Solution Manual for Principles of Corporate Finance 14th Edition by Richard B...
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financial instruments, financial markets, and financial institutions is a financial system of economics of a country
1. ยฉ The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
Chapter 3
Financial Instruments,
Financial Markets,
and Financial Institutions
2. 3-2
The Financial System:
The Big Questions
1. What is a financial instrument and
what is their role in the economy?
2. What are financial markets and how
do they work?
3. What are financial institutions and why
are they so important?
4. 3-4
Preliminaries:
Definitions
Types of Finance
โ Indirect: Institution stands between lender
and borrower.
โ Direct: Borrowers sell securities directly to
lenders in the financial markets
Assets & Liabilities
โ Asset: Something of value that you own
โ Liability: Something you owe.
7. 3-7
Financial Instruments:
Uses
โMeans of Payment
Purchase goods and services
โStore of Value
Transfer purchasing power into the future
โTransfer of Risk
Transfer risk to from one person to another
8. 3-8
โข Builders of big building transfer the risk
of a terrorist attack to someone else.
โข Without terrorism insurance they
donโt build
โข Following 9/11 they couldnโt get it
because no one knew how to price it
โข The government stepped in
as it does for natural disasters
10. 3-10
โข Stock analysts conflict of interest
Accurate information to retail customers
versus
Pump up value of corporate clientsโ stocks
โข The problem was serious in late 1990s
โ Analysts and firms were fined
โ Law was changed to force separation
โข Investors require accurate information
12. 3-12
Financial Instruments:
What Makes Them Valuable?
1. Size of the payment:
Larger ๏ฎ more valuable
2. Timing of payment:
Sooner ๏ฎ more valuable
3. Likelihood payment is made
More likely ๏ฎ more valuable
4. Conditions under with payment is made
When you need it most ๏ฎ more valuable
17. 3-17
Financial Markets:
Roles
โLiquidity:
Ensure owners can buy and sell
financial instruments cheaply.
โInformation:
Pool and communication information about
issuers of financial instruments.
โRisk sharing:
Provide individuals a place to buy and sell risk.
19. 3-19
Financial Market Structure:
Centralized, OTC, and ECNs
Centralized Exchange
Physical location where trading takes place
Over-the-Counter Market (OTC)
Networks of dealers connected electronically
Electronic Communications Network (ECN)
Electronic networks where buyers and sellers
interact directly.
20. 3-20
Financial Market Structure:
Debt, Equity, and Derivatives
Debt and Equity Markets:
Financial claims are bought and sold for
immediate cash payment
Derivative Markets:
Financial claims based on underlying
instruments are bought and sold for
payment at a future date
23. 3-23
โข Investors provide capital when they know
they can get it back.
โข Disparities in investor protection help explain
differences in financial development.
โข Without investor protection a countryโs
financial system does not develop.
โข This hampers growth.
24. 3-24
Financial Institutions:
Their Role
โข Reduce transactions cost by specializing in
the issuance of standardized securities
โข Reduce information costs of screening and
monitoring borrowers.
โข Issue short term liabilities and purchase long-
term loans.
27. 3-27
Financial Industry Structure: I
1. Depository Institutions:
Take deposits and make loans
2. Insurance Companies
Accept premiums, pay out based on events
3. Pension Funds
Invest contributions, provide payments
to retirees
28. 3-28
Financial Industry Structure: II
4. Security Firms
Proved access to financial markets
5. Finance Companies
Raise funds in financial markets, make loans
6. Government Sponsored Enterprises
Raise funds in financial markets, make loans,
provide guarantees.
29. 3-29
โข Get list of mortgage brokers
โข Call around
โข Compare quotes very carefully
โข Get the cheapest one you can find
30. ยฉ The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
Chapter 3
End of Chapter