1. Institutions & Derivative Instruments
Financial Markets,
Institutions & Derivative Instruments
ECO 473 – Money & Banking – Dr. D. Foster

2. Economic Functions of Financial Markets
Match savers and investors
Savers want to  wealth
Investors want to create wealth
Spread/share risk.
Successful strategy - diversification
Savers seek out mutual funds
Savers seek out financial intermediaries
Investors seek OPM

3. Financial Markets - Why & Who
Why - Intermediation
Who . . .
banks
credit unions
S&Ls
thrifts
savings banks
pension funds
Insurance companies
mutual funds
mortgage brokers
investment bankers
finance companies

4. Government Players Federal Financing Bank Banks for Cooperatives
Federal Intermediate Credit Banks
Federal Land Banks Federal National Mortgage Association
(FNMA, or “Fannie Mae”)
General National Mortgage Association
(GNMA, or “Ginnie Mae”)
Federal Home Loan Banks (FHLBs)
Federal Home Loan Mortgage Corporation
(FHLMC, or “Freddie Mac”)

5. Financial Markets - New & Used
New - Primary Markets
stocks (IPO), bonds, mortgages, other.
Used - Secondary Markets
exchange of ownership.
Where: NYSE, NASDAQ, OTC . . .

6. Financial Markets - Short & Long
Short - Money Markets
A financial instrument that matures w/in one year.
Used to facilitate liquidity demands.
Need funds soon.
Have excess cash.
Fed’l funds
Repurchase agreements
Bankers’ acceptances
Euro$ funds
3 mo. & 6 mo. T-Bills
Commercial paper
Bank CDs

7. Money Market Instruments Outstanding, 2000-2012

8. Financial Markets - Short & Long
Long - Capital Markets
Maturities of more than one year.
Used for capital purchases (investment).
Less liquid & more risk than MM.
Corporate stock
Corporate bonds
U.S. Treasury bonds
Other U.S. & Munis
Mortgages
Comm./Con. loans

9. Capital Market Instruments Outstanding, 2012

10. What Assets Should Savers Hold?
: Stocks 8% real; bonds 2% real
Stocks returns are more volatile.
Trade-off is between risk and return.
Age is an issue.
Can you pick stocks?
No - Efficient Market Hypothesis.
There can’t be systematically undervalued securities. 10

11. Financial Institutions
Mutual Funds
Sell diversification to individual savers.
Government regulations limit risks.
8,000 mutual funds in the United States.
Hedge Funds
Raise money from wealthy people/institutions
Largely unregulated
Use leverage which magnifies gains/losses.
Trade in derivative instruments. 11 11

12. Brokers and Dealers Investment Banks
A broker buys and sells securities for others
May be “full service” or “discount.”
A dealer buys and sells for itself, making a market in these securities.
Investment Banks
Underwrites and advises companies on mergers and acquisitions.
Investment banks buy and sell securities and derivatives. 12

13. The End of Investment Banks?
1930s regulations
collapse of the MBS market.
Bear Stearns - couldn’t roll over debt.
Lehman Brothers - $639 bill. in assets.
Merrill Lynch - sold to BoA
Goldman Sachs & Morgan Stanley- converted to commercial banks.

14. Case Study – 2004 Google IPO
Google structured IPO as a “Dutch” auction.
Google saved on investment bank services.
Presumption is Google will earn more $$.
Had touted a price of $135 earlier.
Ended up with a price of $85.
Earned $1.67 billion on sale.
Conclusion: Investment underwriters are not biased!

15. Case Study – 2004 Google IPO 8/2012 trading at about $542 After IPO,
At peak, traded at
almost $715
8/2012 trading
at about $542
After
IPO,
traded
at $106
$935 – 9/16/2017 15 15

16. Institutions & Derivative Instruments
Financial Markets,
Institutions & Derivative Instruments
ECO 473 – Money & Banking – Dr. D. Foster