Chapter 1

Introduction

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Types of Assets
Tangible Assets
Value is based on physical properties
Examples include buildings, land, machinery

Intangible Assets
Claim to future income
Examples include various types of financial

assets

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Types of Financial Assets

Bank loans
Government

Common stock
Preferred stock

bonds
Corporate
bonds
Municipal
bonds
Foreign bond

Foreign stock

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Debt vs. Equity

Debt Instruments
Fixed dollar payments
Examples include loans, bonds

Equity Claims
Dollar payment is based on earnings
Residual claims
Examples include common stock, partnership

share

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Price of Financial Asset and

Risk
The price or value of a financial asset is

equal to the present value of all expected

future cash flows.
Expected rate of return
Risk of expected cash flow

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Types of Investment Risks

Purchasing power risk or inflation risk
Default or credit risk
Exchange rate or currency risk

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Role of Financial Assets

Transfer funds from surplus units to deficit

units.
Transfer funds so as to redistribute
unavoidable risk associated with cash flows
generated from both tangible and
intangible assets.

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Key Points You Should

Understand

Difference between tangible and financial

assets
Difference between debt and equity
Cash flow of a financial asset
Three types of risks associated with
financial asset
Two principal economic functions of
financial assets

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Role of Financial Markets

Determine price or required rate of return

of asset.
Provide liquidity.
Reduce transactions costs, which consists
of search costs and information costs.

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Classification of Financial
Markets
Debt vs. equity markets

Money market vs. capital market

Primary vs. secondary market
Cash or spot vs. derivatives market
Auction vs. over-the-counter vs.

intermediated market

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Financial Market Participants

Households
Business units
Federal, state, and local governments
Government agencies
Supranationals
Regulators

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Key Points You Should

Understand

Three economic functions of financial

markets
Ways that financial markets can be
classified
Market participants

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Globalization of Financial
Markets

Deregulation or liberalization of financial

markets
Technological advances
Increased institutionalization

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Classification of Global
Financial Markets
InternalMarket
(alsocallednational
market)

DomesticMarket

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ExternalMarket
(alsocalledinternational
market,offshoremarket,
andEuromarket)

ForeignMarket

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Motivation for Using Foreign

Markets and Euromarkets
Limited fund availability in internal market
Reduced cost of funds
Diversifying funding sources

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Derivatives Market
Futures/forward contracts are obligations

that must be fulfilled at maturity.

Options contracts are rights, not
obligations, to either buy (call) or sell (put
the underlying financial instrument.

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Role of Derivative
Instruments

Protect against different types of

investment risks, such as purchasing power

risk, interest rate risk, exchange rate risk.
Advantages:
Lower transactions costs
Faster to carry out transaction
Greater liquidity

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Key Points You Should

Understand

Three major factors that have integrated

financial markets
Institutionalization of financial markets
Internal and external markets
Motive to raise money outside of domestic
market
Two basic types of derivatives
Principal economic role of derivatives
Potential uses of derivatives
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Types of Regulation
Disclosure regulation
Financial activity regulation
Regulation of financial institution
Regulation of foreign participation

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Regulation in the United

States
Reasons for regulation
Stock market crash of 1929
Great Depression of 1930s

Regulation primarily by SEC, CFTC,

Treasury, and Federal Reserve

Blueprint for Regulatory Reform
Split regulation by functions
Market stability regulator
Prudential regulator
Business conduct regulator

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Key Points You Should

Understand

Explanation for the existence of regulation

Goals sought in regulation
Major forms of regulation
Blueprint for Regulatory Reform

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All rights reserved. No part of this publication may be reproduced,

stored in a retrieval system, or transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording, or otherwise, without
the prior written permission of the publisher. Printed in the United
States of America.

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