Financial Markets & Interest Rates

Financial System Surplus Economic Units Surplus Economic Units Deficit Economic Units Deficit Economic Units

Securities Documents that represent the right to receive funds in future. Documents that represent the right to receive funds in future. Holder of security is the bearer. Holder of security is the bearer. Ease the exchange of funds in financial system. Ease the exchange of funds in financial system. IOU may also state when you are to be paid. IOU may also state when you are to be paid. Trading of securities is done through financial intermediaries. Trading of securities is done through financial intermediaries.

Financial Intermediaries Investment Bankers Investment Bankers Brokers Brokers Dealers Dealers

Investment Bankers Help businesses, state and local government to sell their securities to investors. Underwriting Basis Underwriting Basis Best Effort Basis Best Effort Basis

Brokers Representative of IBs. Representative of IBs. Handle orders to buy and sell securities. Handle orders to buy and sell securities. Commission is provided in lieu of their services. Commission is provided in lieu of their services.

Dealers Make their living by trading of securities. Make their living by trading of securities. Bid Price Bid Price Ask/Offer Price. Ask/Offer Price.

Financial Markets Financial Markets Primary Market Primary Market When a corporation issues securities, cash flows from investors to the firm. When a corporation issues securities, cash flows from investors to the firm. Usually an underwriter is involved Usually an underwriter is involved Secondary Markets Secondary Markets Involve the sale of “used” securities from one investor to another. Involve the sale of “used” securities from one investor to another. Securities may be exchange traded or trade over-the-counter in a dealer market. Securities may be exchange traded or trade over-the-counter in a dealer market.

Financial Markets Money Market Money Market Capital Market Capital Market OTC OTC Market Efficiency Market Efficiency

Securities in Money Market Best Place for the parking of surplus funds for the short period of time. Treasury Bills Treasury Bills Negotiable certificates of deposit Negotiable certificates of deposit Commercial Papers Commercial Papers Euro Dollars Euro Dollars Bankers Acceptance Bankers Acceptance

Treasury Bills Issued by United States on weekly basis. Issued by United States on weekly basis. At maturity government pays the face value. At maturity government pays the face value. Considered as bench mark of safety. Considered as bench mark of safety. Essentially having no risk at all. Essentially having no risk at all.

Negotiable Certificates of Deposit Issued by local banks. Issued by local banks. To be paid on certain date along with interest. To be paid on certain date along with interest. Small denominations are safe investments Small denominations are safe investments Large denominations are negotiable CDs. Large denominations are negotiable CDs.

Commercial Papers Short term promissory notes. Short term promissory notes. Issued by large corporation with strong credit rating. Issued by large corporation with strong credit rating. Unsecured due non existence of collateral. Unsecured due non existence of collateral. Most of the buyers are large institution. Most of the buyers are large institution.

Euro Dollars Banker’s Acceptance

Securities In the Capital Market When organizations want to raise money for a long period of time, they issue capital securities.  Bonds  Stocks

Bonds IOU that promises to pay their owner a certain sun of money along with periodic payments of interest.

Bond Terminology & Types Face Value Face Value The amount that the bond promises to pay in future. Maturity Date Maturity Date The date on which issuer is obligated to pay the face value Coupon Interest Coupon Interest The interest payments made to bond owner during the life of the bond

Treasury Notes & Bonds Municipal Bonds Corporate Bonds

Types Of Bonds Munis Munis General Obligation Bonds General Obligation Bonds Revenue Bonds Revenue Bonds Investment Grade Bonds Investment Grade Bonds Junk Bonds Junk Bonds

Corporate Stock Shares of ownership interest. Shares of ownership interest. Bearer/Investors are called stock holders. Bearer/Investors are called stock holders. Money raised from sale of stock doesn't ever have to be paid back.. Money raised from sale of stock doesn't ever have to be paid back.. Common Stock Common Stock Preferred stock Preferred stock

Interest Interest represents the return or compensation a lender demands before agreeing to loan money.

Determinants of Interest Rate Nominal interest rate Nominal interest rate Real rate of interest Real rate of interest Inflation premium Inflation premium Maturity risk premium Maturity risk premium Liquidity risk premium Liquidity risk premium Default risk Premium Default risk Premium