Course:

Financial Markets and Institutions:

Topic # 1: Financial System and Financial Markets:

Introduction:
The financial system is the collection of markets, institutions, laws, regulations and techniques through which bonds, stocks, and other securities are traded, interest rates are determined, and financial services are produced and delivered.

The primary task of the financial system is to move scarce loanable funds from those who save to those who borrow to buy goods and services and to make investments in new equipment and facilities, so that the economy can grow and the standard of living can increase.

FINANCIAL SECTOR

ECONOMIC GROWTH

ENHANCEMENT IN HRD

IMPROVEMENT IN DISTRIBUTION OF INCOME

SOCIETY WELFARE

Types of markets:
1. Equity / Capital Markets 2. Debt Markets

Types of markets:
1. Equity / Capital Markets (Stock Exchanges)

2. Debt Markets (Money Market, Bond Market)

Financial System:
Channel for Savings and Investment
Nature of savings: 1. Households: current income tax payments consumption expenditures 2. Businesses: retained earnings 3. Governments: current revenues expenditures.

Financial System:
Channel for Savings and Investment
Nature of investment (Investment generally refers to the acquisition of capital goods). 1. Households: purchase of a home 2. Businesses: expenditures on capital goods and inventories 3. Governments: building/maintaining public facilities

Financial System:
Channel for Savings and Investment
The financial markets enable the exchange of current income for future income and the transformation of savings into investment so that production, employment, and income can grow, and living standards can improve. The suppliers of funds to the financial system expect not only to recover their original funds but also to earn additional income as a reward for waiting and assuming risk.

Functions performed by Financial System & Markets:

Savings function. The global system of financial
markets and institutions provides a conduit for the publics savings. *Wealth function. The financial instruments sold in the money and capital markets provide an excellent way to store wealth. * Wealth: means accumulated savings built up over time, represents stock of assets.

Liquidity function. Financial markets

Functions performed by Financial System & Markets:

provide liquidity for savers who hold financial instruments but are in need of money. *Liquidity: Immediately spendable cash. Credit function. Financial markets furnish credit to finance consumption and investment spending. Payments function. The financial system provides a mechanism for making payments for goods and services, in the form of currency, checking accounts, debit cards, credit cards, digital cash, etc.

Functions performed by Financial System & Markets:

Risk protection function. The financial markets
offer protection against life, health, property, and income risks, by permitting individuals and institutions to engage in both *risk-sharing and **risk reduction. *Risk Sharing: Occurs when an individual or institution transfers risk exposure to someone willing to accept that risk (such as insurance company). **Risk Reduction: Usually takes place when we diversify our wealth across wide variety of different assets so that our overall losses are likely to be more limited.

Functions performed by Financial System & Markets:

Policy function. The financial
markets are a channel through which government may attempt to stabilize the economy, avoid inflation, create demand for investment, reduce liquidity in market, etc .

Functions performed by Financial System & Markets:

The financial services that are most widely sought by the public include: Payments services Insurance services Credit services Receipt services Agency services

Factors Tying All Financial Markets Together:

*Perfect and efficient markets. There is
some research evidence suggesting that financial markets are closely tied to one another due to their near perfection and efficiency.

Factors Tying All Financial Markets Together:

*Perfect Market: It is one in which the cost of carrying out transaction is zero or nearly zero and all market participants are price takers (rather than being able to dictate prices to the market). In such a market, there are no significant government restriction on trading & movement of funds; rather competition among buyers and sellers set the terms of trade.

Factors Tying All Financial Markets Together:

Efficient Market: In which prices fully reflect the latest available information.

Financial markets in the real world. In the

real world however, market imperfection and information asymmetry exist. Asymmetry Information: Different participants in the markets often operate with different sets of information.

End of topic no. 1