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2.WEEK

2.WEEK. INTRODUCTION TO FINANCIAL MARKETS, INSTITUTIONS AND INSTRUMENTS. Why study Financial Markets and Institutions?. Prudent investment and financing requires a full understanding of the structure of domestic and international markets

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2.WEEK

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  1. 2.WEEK INTRODUCTION TO FINANCIAL MARKETS, INSTITUTIONS AND INSTRUMENTS

  2. Why study Financial Markets and Institutions? • Prudent investment and financing requires a full understanding of • the structure of domestic and international markets • the flow of funds through domestic and international markets • the strategies used to manage risks faced by investors and savers

  3. FINANCIAL SYSTEM • Financial markets • Financial institutions & İndividuals • Financial assets (instruments, securities) • Rules and regulations

  4. Financial Markets • Financial markets are structures through which funds flow. • Financial markets consist of - fund suppliers or lenders - fund demanders or borrowers - financials instruments (fin assets, securities) - financial institutions (intermediaries)

  5. Types of Financial Markets • Money market • Foreign exchange market • Stock market • Bonds and bills market • Derivatives market • Gold market

  6. Types of Fınancıal Markets cont. • Financial markets can be distinguished along three dimensions • primary versus secondary markets • money versus capital markets • organized versus over the counter markets

  7. Primary versus Secondary Markets • Primary markets • markets in which users of funds (e.g., corporations and governments) raise funds by issuing financial instruments (e.g., stocks and bonds) • Secondary markets • markets where financial instruments are traded among investors (e.g., NYSE and Nasdaq)

  8. Money versus Capital Markets • Money markets • markets that trade debt securities with maturities of one year or less (e.g., CDs and U.S. Treasury bills) • Capital markets • markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year

  9. Organized markets Have a central physical location Commission Registration is required Controlling system: Formal Customers’ orders provide liquidity Listing OTC markets No physical location No commission No need for registration Any controlling system: Informal Dealers No listing (except NASDAQ) Organized versus Over the Counter(OTC) Markets

  10. Money Market Instruments Outstanding, ($Bn)

  11. Capital Market Instruments Outstanding, ($Bn)

  12. Foreign Exchange (FX) Markets • FX markets • trading one currency for another (e.g., dollar for yen) • Spot FX • the immediate exchange of currencies at current exchange rates • Forward FX • the exchange of currencies in the future on a specific date and at a pre-specified exchange rate

  13. DerivativeSecurityMarkets • Derivative security • a financial security whose payoff is linked to (i.e., “derived” from) another security or commodity • generally an agreement between two parties to exchange a standard quantity of assets at a predetermined price on a specific date in the future

  14. The Role (Economic Functions)of Financial Markets • They provide a mechanism for determinig the price of financial assets: Price discovery process, Efficiency of Financial Markets. • They make assets more liquid. • They reduce cost of exchanging assets: Search costs, Information costs.

  15. Financial Institutions (FIs) • Financial Institutions • institutions through which suppliers channel money to users of funds • Financial Institutions are distinguished by whether they accept deposits • depository versus non-depository financial institutions

  16. Depository versus Non-Depository FIs • Depository institutions • commercial banks, savings associations, savings banks, credit unions • Non-depository institutions • insurance companies, securities firms and investment banks, mutual funds, pension funds

  17. Flow of Funds in a World without FIs: Direct Transfer Financial Claims (equity and debt instruments) Suppliers of Funds (households) Users of Funds (corporations) Cash

  18. Flow of Funds in a World with FIs FIs (brokers) FIs (asset transformers) Users of Funds Suppliers of Funds Cash Cash Financial Claims (equity and debt securities) Financial Claims (deposits and insurance policies)

  19. Services that are provided by FIs • Transform fin. assets acquired into assets that are more attractive to the public. (Fin. Intermediaries) • Exchange fin. Assets on the behalf of others (Brokers) • Exchange fin. Assets for their own. (Dealers) • Assists in the creation of fin. assets for their customers and then sell these fin. assets to others.(underwriting) • Provide inv. advices • Provide portfolio management

  20. FIs Benefit Suppliers of Funds • Reduce monitoring costs • Increase liquidity and lower price risk • Reduce transaction costs • Provide maturity intermediation • Provide denomination intermediation

  21. FIs Benefit the Overall Economy • Conduit through which Federal Reserve conducts monetary policy • Provides efficient credit allocation • Provide for intergenerational wealth transfers • Provide payment services

  22. Credit Foreign exchange Country or sovereign Interest rate Market Off-balance-sheet Liquidity Technology Operational Insolvency Risks Faced by Financial Institutions

  23. Financial Assets • An asset is any possession that has value in exchange. • Tangible-intangible assets • Financial assets= Financial Instruments=Securities are intangible assets. • Issuer: The entitiy that agrees to make future cash payments. • Investor: The owner of the financial asset.

  24. Examples of Fin. Assets • The bond issed by the Turkish governmnet • The bond issued by Koç Holding • An automibile loan. • A home mortgage. • Common Stock issued by a company.

  25. Debt vs Equity Claims • Debt Claims (Debt Instruments)= Fixed Income securities= Bonds • Equity Claims (Residual claims)=Common Stock • There are also preferred stock, convertible bonds.

  26. The Role of Financial Assets • Fin Assets has two economic functions; 1. Transfering of funds who have surplus of funds to those who need funds to invest in tangible assets. 2. Transferring funds in such a way that redistributes the unavoidable risk associated with the CF generated by the tangible assets among those seeking and those providing the funds.

  27. Regulation of Financial Institutions • FIs are heavily regulated to protect society at large from market failures • Regulations impose a burden on FIs and recent U.S. regulatory changes have been deregulatory in nature • Regulators attempt to maximize social welfare while minimizing the burden imposed by regulation

  28. Globalization of Financial Markets and Institutions • The pool of savings from foreign investors is increasing and investors look to diversify globally now more than ever before • Information on foreign markets and investments is becoming readily accessible and deregulation across the globe is allowing even greater access • International mutual funds allow diversified foreign investment with low transactions costs

  29. Globalization of Financial Markets and Institutions cont. • Foreign Markets: Foreigners can issue securities in other country markets, subject to national regulations. For example, Japanese firms can issue dollar-dominated securities in the United States but they must follow U.S. regulations, which apply to nationals and foreigners alike.

  30. Globalization of Financial Markets and Institutions cont. International (Off shore or Euro) Market: • Securities are issued outside the jurisdiction of any country. • The motivation for foreign and Eurodollar is that many underdeveloped nations simply do not have a sizable capital market to meet their funds needs. Also Eurodollar loans are often less expensive since institutions holding such funds are not hampered by regulations.

  31. Financial Innovation Categorizations of Financial Innovation; • Market-broadening Instruments • Risk management instruments, • Arbitraging instruments

  32. Motivation for Financial Innovation • Increased volatility of interest rates, inflation, equity prices, exchange rates. • Advances in computer&telecomminication technologies. • Greater sophistication and educational training among professional market participants. • Financial intermediary competition. • Incentives to get around existing regulation and tax laws. • Changing global patterns of financial wealth

  33. Asset Securitization It involves tha collection or pooling of loans and sale of securities backed by those loans.

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