1. Chapter 2 An Overview of the Financial System
Money and Banking
Chapter 2
An Overview of the Financial System

2. Learning Objectives Compare and contrast direct and indirect finance.
Identify the structure and components of financial markets.
List and describe the different types of financial market instruments.
Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries.
List and describe the different types of financial intermediaries.
Identify the reasons for and list the types of financial market regulations.

3. Financial Markets vs. Financial Intermediaries
Financial Markets – bring savers and borrowers directly together
Financial Intermediaries – bring savers and borrowers together indirectly through a middleman such as a bank

5. Financial Markets
Channel funds from economic players that have saved surplus funds to those that have a shortage of funds
Demand Funds
(Investment)
Excess Funds
(Savings)
Financial Markets
(Stocks/Bonds)
Direct finance: borrowers borrow funds directly from lenders in financial markets by selling them securities

6. Structure of Financial Markets
Debt Markets
BONDS : Debt instruments (maturity)
Contractual agreement by the borrower to pay the holder a fixed dollar amount at regular intervals (interest payments)
Maturity of the instrument: number of years until expiration
Short term -- less than one year
Intermediate term – between 1 and 10 years
Long term – more than ten year

7. Structure of Financial Markets
Equity Markets
STOCKS : Equities
If an individual owns one share of common stock out of 100,000 – he owns 1/100,000 of the company
Dividends – periodic payments to shareholders by the company
No maturity – you can sell your stock at any time

8. Structure of Financial Markets
Primary Market
Initial stock/bond issued sold to investment banks
Not well known to public
Investment bank: guarantees a price for the security then sells it to the public (underwriting)
Secondary Market
Stocks/bonds that have already been issued are resold to the public
Stock Exchanges – secondary markets for equities
New York Stock Exchange
Shanghai Stock Exchange
London Stock Exchange
When the stock is resold
Person who sold the stock gets money in exchange
Company that issues the stock does not

9. Structure of Financial Markets
Secondary markets are organized in two ways:
Exchanges -- buyers and sellers of securities meet in one place to conduct the trades
New York Stock Exchange
Over-the-counter (OTC) – dealers are ready to buy/sell securities to anyone that comes to them directly and is willing to accept their price
Thanks to technology – highly competitive market

10. Structure of Financial Markets
Money Market – short-term debt instruments (< 1 year)
US Treasury Bills (1, 3, 6 month bonds)
Bank Certificates of Deposit
Commercial Paper
Federal Funds
Capital Market – longer-term debt instruments (> 1 year) and equity instruments
Stocks
Mortgages/Mortgage backed securities
Corporate Bonds
US Gov’t/Gov’t Agency Securities
State/Local bonds
Consumer/Commerical Loans

11. Money Market Instruments

12. Capital Market Instruments