high durable and high capability

1. Chapter 1 & 2
Why study financial markets and institutions?

2. Participants
Participants in the market development process
To understand the framework, discuss
- Roles and wish of each participant

3. Wish lists of each participant
Borrower’s wish list
- Low borrowing cost
- Infrequent interest payments
- No monitoring
- Long maturity
- No collateral
Lender’s Liquidity
provider’s wish list
- High interest rate
- Frequent payments
- Full control over borrower’s use of
borrowed - funds
- Low maturity
- Ample liquid collateral
Liquidity provider’s wish list
- Attractive financial instruments
- Sufficient counterparties to transact with
- Low transaction costs
- Fast and secure settlement process
Regulator’s wish list
- Stable financial markets
- Developed financial markets
- Absence of financial crisis

4. ??
Financial Markets vs Financial Institutions

5. Financial markets
 Definition - Financial market is a platform that
facilitate traders to buy and sell financial
instruments/securities. It is a network where traders
participate to buy and sell their securities.
- Funds are transferred from people with excess funds
to those with shortage

6. Financial markets
Importance
 Mobilize funds from savers to investors thereby
promote economic efficiency
 Helps savers to become potential investors
 Helps business to raise fund thereby expand their
business

7. Financial markets
Functions
 Financial instruments price determination
 Formation of capital/Pooling resources
 Mobilization of funds
 Ensures liquidity
 Risk sharing
 Clearing and settling payments
 Saves time and money thereby decrease transaction
costs

8. Segments of Financial Markets
1. Direct Finance
• Borrowers borrow directly from lenders in financial markets
by selling financial instruments which are claims on the
borrower’s future income or assets
2. Indirect Finance
• Borrowers borrow indirectly from lenders via financial
intermediaries (established to source both loanable funds
and loan opportunities) by issuing financial instruments
which are claims on the borrower’s future income or assets

9.  Money Vs Capital Markets
 Primary Vs Secondary Markets
Exchanged/Organized Vs
Over-the-Counter Markets (OTC)
Broad Classifications of Financial Markets

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

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

12. Organized vs. Over-the-Counter
Markets
 Organized
Organized
 Visible Marketplace
 Members Trade
 Securities Listed
 NewYork Stock Exchange
 OTC
OTC
 Wired Network of Dealers
 No Central, Physical Location
 All Securities Traded off the
Exchanges

13. Flow of funds through the financial system

14. Function of Financial Intermediaries: Indirect Finance

15. - Transactions Costs
1. Financial intermediaries make profits by reducing transactions costs
2. Reduce transactions costs by developing expertise and taking advantage
of economies of scale
- Liquidity Services
A financial intermediary’s low transaction costs mean that it can
provide its customers with liquidity services
1. Banks provide depositors with checking accounts that enable them to pay
their bills easily
2. Depositors can earn interest on checking and savings accounts and yet
still convert them into goods and services whenever necessary
Function of Financial Intermediaries: Indirect Finance

16. - FI’s low transaction costs allow them to reduce the exposure
of investors to risk, through a process known as risk sharing
 FIs create and sell assets with lesser risk to one
party in order to buy assets with greater risk from another party
 This process is referred to as asset transformation, because in a
sense risky assets are turned into safer assets for investors
- Financial intermediaries also help by providing the means for
individuals and businesses to diversify their asset holdings.
Function of Financial Intermediaries: Indirect Finance

17. Types Vs Assets and Liabilities of FIs

18. Overview of Financial System of Bangladesh
Financial system is classified into:
 Formal sector, includes all regulated institutions like Banks, Non-Bank Financial
Institutions (FIs), Insurance Companies, Capital Market Intermediaries like Brokerage
Houses, Merchant Banks etc.; Micro Finance Institutions (MFIs).
 Semi formal sector, includes those institutions which are regulated otherwise but
do not fall under the jurisdiction of Central Bank, Insurance Authority, Securities
and Exchange Commission or any other enacted financial regulator. This sector is
mainly represented by Specialized Financial Institutions like House Building Finance
Corporation (HBFC), Palli Karma Sahayak Foundation (PKSF), Samabay Bank,
Grameen Bank etc., Non Governmental Organizations (NGOs and discrete government
programs.
 Informal sector, includes private intermediaries which are completely
unregulated.

19. Source : Bangladesh Bank

20. Regulation of Financial Markets
Reasons for Regulation
1.Increase Information to Investors
 Decreases adverse selection and moral hazard problems
 SEC forces corporations to disclose information
2.Ensuring the Soundness of Financial Intermediaries
 Prevents financial panics
 Chartering, reporting requirements, restrictions on assets and activities,
deposit insurance, and anti-competitive measures
3.Improving Monetary Control
 Reserve requirements
 Deposit insurance to prevent bank panics

21. Regulation Reason:
Increase Investor Information
 Asymmetric information in financial markets means that investors
may be subject to adverse selection and moral hazard problems that
may hinder the efficient operation of financial markets and may also
keep investors away from financial markets
 The Securities and Exchange Commission (SEC) requires
corporations issuing securities to disclose certain information about
their sales, assets, and earnings to the public and restricts trading by
the largest stockholders (known as insiders) in the corporation
SEC home page https://www.sec.gov.bd/

22. Regulation Reason:
Increase Investor Information
 Such government regulation can reduce adverse selection and moral
hazard problems in financial markets and increase their efficiency by
increasing the amount of information available to investors. Indeed,
the SEC has been particularly active recently in pursuing illegal insider
trading.

23. Regulation Reason: Ensure Soundness of
Financial Intermediaries
 Asymmetric information makes it difficult to evaluate whether the
financial intermediaries are sound or not.
 Can result in panics, bank runs, and failure of intermediaries.

24. Regulation Reason: Ensure Soundness
of Financial Intermediaries (cont.)
 To protect the public and the economy from financial panics, the
government has implemented six types of regulations:
─ Restrictions on Entry
─ Disclosure
─ Restrictions on Assets and Activities
─ Deposit Insurance
─ Limits on Competition
─ Restrictions on Interest Rates

25. Regulation:
Restriction on Entry
 Restrictions on Entry
─ Regulators have created very tight regulations as to who is allowed
to set up a financial intermediary
─ Individuals or groups that want to establish a
financial intermediary, such as a bank or an insurance company,
must obtain a charter from the state or the federal government
─ Only if they are upstanding citizens with impeccable credentials and
a large amount of initial funds will they be given a charter.

26. Regulation: Disclosure
 Disclosure Requirements
 There are stringent reporting requirements for financial
intermediaries
─ Their bookkeeping must follow certain strict principles,
─ Their books are subject to periodic inspection,
─ They must make certain information available to
the public.

27. Regulation: Restriction on
Assets and Activities
 Restrictions on the activities and assets of intermediaries helps to
ensure depositors that their funds are safe and that the bank or other
financial intermediary will be able to meet its obligations.
 Intermediary are restricted from certain risky activities
 And from holding certain risky assets, or at least from holding a
greater quantity of these risky assets than is prudent

28. Regulation Reason:
Improve Monetary Control
 Because banks play a very important role in determining the
supply of money (which in turn affects many aspects of the
economy), much regulation of these financial intermediaries is
intended to improve control over the money supply
 One such regulation is reserve requirements, which make it
obligatory for all depository institutions to keep a certain fraction
of their deposits in accounts with the Bangladesh Bank, the central
bank of Bangladesh
 Reserve requirements help to exercise more precise control over
the money supply

30. Why study Financial markets
Financial markets

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

32. Why Study Financial Markets?
 Well functioning financial markets, such as the bond
market, stock market, and foreign exchange market, are
key factors in producing high economic growth.

33. Why study financial institutions?
 Financial Institutions are the institutions that make
financial markets work
 “Financial Institutions are the intermediaries, that take
funds from the people who save and lend it to people
who have productive investment opportunities”.

34. Revision
Let us take a moment to revisit the four steps of the framework we
introduced earlier in this section:
Define the roles of the four canonical participants.
Examine their incentives for designing, executing, trading, and enforcing
financial contracts.
Identify the obstacles that prevent participants from contracting, trading,
or enforcing.
Describe possible resolutions for contracting obstacles.

35. Write down each participant (borrower, lender, liquidity
provider, and regulator) roles in the left side of the
table below: