1- Financial Instruments, Financial Markets, And Financial 1 d

8/19/2019 1- Financial Instruments, Financial Markets, And Financial 1 d

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Financial Instruments, FinancialMarkets, and Financial

Institutions


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• Well-functioning nancial markets are an essentpart of any modern healthy economy

• funds are oered by the lenders/savers ho have!cess funds and purchased by the

borroers/spenders ho need those funds• direct fnance- when borrowers and lenders

meet directly

• Indirect fnance- when borrowers and lendemeet through fnancial intermediary


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• "hrough these markets the funds #o that

for the development of ne products/ideas,e!pansion of the production of e!isting prodand consumer spending on $big ticket$ itemlike houses, cars, and college tuition

• Without these markets, rms may be unable

e!pand production or invent ne products aconsumers ill be unable to aord certainproducts%


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Financial Instruments

• transfer of available funds

• buying and selling of fnancial instrumentssecurities

• A fnancial instrument is the written legalobligation o one party to transer somethingvalue, usually money, to another party at som uture date, under certain conditions.


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Financial Instruments

• '( binding, enforceable contract under the rule la, protecting potential buyers%

• )( transfer of value beteen to parties, here party can be a bank, insurance company, a

government, a rm, or an individual%

• "he future dates may be very specic *like a momortgage payment( or may be +uite uncertain adepend on certain events *like an insurance poli


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Financial instruments

• can function as a means of payment or a store of

• means of payment

• fall ell short of money in terms of li+uidity, divis

and acceptance• better stores of value since they allo for greater

increases in ealth over time, but ith higher levrisk


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• ( function of these instruments is risktransfer

• buyers are shifting risk to the seller

• paying the seller to assume certain risk

• !% insurance


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• standardi.ed in that they have the samobligations and contract for buyers

• !% tocks, loans

• 0niformity reduce cost


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• provide certain relevant information abthe issuer, the characteristics and the rof the security

• even the playing eld among dierentparties and reduce unfair advantages


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Financial instruments• si.e, timing and certainty of cash #os are all importa

• The larger amount promised, the greater the valu

• The sooner the payments are promised, the greathe value

• The more certain the payments, the greater the v

• The more needed the payment, the greater the va• Ex. insurance


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1sset class

Instrument type

ecurities 2ther cash!change-tradedderivatives

4ebt *longterm(5 ' year

6onds 7oans6ond futures2ptions onbond futures

4ebt *shortterm(8 ' year

6ills, e%g% "-bills3ommercialpaper

4eposits3erticates ofdeposit

hortterm interestrate futures

+uity tock 9/1 tock options+uity futures

http://en%ikipedia%org/iki/Financial;instrument


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Financial Marets

• many markets, each dealing ith aparticular type of nancial instrument

• providing a mechanism for +uickly and

cheap buying and selling of securities• nancial markets oer liquidity


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Financial Marets

• interaction of buyers and sellers todetermine the price

• price conveys important inormation ab

the prospects of the issuer• mechanism for buying and selling the

instruments that transer risks beteenbuyers and sellers%


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Primary vs. Secondary Marke

• primary maret are brand ne, or neissues

• sold to the buyer by the issuer

• "econdary- resold by the previous buy


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• primary market, investment bans assibusiness in selling a ne issue to the pub

• Investment banks underwrite ne secur

meaning that they buy the ne issue frombusiness and sell it to the public

• banks charge fees for this service


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• the secondary market

• ecurities broers facilitate trade bymatch buyers ith sellers

• commission on each match *or trade(%


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• ecurities dealers act as the buyer and sel

• +uoting a price at hich they ill buy asecurity *the bid price( and the price at

they ill sell the security *the as price(%• dierence is knon as the bid-as spread

• ho dealers make their money


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• dealers are often referred to as $markemakers<

• $make a market$ in that security

• on an inventory of the securities


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• the better the secondary market, the betteprimary market%

• li#uidity

• If, for e!ample, Microsoft stock is easy to and sell in the secondary market *highly lithen it ill be popular in the primary mark


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Exchanges vs. OTC Market

• buying and selling occurs in a central,physical location, then securities are tron an exchange%

• !% =


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• dispersed buyers and sellers, linked bycomputer% "his is knon as an over-thecounter *2"3( market

• "oday 2"3 markets link buyers and selelectronically through dealers

• !% =4>, 9141?


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• 39s or electronic communicationnetorks oer yet a third option for buand seller to nd each other directly i

no dealer or broker


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Debt vs. Equity vs. Derivative Mar

• debt instruments, like a bond or a bankloan, involve a promise by the borroepay the lender%

• !ed payments at specied intervals unnal date

• "he time until all payments are made isknon as the maturity


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• "hort-term debt securities have a maturityup to ' year% "his part of the debt market is knon as the money maret.

•

Intermediate-term debt securities have amaturity of beteen ' and '@ years%

• $ong-term debt securities have a maturity years or more%


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• +uity instruments

• shares of common stock

• claims on the earnings and assets of a

corporation• ntitled to the percentage that you are

holding


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•

the si.e and timing of the payments are not !edome e+uities securities entitle the oner to perpayments *knon as dividends( but these paymare not guaranteed% "his means that e+uity holdbenet from a rmAs protability in a ay that deholders do not%

• there is no maturity date for e+uity securities soare considered long-term securities

• stock holders are considered residual claimantthe event of bankruptcy%


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• 4erivatives markets

• value from other underlying assets


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• Financial Institutions

• Depository nstitutions

• !on"depository nstitutions


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• Depository nstitutions

•

%ommercial bans- include commercial loanconsumer loans, mortgages, 0%% governmentbonds, municipal bonds%

• "avings and $oan &ssociations- originallyrestricted to oering savings accounts and 34making mortgage loans *Mutual "avings ban

• %redit 'nions - are nonprot and credit uniomembership is organi.ed around a particular gsuch as company employees, a union, or even church parish


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• !on"depository nstitutions

• $i(e insurance companies - buyer of corpobonds and mortgages *long term(

• Fire and casualty insurance -less predictabthan life insurance% assets are more li+uid thainsurance companies, municipal bonds, corpobonds, stocks, and 0%% government bonds


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• )ension (unds - private or government *BI(, assets are more long term

• Finance companies - raise funds by usingcommercial paper, then use these funds to mbusiness loans, construction loans, auto loanand other consumer loans

-e!% B Finance 3ompany


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• "ecurities frms - brokers, investmentbanking/underriting and mutual fund

• Mutual funds- for diversication purposes

•Money maret mutual (unds - buy monemarket instruments, like interest bearingchecking account


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• *"Es or *overnment-sponsoredenterprises - Fannie Mae *homemortgages(, allie Mae, Freddie Mac

1- Financial Instruments, Financial Markets, And Financial 1 d

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