Financial Markets. Types of Assets Tangible Assets Value is based on physical properties Examples include buildings, land, machinery Intangible Assets.

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Presentation transcript:

Financial Markets

Types of Assets Tangible Assets Value is based on physical properties Examples include buildings, land, machinery Intangible Assets Claim to future income Examples include various types of financial assets

Types of Financial Assets Bank loans Government bonds Corporate bonds Municipal bonds Foreign bond Common stock Preferred stock Foreign stock

Debt vs. Equity Debt Instruments Fixed dollar payments Examples include loans, bonds Equity Claims Dollar payment is based on earnings Residual claims Examples include common stock, partnership share

Price of Financial Asset and Risk The price or value of a financial asset is equal to the present value of all expected future cash flows. Expected rate of return Risk of expected cash flow

Types of Investment Risks Purchasing power risk or inflation risk Default or credit risk Exchange rate or currency risk

Flow of Funds Provides the ability to transfer income through time Borrowing sacrifices future income to increase current income. Saving, or investing, sacrifices current income in exchange for greater expected income in the future.

Flow of Funds 1. Direct Transfer business sells its stock directly to investors

Flow of Funds 2. Indirect Transfer through Investment Bankers investment banker acts as middleman and facilitates issuance of securities by reselling the securities to savers

Flow of Funds 3. Indirect Transfer through financial intermediary bank or mutual fund obtains funds from savers and uses the money to lend or purchase securities

Role of Financial Assets Transfer funds from surplus units to deficit units. Transfer funds so as to redistribute unavoidable risk associated with cash flows generated from both tangible and intangible assets.

Role of Financial Markets Determine price or required rate of return of asset. Provide liquidity. Reduce transactions costs, which consists of search costs and information costs.

Classification of Financial Markets Debt vs. equity markets Money market vs. capital market Primary vs. secondary market Cash or spot vs. derivatives market Auction vs. over-the-counter vs. intermediated market

Financial Market Participants Households Business units Federal, state, and local governments Government agencies Supranationals Regulators

Globalization of Financial Markets Deregulation or liberalization of financial markets Technological advances Increased institutionalization

Classification of Global Financial Markets Internal Market (also called national market) External Market (also called international market, offshore market, and Euromarket) Domestic MarketForeign Market

Motivation for Using Foreign Markets and Euromarkets Limited fund availability in internal market Reduced cost of funds Diversifying funding sources

Derivatives Market Futures/forward contracts are obligations that must be fulfilled at maturity. Options contracts are rights, not obligations, to either buy (call) or sell (put the underlying financial instrument.

Role of Derivative Instruments Protect against different types of investment risks, such as purchasing power risk, interest rate risk, exchange rate risk. Advantages: Lower transactions costs Faster to carry out transaction Greater liquidity

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