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© 2006 Thomson Business and Professional Publishing. All rights reserved. T H I R D E D I T I O N PowerPoint Presentation by Charlie Cook The University.

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Presentation on theme: "© 2006 Thomson Business and Professional Publishing. All rights reserved. T H I R D E D I T I O N PowerPoint Presentation by Charlie Cook The University."— Presentation transcript:

1 © 2006 Thomson Business and Professional Publishing. All rights reserved. T H I R D E D I T I O N PowerPoint Presentation by Charlie Cook The University of West Alabama Domestic and International Financial Markets Chapter 3 Unit 1 Introduction

2 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–2 Fundamental Issues 1.What is the main economic function of financial markets? 2.What are primary and secondary markets for financial instruments? 3.What are money markets, and what are key money market instruments? 4.What capital markets, and what are key capital market instruments?

3 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–3 Fundamental Issues (contd) 5.Why has automated financial trading grown, and what are its implications for world financial markets? 6.What are vehicle currencies, and what are the predominant vehicle currencies in international markets?

4 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–4 Access to the powerpoint notes! con367/index.htmhttp://domin.dom.edu/faculty/adjunct/tporebski/e con367/index.htm From there, each chapter is linked to the schedule page. About a chapter a week will be linked.

5 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–5 Saving and Investment The major purpose of financial markets is to channel savings to productive investment Saving: Forgone consumption. Investment: Additions to the stock of capital goods. Capital goods: Goods that may be used to produce other goods or services in the future.

6 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–6 Financial Markets and Instruments Financial instruments (also called securities): What are financial instruments? Just as a surgeon uses tools or instruments, so do people in financial markets, but here the instruments are in the form of paper documents. These instruments connect buyers and sellers Claims that those who lend their savings have on the future incomes of the borrowers who use those funds for investment. Used to undertake crucial exchanges of financial resources Help to reduce risks of financial loss

7 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–7 The Function of Financial Markets Figure 3–1 Financial markets facilitate the transfer of funds from savers to those who wish to invest in capital goods. For instance, companies that wish to undertake investment projects offer financial instruments to savers in exchange for funds to finance the projects.

8 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–8 Ways of classifying financial markets By the type of instrument, such as stocks, bonds, etc Primary and Secondary Financial Markets By term to maturity, money markets and capital markets.

9 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–9 Primary and Secondary Financial Markets Primary market: A financial market in which newly issued financial instruments are purchased and sold. Initial public offerings (IPOs) of stocks are underwritten and marketed by investment banks. Underwrites means the investment bank guarantees the initial fixed share price. Secondary market: A financial market in which financial instruments issued in the past are traded. Brokers: Institutions that specialize in matching buyers and sellers of financial instruments in secondary markets.

10 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–10 Primary and Secondary Financial Markets Secondary markets help make financial instruments more liquid.

11 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–11 Money Markets and Capital Markets Short-term maturity (money markets): Maturity of less than one year. Service current liquidity needs. Intermediate-term maturity (capital markets): Maturity between one year and ten years. Fund long-term capital investments. Long-term maturity (bond markets): Maturity of more than ten years.

12 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–12 Money Market Instruments Treasury bills (T-bills): Short-term debt obligations of the federal government issued with maturities of three, six, or twelve months. No explicit interest payments Sold at a discount Highly liquid, active secondary market Safest of the money market instruments

13 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–13 Money Market Instruments Commercial paper: A short-term debt instrument issued by businesses in lieu of borrowing from banks. Certificates of deposit (CDs): Time deposits issued by banks and other depository institutions that are negotiable instruments traded in secondary markets. Can be resold in secondary market Minimum denomination of $100,000 (in practice, to trade in secondary market the minimum is $2,000,000)

14 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–14 Money Market Instruments (contd) Repurchase agreement A contract to sell a financial asset with the understanding that the seller will buy back the asset at a later date and, typically, at a higher price. Usually the financial asset sold is a government security. –Used by banks and large corporations

15 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–15 Money Market Instruments (contd) Federal funds market: The money market in which banks borrow from and lend to each other deposits that they hold at Federal Reserve banks. Generally very short loans, often overnight Basically a market for excess reserves: banks that are short on excess reserves borrow from banks with such reserves Borrowing bank pays an interest rate known as the Federal Funds rate

16 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–16 Money Market Instruments (contd) Bankers acceptance: A bank loan typically used by a company to finance storage or shipment of goods. Instruments created in course of financing international trade Bankers acceptance is a bank draft, like a check, guaranteeing future payment Active secondary market

17 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–17 Money Market Instruments Outstanding Figure 3–2 SOURCE: Board of Governors of the Federal Reserve System, Federal Reserve Bulletin Statistical Supplement, April 2005.

18 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–18 International Money Markets Capital mobility: The extent to which savers can move funds across national borders for the purpose of buying financial instruments issued in other countries. International money markets: Markets for cross-border exchange of financial instruments with maturities of less than one year. Many such instruments traded, the biggest being the market for foreign exchange. International derivative securities, whose returns are derived from other instruments, are sometimes classified here as well.

19 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–19 The Eurocurrency Markets Eurocurrency markets: Markets for bonds, loans, and deposits denominated in the currency of a given nation but held and traded outside that nations borders. Eurocommercial paper: A short-term debt instrument issued by a firm and denominated in a currency other than that of the country where the firm is located. Eurocurrency deposits: Bank deposits denominated in the currency of one nation but located in a different nation.

20 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–20 Cross-Border Positions of Major World Banks (Exchange-Rate-Adjusted Changes) Table 3–1 SOURCE: Bank for International Settlements, International Banking Statistics, June 2005, and authors estimates.

21 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–21 Foreign Deposits Held at Offices of U.S. Banks. Figure 3–3 SOURCE: Federal Deposit Insurance Corporation, authors estimates.

22 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–22 Capital Market Instruments: Equities Equities: Shares of ownership, such as corporate stock, issued by business firms. Owners of equities are residual claimants on the income and net worth of a corporation, meaning other debt holders of the corporation are paid first. The rate of return on equities varies with the profitability of the firm. Dividends: Periodic payments to holders of corporate equities.

23 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–23 Types of Equities Common stock: Shares of corporate ownership that entitle the owner to vote on management issues but offer no guarantees of dividends or of market value in the event of corporate bankruptcy. Preferred stock: Shares of corporate ownership that entail no voting rights but entitle the owner to dividends if any are paid by the corporation and to any residual value of the corporation after other creditors have been paid.

24 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–24 Stock (Equity) Exchanges Stock exchanges: Organized marketplaces for corporate equities and bonds. New York Stock Exchange (NYSE) The oldest (1792) and largest exchange where roughly half of the stock trading in the United States is doneshares of more than 3,000 companies are traded there. The number of NYSE membership positions, called seats, is fixed at

25 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–25 Stock (Equity) Exchanges Over-the-counter (OTC) stocks: Equity shares offered by companies that do not meet listing requirements for major stock exchanges, or choose not to be listed there, and instead are traded in decentralized markets. National Association of Securities Dealers Automated Quotation (Nasdaq): The electronic network of 500 dealers over which most over-the-counter stocks are traded. Microsoft, Intel, and Cisco trade on this exchange.

26 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–26 Reading Stock Quotations Figure 3–5 52 Week Hi:Highest dollar price of a share of J. P. Morgan Chase common stock during the past 52 weeks, which was $ Week Lo:Lowest dollar price of a share of J. P. Morgan Chase common stock during the past 52 weeks, which was $ Stock:Corporate name of J. P. Morgan Chase. Sym:Symbol identifying J. P. Morgan Chase, which is JPM. Div:Annual dollar dividend per share, which was $1.36 per share. Yld %:Stock yield measured as the annual dividend as a percentage of the closing price for the day, which was $1.36 divided by $35.71 times 100, or approximately 3.8%. PE:Ratio of stock price to the annual earnings per share, which was equal to 30 for J. P. Morgan Chase. Vol 100s:Hundreds of J. P. Morgan Chase shares traded this day, or 9,026,200 shares. Close:Price of J. P. Morgan Chase shares at days end, or $35.71 per share. Net Chg:Dollar change in price of J. P. Morgan Chase shares relative to previous days trading, which was an increase of $0.11.

27 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–27 Capital Market Instruments Corporate bonds: Long-term debt instruments of corporations. Issued by corporations –Usually have excellent credit ratings –Pay interest twice a year and principal at maturity –Maturities range from 2 – 30 years –Convertible bonds can be redeemed for shares of stock

28 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–28 Capital Market Instruments Treasury notes and bonds: Notes have maturities ranging from one to ten years. Bonds have maturities of ten years or more. Issued by U.S. Treasury to finance deficits of federal government Pay semiannual dividends and return of principal at maturity

29 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–29 Capital Market Instruments Securities of U.S. Government Agencies: Long-term bonds issued by various government agencies that support Commercial, residential, & agricultural real estate lending Student loans General National Mortgage Association (GNMA) Ginnie Mae Securities back by the value of household mortgages

30 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–30 Capital Market Instruments (contd) Municipal bonds: Long-term debt instruments issued by state and local governments. Long-term instruments issued by state and local governments to finance expenditures on schools, roads, college dorms and the like. One advantage is tax status: exempt from Federal income tax and also state taxes for investors living in the issuing state.

31 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–31 Capital Market Instruments (contd) Mortgage loans: Long-term loans to individual homeowners or to businesses for purchases of land and buildings. Mortgage-backed securities: Financial instruments whose return is based on the underlying returns on mortgage loans.

32 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–32 Capital Market Instruments (contd) Commercial loans: Long-term loans made by banks to businesses. Consumer loans: Long-term loans made by banks and other institutions to individuals. Not as many secondary markets for these loans

33 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–33 Capital Market Instruments Outstanding. Figure 3–4 SOURCE: Board of Governors of the Federal Reserve System, Federal Reserve Bulletin Statistical Supplement, April 2005; 3.1 Flow of Funds Release, June 9, 2005.

34 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–34 International Capital Markets Euronotes: Medium-term debt instruments issued in a currency other than that of the country where the instruments are issued. Eurobonds: Long-term debt instruments issued in a currency other than that of the country where the instruments are issued.

35 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–35 The Cybertrading Revolution and Its International Ramifications Electronic trading began in the 1990s, companies like etrade.com, etc. Can now buy stocks online Electronic communication networks (ECNs) link buyers and sellers of stock around the world Lower fees and transaction costs Speedier access to market information and trades Lower printing costs to brokerages Some companies now offer commercial paper online.

36 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–36 The Cybertrading Revolution and Its International Ramifications International Cybertrading has taken off CORES: Computer assisted order routing and execution systems, CATS, computer assisted trading system, and many others, all making for computer purchase and sale of securities.

37 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–37 The Cybertrading Revolution and Its International Ramifications International Cybertrading Concerns Rules for securities trading in a global environment: not all nations have the same trading rules Exacerbation of financial uncertainty leading to crises Enforcement of capital controls restricting the ability of a nations residents to hold and trade assets denominated in foreign currencies. Cybertechnology makes such controls more costly and difficult.

38 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–38 Vehicle Currencies Vehicle currency: A commonly accepted currency that is used to denominate a transaction that does not take place in the nation that issues the currency. The U.S. dollar has traditionally been the predominant vehicle for international transactions. Shift is toward the use of multiple currencies (e.g., euro, yen, and pound)

39 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–39 A Timeline of Vehicle Currencies Table 3–4 The U.S. dollar is the latest in a long line of vehicle currencies. SOURCE: Robert Mundell, The International Impact of the Euro and Its Implications for Transition Economies, in Central Banking, Monetary Policies, and the Implications for Transition Economies, ed. Mario Blejer and Marko Skreb (Boston: Kluwer Academic Publishers, 1999), pp. 403–428.

40 © 2006 Thomson Business and Professional Publishing. All rights reserved.3–40 Leading Vehicle Currencies Table 3–5 SOURCE: Data from Bank for International Settlements, International Banking Statistics and Securities Statistics, 2005.


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