Financial Markets and Institutions 6th Edition

1. PowerPoint Slides for: Financial Markets and Institutions6th Edition By Jeff Madura Prepared by David R. Durst The University of Akron

2. Role of Financial Markets and Institutions 1

3. Chapter Objectives • Describe the types of financial markets • Describe the role of financial institutions with financial markets • Identify the types of financial institutions that facilitate transactions

4. Overview of Financial Markets • Financial markets provide for financial intermediation--financial savings (Surplus Units) to investment (Deficit Units) • Financial markets provide payments system • Financial markets provide means to manage risk Financial Market: a market in which financial assets (securities) such as stocks and bonds can be purchased or sold

5. Overview of Financial Markets • Broad Classifications of Financial Markets Money versus Capital Markets Primary versus Secondary Markets Organized versus Over-the-Counter Markets

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

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

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

9. Securities Traded in Financial Markets • Money Market Securities • Debt securities Only • Capital market securities • Debt and equity securities • Derivative Securities • Financial contracts whose value is derived from the values of underlying assets • Used for hedging (risk reduction) and speculation (risk seeking)

10. Debt vs. Equity Securities Debt Securities: Contractual obligations (IOU) of Debtor (borrower) to Creditor (lender) • Investor receives interest • Capital gain/loss when sold • Maturity date

11. Debt vs. Equity Securities Equity Securities: Claim with ownership rights and responsibilities • Investor receives dividends if declared • Capital gain/loss when sold • No maturity date—need market to sell

12. Valuation of Securities • Value a function of: • Future cash flows • When cash flows are received • Risk of cash flows • Present value of cash flows discounted at the market required rate of return • Value determined by market demand/supply • Value changes with new information

13. Economic Conditions Industry Conditions Impact of Future Cash Flows Evaluation of Security Pricing Investor Decision to Trade Firm Specific Information Investor Assessment of New Information Exhibit 1.3

14. Financial Market Efficiency • Security prices reflect available information • New information is quickly included in security prices • Investors balance liquidity, risk, and return needs

15. Financial Market Regulation • To Promote Efficiency • High level of competition • Efficient payments mechanism • Low cost risk management contracts Why Government Regulation?

16. Financial Market Regulation Why Government Regulation? • To Maintain Financial Market Stability • Prevent market crashes • Circuit breakers • Federal Reserve discount window • Prevent Inflation--Monetary policy • Prevent Excessive Risk Taking by Financial Institutions

17. Financial Market Regulation • To Provide Consumer Protection • Provide adequate disclosure • Set rules for business conduct • To Pursue Social Policies • Transfer income and wealth • Allocate saving to socially desirable areas • Housing • Student loans Why Government Regulation?

18. Financial Market Globalization • Increased international funds flow • Increased disclosure of information • Reduced transaction costs • Reduced foreign regulation on capital flows • Increased privatization Results: Increased financial integration--capital flows to highest expected risk-adjusted return

19. Role of Financial Institutions in Financial Markets • Information processing • Serve special needs of lenders (liabilities) and borrowers (assets) • By denomination and term • By risk and return • Lower transaction cost • Serve to resolve problems of market imperfection

20. Role of Financial Institutions in Financial Markets Types of Depository Financial Institutions Commercial Banks $5 Trillion Total Assets Savings Institutions $1.3 Trillion Total Assets Credit Unions $.5 Trillion Total Assets

21. Types of Nondepository Financial Institutions • Insurance companies • Mutual funds • Pension funds • Securities companies • Finance companies • Security pools

22. Role of Nondepository Financial Institutions • Focused on capital market • Longer-term, higher risk intermediation • Less focus on liquidity • Less regulation • Greater focus on equity investments

23. Trends in Financial Institutions • Rapid growth of mutual funds and pension funds • Increased consolidation of financial institutions via mergers • Increased competition between financial Institutions • Growth of financial conglomerates

24. Global Expansion by Financial Institutions • International expansion • International mergers • Impact of the single European currency • Emerging markets