Financial markets

and Institutions
Introduction
AN OVERVIEW OF FINANCIAL
MARKETS
What is Financial Markets?
Structure of Financial markets?
Instruments traded in Financial markets?
Functions of Financial markets
AN OVERVIEW OF FINANCIAL
MARKETS
Financial Markets are the integral part of
Financial System.

What is Financial System?

What is Financial system?
Its a framework for describing set of markets,
organisations, and individuals that engage
in the transaction of financial instruments
(securities), as well as regulatory institutions.

Market + Organisation + Individuals

What is Financial system?
the basic role of FS is essentially channelling of
funds within the different units of the economy
from surplus units to deficit units for productive
purposes
AN OVERVIEW OF FINANCIAL SYSTEM
1. What is Financial Markets?
Financial markets perform the essential function
of channeling funds from economic players that
have saved surplus funds to those that have a
shortage of funds

At any point in time in an economy, there are

individuals or organizations with excess amounts of
funds, and others with a lack of funds they need for
example to consume or to invest.
Financial Markets cont
Exchange between these two groups of agents
is settled in financial markets

The first group is commonly referred to as

lenders, the second group is commonly referred
to as the borrowers of funds
Financial Markets
There exist two different forms of exchange in financial markets.
The first one is direct finance, & Indirect Finance

Direct Finance in which lenders and borrowers meet directly to

exchange securities.
indirect finance in which financial trade occurs with the help of
financial intermediaries. In this scenario borrowers and lenders
never meet directly, but lenders provide funds to a financial
intermediary such as a bank and those intermediaries
independently pass these funds on to borrowers
What is Securities
Securities are claims on the
borrowers future income or assets.
Common examples are stock, bonds
or foreign exchange
Structure of Financial Markets
Debt vs Equity markets
Primary vs Secondary markets
Exchange vs Over the Counter (OTC)
Money vs Capital Markets
Debt vs Equity
Financial markets are split into debt and
equity market

Debt titles are the most commonly traded security. In

these arrangements, the issuer of the title (borrower)
earns some initial amount of money (such as the
price of a bond) and the holder (lender) subsequently
receives a fixed amount of payments over a
specified period of time, known as the maturity of a
debt title
Specimen of Debt Instrument
Properties of Debt
initial amount of money (such as the price of
a bond)
a fixed amount of payments (Interest Rate)
a specified period of time, known as the
maturity of a debt title.
Debt Securities
Debt titles can be issued on
short term (maturity < 1 yr.),
long term (maturity >10 yrs.)
and intermediate terms (1 yr. < maturity < 10 yrs.).
The holder of a debt title does not achieve
ownership of the borrowers enterprise.

Common debt titles are bonds or mortgages.

Equity Securities
An instrument that signifies an ownership position
(called equity) in a corporation, and represents a
claim on its proportional share in the corporation's
assets and profits
The most common equity title is (common) stock.
an equity instruments makes its buyer (lender) an
owner of the borrowers enterprise
Equity titles do not expire and their maturity
is, thus, infinite. Hence they are considered
long term securities.
Equity Securities
For example, if a company has 1000 shares of
stock outstanding and a person owns 50 of them,
then he/she owns 5% of the company.
Primary Market Vs Secondary market
Primary markets are markets in which financial
instruments are newly issued by borrowers
Secondary markets are markets in which
financial instruments already in existence are
traded among lenders
Primary Markets
The primary markets are where investors can get
first crack at a new security issuance. The issuing
company or group receives cash proceeds from
the sale, which is then used to fund operations
or expand the business
Secondary market
Secondary markets can be organized as
exchanges, in which titles are traded in a
central location, such as a stock exchange, or
alternatively as over-the-counter markets in
which titles are sold in several locations.
Exchange vs Over the Counter (OTC)

Exchange acts as a market where stock buyers

connect with stock sellers
The primary function of an exchange is to help
provide liquidity; in other words, to give sellers a
place to "liquidate" their share holdings.
(OTC) refers to markets other than the organized
exchanges described above. OTC markets
generally list small companies, and often (but
not always) these companies have "fallen off" to
the OTC market because they were delisted from
stock exchanges
OTC
In general, the reason for which a stock is traded
over-the-counter is usually because the company
is small, making it unable to meet exchange
listing requirements.
Also known as "unlisted stock", these securities
are traded by broker-dealers who negotiate
directly with one another over computer
networks and by phone
MONEY MARKETS VS CAPITAL MARKETS
Money markets are markets in which only
short term debt titles are traded.

Capital markets are markets in which

longer term debt and equity
instruments are traded
Money Market
The money market provides very short-term
funds to corporations, municipalities and the
United States government. Money market
securities are debt issues with maturities of one
year or less
Capital Market
The capital market is a source of intermediate-term
to long-term financing in the form of equity or debt
securities with maturities of more than one year.
Its a Markets for buying and selling equity and debt
instruments
Capital markets channel savings and investment
between suppliers of capital such as retail investors
and institutional investors, and users of capital like
businesses, government and individuals
Capital Market
Capital markets typically involve issuing
instruments such as stocks and bonds for the
medium-term and long-term.
Capital markets typically involve issuing
instruments such as stocks and bonds for the
medium-term and long-term.
Suppliers of capital generally want the
maximum possible return at the lowest possible
risk, while users of capital want to raise capital
at the lowest possible cost.
Functions of Financial markets
Borrowing and Lending
Financial markets channel funds from households, firms,
governments and foreigners that have saved surplus funds to
those who encounter a shortage of funds (for purposes of
consumption and investment)

Price Determination
Financial markets determine the prices of financial assets. The
secondary market herein plays an important role in
determining the prices for newly issued assets
Functions of Financial markets
Coordination and Provision of Information
The exchange of funds is characterized by a high amount of
incomplete and asymmetric information. Financial markets collect
and provide much information to facilitate this exchange.

Risk Sharing
Trade in financial markets is partly motivated by the transfer of risk
from borrowers to lenders who use the obtained funds to invest
Functions of Financial markets
Liquidity
The existence of financial markets enables the owners of assets
to buy and resell these assets. Generally this leads to an
increase in the liquidity of these financial instruments

Efficiency
The facilitation of financial transactions through financial
markets lead to a decrease in informational cost and
transaction costs, which from an economic point of view leads
to an increase in efficiency.
II.FINANCIAL INSTITUTIONS
What are Financial Institutions?
Financial Institutions and their function
Types of Financial Institutions
What are Financial Institutions?
An establishment that focuses on dealing with
financial transactions, such as investments,
loans and deposits
Conventionally, financial institutions are
composed of organizations such as banks, trust
companies, insurance companies and
investment dealers
Financial Institution
Financial Institutions classified in four
categories

Brokers Engage in trade in securities

Dealers
(direct finance)
Investment banks

Financial intermediaries Engage in financial asset

transformation (indirect
finance)
Brokers
Brokers are agents who match buyers with
sellers for a desired transaction
A broker does not take position in the assets she/he trades (i.e.
does not maintain inventories of those assets)

Brokers charge commissions on buyers and/or sellers using their

services

Examples: Real estate brokers, stock brokers

Dealers
Like brokers, dealers match sellers and buyers
of financial assets
Dealers, however, take position in their assets, their trading.

As opposed to charging commission, dealers obtain their profits from

buying assets at low prices and selling them at high prices.

A dealers profit margin, the so-called bid-ask spread is the

difference between the price at which a dealer offers to sell an asset
(the asked price) and the price at which a dealer offers to buy an
asset (the bid price)
Investment Banks
Investment banks assist in the initial sale of
newly issued securities (e.g. IPOs)
Investment banks are involved in a variety of
services for their customers, such as advice,
sales assistance and underwriting of issuances
Investment banks help corporations issue new
shares of stock in an initial public offering or
follow-on offering. They also help corporations
obtain debt financing by finding investors for
corporate bonds
Financial intermediaries
Financial intermediaries are firms that collect
the funds from lenders and channel those funds
to borrowers
Financial intermediaries match sellers and
buyers indirectly through the process of
financial asset transformation
Financial intermediaries
There are roughly three classes of financial
intermediaries:
Depository institutions accept deposits from savers and
transform them into loans (Commercial banks, savings and
loan associations, mutual savings banks and credit unions)

Contractual savings institutions acquire funds at periodic

intervals on a contractual basis (insurance and pension funds)

Investment intermediaries serve different forms of

finance. They include finance companies, mutual funds
and money market mutual funds.
 Savings and Loans Associations (S&L)
Depository
Institutions Mutual Saving Banks

Credit Unions

Specialized Banks

Contractual
savings Insurance Companies
Institutions
Pension Funds

Finance Companies
Investment
Intermedarie
s Mutual Funds (Investment Funds)