1. Overview of Market Participants & Financial innovation
Chapter 2
Overview of Market Participants & Financial innovation

2. Learning Objective Participants in Financial Markets
Business of Financial institutions
Financial Intermediary
Economic functions of Financial Intermediaries
Asset & Liability management of Financial institutions
Government Regulations
Primary reasons for financial innovation

3. Classification of Entities
Central governments
Agencies of central government
Municipal governments
Supranational
Non- financial businesses
Financial enterprises
households

4. Classification of Entities
Central governments
Debt obligations issued by central Governments carry full faith & credit of the borrowing Government.
Agencies of central government
Federally related institutions, Government sponsored enterprises
Municipal governments
Supranational
An organization that is formed by two or more central governments through international treaties.

5. Classification of Entities
Non- financial businesses
Corporations & non-corporate business
Financial enterprises
households

6. Classification of Entities
Financial intermediaries
Depository institutions-commercial banks, S&L associations and credit unions
Insurance companies
Pension funds

7. Classification of Entities
Financial Enterprises
Exchanging financial assets on behalf of customers. (Brokers)
Exchanging financial assets for their own account. (Dealers)
Assisting in creation of financial assets for their customers and then selling those financial assets to other market participants. (Underwriting)
Providing investment advice to other market participants.
Managing portfolios of other market participants.

8. Role of Financial Intermediaries
Obtain funds by issuing financial claims against themselves to market participants, then investing those funds.
Direct investments- investments made by the financial intermediaries. (assets can be loans /or securities)
Transform financial assets that are less desirable for a large part of the public into other financial assets(their own liabilities ) which are more widely preferred by the public.

9. Role of Financial Intermediaries
This transformation involves four basic economic functions:
Maturity intermediation
Risk reduction and diversification
Reducing the costs of contracting and information processing
Providing a payment mechanism

10. Nature of Liabilities Liability Type Amount of cash outlay
Timing of cash outlay
Type I
Known
Type II
Uncertain
Type III
Type IV

11. Nature of Liabilities Type I liabilities: Fixed deposit account
Guaranteed investment contract (GIC) issued by the insurance companies
Type II:
Life insurance policy

12. Nature of Liabilities Type III liabilities:
Floating rate Certificate of deposits issued by the depository institutions
Type IV liabilities:
Automobile and home insurance policies

13. Liquidity Needs Uncertainty about timing and amount of cash outlays
Potential for the depositor or policy holder to withdraw cash early.

14. Liquidity Needs Reduction in cash inflows:
Depository institutions- inability to obtain deposits
Insurance companies- reduced premium because of the cancellation of policies
Investment companies- not being able to find new buyers for shares.

15. Regulation OF Financial Markets
Disclosure Regulation
Financial Activity Regulation
Regulation of Financial Institutions
Regulation of Foreign Participants

16. Financial Innovation Categorizations of Financial Innovation
Market-broadening Instruments- Increase liquidity of markets and availability of funds by attracting new investors and offering new opportunities for borrowers
Risk- management instruments
reallocate risk to those who are less risk averse.

17. Financial Innovation
Arbitraging instruments and processes- enable investors and borrowers to take advantage of differences in costs and returns between markets.

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