1. What is Financial
Systems?
The best-known markets are the stock exchanges
in major financial centers such as London, New
York and Tokyo.
These and other markets are used by individuals
as well as by financial and non-financial firms.
7. 1.1. What is Financial
Systems?
Thirdly, borrowers and lenders may decide to
deal via institutions or ‘intermediaries’.
In this case lenders have an asset – a bank or
Savings and Loan Associations (S&Ls) and
Mutual Savings Banks, or contributions to a life
assurance or pension fund – which cannot be
traded but can only be returned to the
intermediary.
8. 1.1. What is Financial
Systems?
Similarly, intermediaries create liabilities, typically
in the form of loans, for borrowers.
These too remain in the intermediaries’ balance
sheets until they are repaid.
Intermediaries themselves will also make use of
markets, issuing securities to finance some of
their activities and buying shares and bonds as
part of their asset portfolio.
9. 1.1. What is Financial
Systems?
Generally, a financial system is described as:
channels funds from lenders to borrowers
creates liquidity and money
provides a payments mechanism
provides financial services such as insurance and
pensions
offers portfolio adjustment facilities
10. 1.1. What is Financial
Systems?
Notice that the above description of what a
financial system does is only one way of
answering our second question.
It is the answer that most economists would give
because the activities on which it focuses are
important to the functioning of the economy as a
whole.
Making borrowing and lending cheap and easy
makes it easier for firms to invest and should,
therefore, increase the rate of economic growth.
11. 1.1. What is Financial
Systems?
An efficient payments system makes it easier to
carry out transactions and encourages trade and
exchange.
The quantity of money in circulation, how wealthy
people feel and the liquidity of their wealth are all
potential influences upon the level of aggregate
demand.
12. 1.2. The Role of Financial Systems
in the Economy
The financial system plays the key role in the
economy by stimulating economic growth,
influencing economic performance of the actors,
affecting economic welfare.
This is achieved by financial infrastructure, in
which entities with funds allocate those funds to
those who have potentially more productive ways
to invest those funds.
A financial system makes it possible a more
efficient transfer of funds.
13. 1.2. The Role of Financial Systems
in the Economy
The financial system perform two main types of
financial service that reduce the costs of moving
funds between borrowers and lenders, leading to
a more efficient allocation of resources and faster
economic growth.
These are
a) The provision of liquidity and
b) The transformation of the risk
characteristics of assets.
14. 1.2. The Role of Financial Systems
in the Economy
Provision of liquidity
The link between liquidity and economic performance
arises because many high return investment projects
require long-term commitments of capital,
but risk adverse lenders (savers) are generally
unwilling to delegate control over their savings to
borrowers (investors) for long periods.
Financial systems mobilize savings by agglomerating
and pooling funds from disparate sources and
creating small denomination instruments.
15. 1.2. The Role of Financial Systems
in the Economy
These instruments provide opportunities for
individuals to hold diversified portfolios. Without
pooling individuals and households would have to buy
and sell entire firms.
Financial system can also transform illiquid assets
(long-term capital investments in illiquid production
processes) into liquid liabilities (financial instrument).
With liquid financial markets savers/lenders can hold
assets like equity or bonds, which can be quickly and
easily converted into purchasing power, if they need
to access their savings.
16. 1.2. The Role of Financial Systems
in the Economy
Transformation of the risk characteristics of assets
The second main service financial system provide is
the transformation of the risk characteristics of assets.
Financial systems perform this function in at least two
ways.
First, they can enhance risk diversification
Diversification entails investing in a collection
(portfolio) of assets whose returns do not always
move together, with the result that overall risk is lower
than for individual assets.
17. 1.2. The Role of Financial Systems
in the Economy
Second, they resolve an information asymmetry problem
that may otherwise prevent the exchange of goods and
services, in this case the provision of capital.
Financial systems facilitate risk-sharing by reducing
information and transactions costs.
If there are costs associated with the channeling of funds
between borrowers and lenders, financial systems can
reduce the costs of holding a diversified portfolio of assets.
Intermediaries perform this role by taking advantage of
economies of scale; markets do so by facilitating the broad
offer and trade of assets comprising investors’ portfolios.
18. 1.2. The Role of Financial Systems
in the Economy
Financial systems can reduce information and
transaction costs that arise from an information
asymmetry between borrowers and lenders.
In credit markets an information asymmetry arises
because borrowers generally know more about their
investment projects than lenders.
A borrower may have an entrepreneurial gut feeling
that cannot be communicated to lenders, or more
simply, may have information about a looming
financial risk to their firm that they may not wish to
share with past or potential lenders.
19. 1.3. The Link between Financial
systems and Economic growth
There are two main channels through which
financial systems can have an effect on economic
growth:
1) Capital Accumulation
2) Technological innovation
20. 1.3. The Link between Financial
systems and Economic growth
1) Capital Accumulation
Financial systems affect capital accumulation in
three ways.
First, financial systems lower the cost of
channeling funds between borrowers and
lenders, by reducing information and transaction
costs.
A decline in the cost of accessing finance frees
up resources for other uses, including
consumption, investment and capital
accumulation.
21. 1.3. The Link between Financial
systems and Economic growth
Second, they can alter individuals ‘and
households ‘saving decisions by making long
term investments more attractive.
If financial intermediaries and markets are unable
to convince savers of the soundness of the
investment projects that they are planning for
funding,
savers may choose to consume rather than save
or place their savings in other, less productive
forms.
22. 1.3. The Link between Financial
systems and Economic growth
Third, financial intermediation affects capital
accumulation by reallocating funds to their most
productive uses, which raises the rate of return to
saving.
However, the effects of a change in the rate of
return on saving are ambiguous.
This is because higher rates of return increase
the cost of consumption today or the cost of not
saving, leading to more saving.
23. 1.3. The Link between Financial
systems and Economic growth
2) Technological innovation
Financial systems may affect technological innovation
by allowing diversification.
Financial systems allow savers to obtain their desired
level of exposure to high risk/reward firms, potentially
increasing the level of finance directed at such
activities.
Financial intermediaries are well suited to provide
external finance to new firms that require dramatic
finance because they can credibly commit to
additional funding based on key benchmarks.
24. 1.3. The Link between Financial
systems and Economic growth
Specialized intermediaries can improve the willingness of
savers to provide finance to firms with innovative or novel
business plans through monitoring and oversight activities.
Financial markets are effective at financing industries
where relatively little information or few data are available
or where a diversity of opinion is persistent.
This is because markets allow investors with similar views
to form coalitions to finance a particular investment project.
New investment financed by financial intermediaries or
markets is a channel for the diffusion of new technologies
and productivity gains.
25. 1.4. The Financial Markets
Financial markets are markets in which funds are
transferred from people who have an excess of
available funds to people who have a shortage.
Financial markets such as bond and stock
markets are crucial to promoting greater
economic efficiency by channeling funds from
people who do not have a productive use for
them to those who do.
26. 1.4. The Financial Markets
Indeed, well-functioning financial markets are a
key factor in producing high economic growth,
and poorly performing financial markets are one
reason that many countries in the world remain
desperately poor.
Activities in financial markets also have direct
effects on personal wealth, the behavior of
businesses and consumers, and the cyclical
performance of the economy.
27. 1.4. The Financial Markets
In economics a market is an organizational device
which brings together buyers and sellers.
Authors usually hurry on to point out that a market
does not have to have a physical location, though
plainly it could do so.
For example, until October 1986 trading in stocks
and shares in the UK was concentrated on the
physical location of the London Stock Exchange
trading floor.
With the introduction of new technology, however,
dealers have since dispersed to their companies’
offices.
28. 1.4. The Financial Markets
In fact, financial markets offer some of the best
examples of buyers and sellers interacting over a
widely dispersed geographical area.
Markets for foreign exchange, for example, of
necessity ‘bring together’ buyers and sellers in
different countries.
The latest communication technology now
permits financial institutions in the US to deal in
shares in Tokyo as readily as they can in New
York.
29. 1.4. The Financial Markets
This is not just a technological marvel.
As we shall see when we come to discuss the
regulation of financial activity, the
‘internationalization’ of financial markets has
serious implications.
More formally we can define Financial market
as:
An organizational framework within which
financial instruments can be bought and sold.
30. 1.4.1. Functions of Financial
Markets
Financial markets perform the essential economic
function of channeling funds from households,
firms, and governments that have saved surplus
funds by spending less than their income to those
that have a shortage of funds because they wish
to spend more than their income.
This function is shown schematically in Figure 1.
32. 1.4.1. Functions of Financial
Markets
Indirect Finance: An institution stands
between lender and borrower.
We get a loan from a bank or finance company to
buy a car.
Direct Finance: Borrowers sell securities
directly to lenders in the financial markets.
Direct finance provides financing for
governments and corporations.
.
33. 1.4.1. Functions of Financial
Markets
In direct finance (the route at the bottom of
Figure 1),
Borrowers borrow funds directly from lenders in
financial markets by selling them securities (also
called financial instruments), which are claims
on the borrower’s future income or assets.
Securities are assets for the person who buys
them but liabilities (IOUs or debts) for the
individual or firm that sells (issues) them.
34. 1.4.1. Functions of Financial
Markets
Why is this channeling of funds from savers to
spenders so important to the economy?
The answer is that the people who save are
frequently not the same people who have
profitable investment opportunities available to
them, the entrepreneurs.
Let’s first think about this on a personal level.
35. 1.4.1. Functions of Financial
Markets
Suppose that you have saved Br. 1,000 this year, but
no borrowing or lending is possible because there are
no financial markets.
If you do not have an investment opportunity that will
permit you to earn income with your savings, you will
just hold on to the Br. 1,000 and will earn no interest.
However, Rediet has a productive use for your Br.
1,000: She can use it to purchase a new tool that will
shorten the time it takes her to build a house, thereby
earning an extra Br. 200 per year
36. 1.4.1. Functions of Financial
Markets
If you could get in touch with Rediet, you could
lend her the Br. 1,000 at a rental fee (interest) of
Br. 100 per year, and both of you would be better
off.
You would earn Br. 100 per year on your Br.
1,000, instead of the zero amounts that you
would earn otherwise, while Rediet would earn
Br. 100 more income per year (the Br. 200 extra
earnings per year minus the Br. 100 rental fee for
the use of the funds).
37. 1.4.1. Functions of Financial
Markets
In the absence of financial markets, you and
Rediet might never get together.
Without financial markets, it is hard to transfer
funds from a person who has no investment
opportunities to one who has them; you would
both be stuck with the status quo, and both of you
would be worse off.
Financial markets are thus essential to promoting
economic efficiency.
38. 1.4.1. Functions of Financial
Markets
The existence of financial markets is also beneficial even if
someone borrows for a purpose other than increasing
production in a business.
Say that you are recently married, have a good job, and
want to buy a house. You earn a good salary, but because
you have just started to work, you have not yet saved
much.
Over time, you would have no problem saving enough to
buy the house of your dreams, but by then you would be
too old to get full enjoyment from it.
Without financial markets, you are stuck; you cannot buy
the house and must continue to live in your tiny apartment.
39. 1.4.1. Functions of Financial
Markets
If a financial market were set up so that people who
had built up savings could lend you the funds to buy
the house, you would be more than happy to pay
them some interest in order to own a home while you
are still young enough to enjoy it.
Then, over time, you would pay back your loan.
The overall outcome would be such that you would be
better off, as would the persons who made you the
loan.
They would now earn some interest, whereas they
would not if the financial market did not exist.
40. 1.4.1. Functions of Financial
Markets
Now we can see why financial markets have such
an important function in the economy.
They allow funds to move from people who lack
productive investment opportunities to people
who have such opportunities.
Thus financial markets are critical for producing
an efficient allocation of capital, which contributes
to higher production and efficiency for the overall
economy.
41. 1.4.1. Functions of Financial
Markets
Well-functioning financial markets also directly
improve the well-being of consumers by allowing
them to time their purchases better.
They provide funds to young people to buy what
they need and can eventually afford without
forcing them to wait until they have saved up the
entire purchase price.
Financial markets that are operating efficiently
improve the economic welfare of everyone in the
society
42. 1.4.2. Structure of Financial Markets
Debt and Equity Markets
A firm or an individual can obtain funds in a
financial market in two ways.
The most common method is to issue a debt
instrument, such as a bond or a mortgage,
which is a contractual agreement by the borrower
to pay the holder of the instrument fixed dollar
amounts at regular intervals (interest and
principal payments) until a specified date (the
maturity date), when a final payment is made.
43. 1.4.2. Structure of Financial
Markets
The maturity of a debt instrument is the number
of years (term) until that instrument’s expiration
date.
A debt instrument is short-term if its maturity is
less than a year and long-term if its maturity is
ten years or longer.
Debt instruments with a maturity between one
and ten years are said to be intermediate-term.
44. 1.4.2. Structure of Financial
Markets
The second method of raising funds is by issuing
equities, such as common stock, which are claims to
share in the net income (income after expenses and
taxes) and the assets of a business.
If you own one share of common stock in a company
that has issued one million shares, you are entitled to
one-millionth of the firm’s net income and one-
millionth of the firm’s assets.
Equities often make periodic payments (dividends) to
their holders and are considered long-term securities
because they have no maturity date.
45. 1.4.2. Structure of Financial
Markets
In addition, owning stock means that you own a
portion of the firm and thus have the right to vote
on issues important to the firm and to elect its
directors.
46. 1.4.2. Structure of Financial
Markets
Primary and Secondary Markets
A primary market is a financial market in which new
issues of a security, such as a bond or a stock, are
sold to initial buyers by the corporation or government
agency borrowing the funds.
A secondary market is a financial market in which
securities that have been previously issued (and are
thus secondhand) can be resold.
The primary markets for securities are not well known
to the public because the selling of securities to initial
buyers often takes place behind closed doors.
47. 1.4.2. Structure of Financial
Markets
An important financial institution that assists in the initial
sale of securities in the primary market is the investment
bank.
It does this by underwriting securities: It guarantees a
price for a corporation’s securities and then sells them to
the public.
The New York and American stock exchanges and
NASDAQ, in which previously issued stocks are traded,
are the best-known examples of secondary markets,
although the bond markets, in which previously issued
bonds of major corporations and the U.S. government are
bought and sold, actually have a larger trading volume.
48. 1.4.2. Structure of Financial
Markets
Other examples of secondary markets are foreign
exchange markets, futures markets, and options
markets. Securities brokers and dealers are crucial to
a well-functioning secondary market.
Brokers are agents of investors who match buyers
with sellers of securities; dealers’ link buyers and
sellers by buying and selling securities at stated
prices.
When an individual buys a security in the secondary
market, the person who has sold the security receives
money in exchange for the security, but the
corporation that issued the security acquires no new
funds.
49. 1.4.2. Structure of Financial
Markets
A corporation acquires new funds only when its
securities are first sold in the primary market.
Nonetheless, secondary markets serve two important
functions.
First, they make it easier and quicker to sell these
financial instruments to raise cash; that is, they make
the financial instruments more liquid. The increased
liquidity of these instruments then makes them more
desirable and thus easier for the issuing firm to sell in
the primary market.
Second, they determine the price of the security that
the issuing firm sells in the primary market.
50. 1.4.2. Structure of Financial
Markets
The investors that buy securities in the primary market will
pay the issuing corporation no more than the price they
think the secondary market will set for this security.
The higher the security’s price in the secondary market,
the higher will be the price that the issuing firm will receive
for a new security in the primary market, and hence the
greater the amount of financial capital it can raise
Conditions in the secondary market are therefore the most
relevant to corporations issuing securities. It is for this
reason that most authors that deal with financial markets,
focus on the behavior of secondary markets rather than
primary markets
51. 1.4.2. Structure of Financial
Markets
Organized Exchanges and Over-the-Counter
Markets
Secondary markets can be organized in two
ways.
One is organized exchanges, where buyers and
sellers of securities (or their agents or brokers)
meet in one central location to conduct trades.
The New York and American stock exchanges for
stocks and the Chicago Board of Trade for
commodities (wheat, corn, silver, and other raw
materials) are examples of organized exchanges.
52. 1.4.2. Structure of Financial
Markets
The other method of organizing a secondary market is
to have an over-the counter (OTC) market, in which
dealers at different locations who have an inventory of
securities stand ready to buy and sell securities “over
the counter” to anyone who comes to them and is
willing to accept their prices.
Because over-the-counter dealers are in computer
contact and know the prices set by one another, the
OTC market is very competitive and not very different
from a market with an organized exchange.
53. 1.4.2. Structure of Financial
Markets
Many common stocks are traded over-the-counter,
although a majority of the largest corporations have their
shares traded at organized stock exchanges such as the
New York Stock Exchange.
The U.S. government bond market, with a larger trading
volume than the New York Stock Exchange, is set up as an
over-the-counter market.
Dealers establish a “market” in these securities by
standing ready to buy and sell U.S. government bonds.
Other over-the-counter markets include those that trade
other types of financial instruments such as negotiable
certificates of deposit, federal funds, bankers’
acceptances, and foreign exchange.
54. 1.4.2. Structure of Financial
Markets
Money and Capital Markets
Another way of distinguishing between markets is on
the basis of the maturity of the securities traded in
each market.
The money market is a financial market in which only
short-term debt instruments (generally those with
original maturity of less than one year) are traded;
The capital market is the market in which longer-
term debt (generally those with original maturity of
one year or greater) and equity instruments are
traded.
55. 1.4.2. Structure of Financial
Markets
Money market securities are usually more widely traded
than longer-term securities and so tend to be more liquid.
In addition, short-term securities have smaller fluctuations
in prices than long-term securities, making them safer
investments.
As a result, corporations and banks actively use the money
market to earn interest on surplus funds that they expect to
have only temporarily.
Capital market securities, such as stocks and long-term
bonds, are often held by financial intermediaries such as
insurance companies and pension funds, which have little
uncertainty about the amount of funds they will have
available in the future.
56. 1.5. Financial Institutions
Firms that provide access to the financial
markets, both
to savers who wish to purchase financial
instruments directly and
to borrowers who want to issue them.
Also known as financial intermediaries.
Examples: banks, insurance companies,
securities firms, and pension funds.
Healthy financial institutions open the flow of
resources, increasing the system’s efficiency.
57. 1.5. Financial Institutions
We can divide intermediaries into two broad
categories:
Depository institutions,
Take deposits and make loans
What most people think of as banks, Saving
and loan associations, Mutual Savings Banks
and credit unions.
Non-depository institutions.
Include insurance companies, pension funds,
mutual fund, Money Market Mutual Funds and
financial companies.
58. 1.5.1 The Roles of Financial
Institutions
a) To give savers ready access to their
funds and lenders to lend excess fund
through intermediation.
b) To reduce transaction costs by
specializing in the issuance of
standardized securities.
c) To reduce the information costs of
screening and monitoring borrowers.
d) They curb asymmetries, helping
resources flow to most productive uses.
e) Play significant role in risk sharing at low
cost
59. 1.5.1 The Roles of Financial
Institutions
When we use the term intermediation, the ‘going-
between’ involves more than just introducing the
parties to each other. Something else has to be
provided.
As a general rule, what financial intermediaries
do is: to create assets for savers and liabilities for
borrowers which are more attractive to each than
would be the case if the parties had to deal with
each other directly.
60. 1.5.1 The Roles of Financial
Institutions
What this means is best understood if we consider an
example.
Take the case of a person wishing to borrow Br.
140,000 to buy a house, intending to repay the loan
over twenty years.
Without the help of an intermediary, this person has to
find someone with Br. 140,000 to lend for this period
and at a rate of interest which is mutually agreeable.
The borrower might be successful. In that case, the
lender has an asset (an interest-bearing loan) and the
borrower has a liability (the obligation to pay interest
and repay the loan).
61. 1.5.1 The Roles of Financial
Institutions
In practice, however, even if the would-be borrower
employed a broker, it seems unlikely that the search
would be successful.
There are probably not many people willing to lend Br.
140,000 to a comparative stranger, knowing that they
cannot regain possession of the money for twenty
years.
Even if such a would-be saver were to be found, he
would probably demand such a high rate of interest
as compensation for the risk that no borrower would
contemplate it.
62. 1.5.1 The Roles of Financial
Institutions
Financial intermediary: An organization which
borrows funds from lenders and lends them to
borrowers on terms which are better for both
parties than if they dealt directly with each other.
The process of indirect finance using financial
intermediaries, called financial intermediation,
is the primary route for moving funds from lenders
to borrowers.
63. 1.5.1 The Roles of Financial
Institutions
Indeed, although the media focus much of their
attention on securities markets, particularly the
stock market, financial intermediaries are a far
more important source of financing for
corporations than securities markets are.
Why are financial intermediaries and indirect
finance so important in financial markets?
To answer this question, we need to understand
the role of transaction costs, risk sharing, and
information costs in financial markets.
64. 1.5.1 The Roles of Financial
Institutions
a) Transaction Costs
Transaction costs, the time and money spent in carrying
out financial transactions, are a major problem for people
who have excess funds to lend.
As we have seen, Rediet needs Br. 1,000 for her new tool,
and you know that it is an excellent investment opportunity.
You have the cash and would like to lend her the money,
but to protect your investment; you have to hire a lawyer to
write up the loan contract that specifies how much interest
Rediet will pay you, when she will make these interest
payments, and when she will repay you the Br. 1,000.
65. 1.5.1 The Roles of Financial
Institutions
Obtaining the contract will cost you Br. 500.
When you figure in this transaction cost for making
the loan, you realize that you can’t earn enough from
the deal (you spend Br. 500 to make perhaps Br. 100)
and reluctantly tell Rediet that she will have to look
elsewhere.
This example illustrates that small savers like you or
potential borrowers like Rediet might be frozen out of
financial markets and thus be unable to benefit from
them.
Can anyone come to the rescue? Financial
intermediaries can.
66. 1.5.1 The Roles of Financial
Institutions
Financial intermediaries can substantially reduce
transaction costs because of two reasons:
They have developed expertise in lowering them;
Their large size allows them to take advantage of
economies of scale, the reduction in transaction
costs per dollar of transactions as the size (scale) of
transactions increases.
For example, a bank knows how to find a good
lawyer to produce an airtight loan contract, and this
contract can be used over and over again in its loan
transactions, thus lowering the legal cost per
transaction.
67. 1.5.1 The Roles of Financial
Institutions
Instead of a loan contract (which may not be all
that well written) costing br. 500,
a bank can hire a topflight lawyer for Br. 5,000 to
draw up an airtight loan contract that can be used
for 2,000 loans.
At a cost of Br. 2.50 per loan, it now becomes
profitable for the financial intermediary to lend
Rediet the Br. 1,000.
68. 1.5.1 The Roles of Financial
Institutions
Because financial intermediaries are able to reduce
transaction costs substantially, they make it possible
for you to provide funds indirectly to people like
Rediet with productive investment opportunities.
In addition, a financial intermediary’s low transaction
costs mean that it can provide its customers with
liquidity services, services that make it easier for
customers to conduct transactions.
For example, banks provide depositors with checking
accounts that enable them to pay their bills easily.
69. 1.5.1 The Roles of Financial
Institutions
In addition, depositors can earn interest on
checking and savings accounts and yet still
convert them into goods and services whenever
necessary.
70. b) Risk sharing
Low transaction costs allow financial intermediaries to
do risk sharing at low cost,
enabling them to earn a profit on the spread between
the returns they earn on risky assets and the
payments they make on the assets they have sold.
This process of risk sharing is also sometimes
referred to as asset transformation, because in a
sense, risky assets are turned into safer assets for
investors.
71. 1.5.1 The Roles of Financial
Institutions
Financial intermediaries also promote risk sharing
by helping individuals to diversify and thereby
lower the amount of risk to which they are
exposed.
(Diversification is just another name for the old
adage that “you shouldn’t put all your eggs in one
basket.”)
Low transaction costs allow financial
intermediaries to do this by pooling a collection of
assets into a new asset and then selling it to
individuals.
72. 1.5.1 The Roles of Financial
Institutions
c) Asymmetric Information: Adverse Selection
and Moral Hazard
The presence of transaction costs in financial
markets explains, in part, why financial
intermediaries and indirect finance play such an
important role in financial markets.
An additional reason is that in financial markets,
one party often does not know enough about the
other party to make accurate decisions.
73. 1.5.1 The Roles of Financial
Institutions
This inequality is called asymmetric
information.
For example, a borrower who takes out a loan
usually has better information about the potential
returns and risk associated with the investment
projects for which the funds are earmarked than
the lender does.
Lack of information creates problems in the
financial system on two fronts: before the
transaction is entered into and after.
74. 1.5.1 The Roles of Financial
Institutions
Adverse selection
is the problem created by asymmetric information
before the transaction occurs.
Adverse selection in financial markets occurs when
the potential borrowers who are the most likely to
produce an undesirable (adverse) outcome—the bad
credit risks—are the ones who most actively seek out
a loan and are thus most likely to be selected.
Because adverse selection makes it more likely that
loans might be made to bad credit risks, lenders may
decide not to make any loans even though there are
good credit risks in the marketplace.
75. 1.5.1 The Roles of Financial
Institutions
To understand why adverse selection occurs,
suppose that you have two aunts to whom you might
make a loan—Aunt Lemlem and Aunt Selam.
Lemlem is a conservative type who borrows only
when she has an investment she is quite sure will pay
off.
Selam, by contrast, is an inveterate gambler who has
just come across a get-rich-quick scheme that will
make her a millionaire if she can just borrow Br. 1,000
to invest in it.
Unfortunately, as with most get-rich-quick schemes,
there is a high probability that the investment won’t
pay off and that Aunt Selam will lose the Br. 1,000.
76. 1.5.1 The Roles of Financial
Institutions
Which of your aunts is more likely to call you to ask
for a loan?
Selam, of course, because she has so much to gain if
the investment pays off. You, however, would not
want to make a loan to her because there is a high
probability that her investment will turn sour and she
will be unable to pay you back.
If you knew both your aunts very well—that is, if your
information were not asymmetric—you wouldn’t have
a problem, because you would know that Selam is a
bad risk and so you would not lend to her.
77. 1.5.1 The Roles of Financial
Institutions
Suppose, though, that you don’t know your aunts
well.
You are more likely to lend to Selam than to
Lemlem because Aunt Lemlem would be
hounding you for the loan.
Because of the possibility of adverse selection,
you might decide not to lend to either of your
aunts, even though there are times when Aunt
Lemlem, who is an excellent credit risk, might
need a loan for a worthwhile investment.
78. 1.5.1 The Roles of Financial
Institutions
Moral hazard
is the problem created by asymmetric information
after the transaction occurs.
Moral hazard in financial markets is the risk (hazard)
that the borrower might engage in activities that are
undesirable (immoral) from the lender’s point of view,
because they make it less likely that the loan will be
paid back.
Because moral hazard lowers the probability that the
loan will be repaid, lenders may decide that they
would rather not make a loan.
79. 1.5.1 The Roles of Financial
Institutions
As an example of moral hazard, suppose that you made a
Br. 1,000 loan to another relative, Uncle Melaku, who
needs the money to purchase a word processor so he can
set up a business typing students’ term papers.
Once you have made the loan, however, Uncle Melaku is
more likely to slip off to the track and play the horses.
If he bets on a 20-to-1 long shot and wins with your money,
he is able to pay you back your Br. 1,000 and live high off
the hog with the remaining Br. 19,000. But if he loses, as is
likely, you don’t get paid back, and all he has lost is his
reputation as a reliable, upstanding uncle.
80. 1.5.1 The Roles of Financial
Institutions
Uncle Melaku therefore has an incentive to go to the
track because his gains (Br. 19,000) if he beats
correctly are much greater than the cost to him (his
reputation) if he beats incorrectly.
If you knew what Uncle Melaku was up to, you would
prevent him from going to the track, and he would not
be able to increase the moral hazard.
However, because it is hard for you to keep informed
about his whereabouts— that is, because information
is asymmetric—there is a good chance that Uncle
Melaku will go to the track and you will not get paid
back.
81. 1.5.1 The Roles of Financial
Institutions
The risk of moral hazard might therefore
discourage you from making the $1,000 loan to
Uncle Melaku, even if you were sure that you
would be paid back if he used it to set up his
business.
Now lets see the roles of financial institutions or
intermediaries
82. 1.5.1 The Roles of Financial
Institutions
The problems created by adverse selection and
moral hazard are an important obstacle to well-
functioning financial markets.
Again, financial intermediaries can alleviate these
problems.
With financial intermediaries in the economy, small
savers can provide their funds to the financial markets
by lending these funds to a trustworthy intermediary
say, the Dashen Bank which in turn lends the funds
out either by making loans or by buying securities
such as stocks or bonds.
83. 1.5.1 The Roles of Financial
Institutions
Successful financial intermediaries have higher
earnings on their investments than small savers,
because they are better equipped than individuals to
screen out bad credit risks from good ones, thereby
reducing losses due to adverse selection.
In addition, financial intermediaries have high
earnings because they develop expertise in
monitoring the parties they lend to, thus reducing
losses due to moral hazard.
The result is that financial intermediaries can afford to
pay lender-savers interest or provide substantial
services and still earn a profit.
84. 1.5.1 The Roles of Financial
Institutions
As we have seen, financial intermediaries play an
important role in the economy because they
provide liquidity services, promote risk
sharing, and solve information problems.
The success of financial intermediaries in
performing this role is evidenced by the fact that
most people invest their savings with them and
obtain loans from them.
85. 1.5.1 The Roles of Financial
Institutions
Financial intermediaries play a key role in
improving economic efficiency because they help
financial markets channel funds from lender-
savers to people with productive investment
opportunities.
Without a well-functioning set of financial
intermediaries, it is very hard for an economy to
reach its full potential