Presentation on theme: "Financial Instruments, Markets and Institutions"— Presentation transcript:
1 Financial Instruments, Markets and Institutions 1
2 Summary of Classification of Financial Markets Classification by nature of claim.Debt market; Equity marketClassification by maturity of claim.Money market; Capital marketClassification by seasoning of claim.Primary market; Secondary marketClassification by immediate delivery or future deliveryCash or spot market; Derivative marketClassification by organizational structureAuction market; Over-the-counter market; Intermediated market
3 Financial Instruments and Markets Primary MarketsMarket for issuing a new security and distributing to saver-lenders.Investment Banks—Information and marketing specialists for newly issued securities.Secondary MarketsMarket where existing securities can be exchangedNew York Stock ExchangeAmerican Stock ExchangeOver-the-counter (OTC) markets
4 Bonds Represent Borrowing Agreement by issuer to pay interest on specified dates and redeem the bond upon maturity.ConsolBond with no maturity date, pay interest foreverCoupon SecuritiesMake interest payments – usually semiannually.Zero-couponMake no interest payments.Sold at price well below face value.Tax ExemptInterest earned is not taxed.
5 Stock Represents Ownership StockholdersOwns part of the corporation and receives dividends from the issuer.Capital GainsDifference between price initially paid and amount received when stock is sold.
6 Types of Corporate Stock Preferred StockFixed dividends, priority over common stockCommon StockVariable dividends, based on company’s profits.ConvertiblePreferred stock that can be converted into common stock at a stated price
7 Measures of Trends in Common Stock Prices Standard & Poor’s 500 Stock IndexBased on prices of 500 individual stocksNASDAQ Composite IndexBased on all stocks listed in NASDAQDow Jones Industrial AverageBased on price of 30 “blue-chip” stocks
8 Both stocks and bonds represent a claim to a stream of payments in the future. Bonds—Interest payment and face value at maturityStocks—Dividends and sales price when sold
9 Mortgages Debt incurred in order to buy land or building Amortized—principal and interest is gradually repaid over the life of loanFixed Rate—Rate of interest is fixedVariable-Rate—Rate of interest varies depending on financial environmentCash flow for lender is uncertainInterest payments may vary - variable rate mortgagesHome owner may prepayRefinance a fixed mortgage if interest rates decline
10 MortgagesSecuritization—Individual mortgages may be “pooled” and sold as a unit to reduce uncertainty.Mortgages may be insured by government agenciesFederal Housing Authority (FHA)Veterans Administration (VA)
11 Options and Futures Contracts Contractual agreement between two parties to exchange an asset in the future at a stated priceDerivative financial instrumentsDerive value from underlying assetsLongBuyer of the contract, receive commodity in the futureShortSeller of the contract, provide commodity in the futureSpeculatorsGamble on price fluctuations and hope to profitHedgersEliminate the risk of price fluctuations
12 The Capital MarketExchange of long-term securities—in excess of one yearGenerally used to secure long-term financing for capital investmentStock market—Largest part of capital market and held by private and institutional investorsCorporate bond market—Held by insurance companies, pension and retirement fundsLocal and state government bonds—Primarily held for tax-exempt featureGovernment securities—Held by commercial banks, the Fed, individual Americans/foreigners, and dealers
13 The Money Market Exchange of short-term instruments—less than one year Highly liquid, minimal riskUse of a temporary surplus of funds by banks or businessesU.S. Treasury bills—short-term debts of US governmentBank Certificates of Deposits—liabilities of issuing bank, interest bearing to corporations that hold themCommercial paper—short-term liabilities of prime business firms and finance companiesFederal Funds—Exchange of excess/deficient reserves between banks on an overnight basis.
14 Role of Financial Intermediaries Act as agents in transferring funds from savers-lenders to borrowers-spenders.Acquire funds by issuing their liabilities to public and use money to purchase financial assetsEarn profits on difference between interest paid and earnedDiversify portfolios and minimize riskLower transaction costsCompetition lowers interest rates—beneficial to economic growth
15 Economic Functions of Financial Markets Interactions of buyers and sellers determines price.Price discovery process.Provides a mechanism to sell.Liquidity.Reduces transactions costs.Search costs.Information costs.
16 Commercial Banks Most prominent financial institution Range in size from huge (BankAmerica) to small (local banks)Major sources of fundsused to be demand deposits of publicnow rely more on “other liabilities”also accept savings and time depositsUses of fundsshort-term government securitieslong-term business loanshome mortgages
17 Life Insurance Companies Insure against deathReceive funds in form of premiumsUse of funds is based on mortality statistics—predict when funds will be neededInvest in long-term securities—high yieldLong-term corporate bondsLong-term commercial mortgages
18 Pension and Retirement Funds Concerned with long runReceive funds from working individuals building “nest-egg”Accurate prediction of future use of fundsInvest mainly in long-term corporate bonds and high-grade stock
19 Mutual Funds Stock or bond market related institutions Pool funds from many peopleInvest in wide variety of securities—minimize risk
20 Money Market Mutual Funds Individuals purchase shares in the fundFund invests in highly liquid short-term money market instrumentsLarge-size negotiable CD’sTreasury billsHigh-grade commercial paper
21 Savings and Loan Associations (S&L’s) Traditionally acquired funds through savings depositsUsed funds to make home mortgage loansNow perform same functions as commercial banksissue checking accountsmake consumer and business loans
22 Commercial and Consumer Finance Companies Acquire funds primarily by selling short term loans (commercial paper)Lend money for consumer purchases or business firms to finance inventories
23 Property and Casualty Insurance Companies Insure homeowners and businesses against lossesReceive premiumsNeed to be fairly liquid due to uncertainty of claimsPurchase a variety of securitieshigh-grade stocks and bondsshort-term money market instruments for liquidity
24 Credit UnionsOrganized as cooperatives for people with common interestMembers buy shares [deposits] and can borrowChanges in the law in 1980 broadened their powerschecking [share] accountsmake long-term mortgage loans