Financial Markets Why Study Financial Markets?

Financial markets channel funds from savers to investors, thereby, promoting economic efficiency. Financial markets also affect personal wealth and the behavior of business firms.

Overview of the Financial System Borrowers-Spenders Businesses Government Households Foreigners Lenders-Savers Households Businesses Government Foreigners INDIRECT FINANCE DIRECT FINANCE Financial Intermediaries Financial Markets FUNDS

Functions of the Financial System The financial system –Allows transfers of funds from a person or a business without investment opportunities to one who has them. –Improves economic efficiency.

Classification of Financial Markets Debt markets –Short-term (maturity < 1 year) Money Market U.S. Treasury bills, negotiable bank certificates of deposit (large denomination), commercial paper, etc. –Long-term (maturity > 10 years) Capital Market Residential mortgages, corporate bonds, U.S. government securities, State and local bonds, bank commercial loans, etc. Equity markets –Long-term------Corporate stocks

Classification of Financial Markets Primary market –New security issues sold to initial buyers. Secondary market –Securities previously issued bought and sold. Exchanges –Trades conducted in central locations. Over-the-counter markets –Dealers at different locations buy and sell.

Internationalization of Financial Markets International Bond Market –Foreign bonds –Eurobonds Bond denominated in a currency other than the one of the country in which it is sold. –Eurocurrencies Foreign currencies deposited in banks outside the home country. World Stock Markets

Some Regulatory Agencies Securities and Exchange Commission –Requires disclosure of information, restricts insider trading Office of the Comptroller of the Currency –Charters and examines the books of federally chartered commercial banks and imposes restrictions on the assets they can hold. Federal Reserve –Examines the books of commercial banks that are members of the system, sets reserve requirements. State Banking and Insurance Commissions –Charter and examine books of state chartered firms.

Regulation of Financial Markets Three Main Reasons for Regulation: –Increase information to investors SEC forces corporations to disclose information. –Decrease adverse selection and moral hazard problems. –Ensure the soundness of financial intermediaries Chartering, reporting requirements, restrictions on assets and activities, deposit insurance –Prevents financial panics –Improve monetary control