Presentation on theme: "Overview of Market Participants & Financial innovation"— Presentation transcript:
1 Overview of Market Participants & Financial innovation Chapter 2Overview of Market Participants & Financial innovation
2 Learning Objective Participants in Financial Markets Business of Financial institutionsFinancial IntermediaryEconomic functions of Financial IntermediariesAsset & Liability management of Financial institutionsGovernment RegulationsPrimary reasons for financial innovation
3 Classification of Entities Central governmentsAgencies of central governmentMunicipal governmentsSupranationalNon- financial businessesFinancial enterpriseshouseholds
4 Classification of Entities Central governmentsDebt obligations issued by central Governments carry full faith & credit of the borrowing Government.Agencies of central governmentFederally related institutions, Government sponsored enterprisesMunicipal governmentsSupranationalAn organization that is formed by two or more central governments through international treaties.
6 Classification of Entities Financial intermediariesDepository institutions-commercial banks, S&L associations and credit unionsInsurance companiesPension funds
7 Classification of Entities Financial EnterprisesExchanging financial assets on behalf of customers. (Brokers)Exchanging financial assets for their own account. (Dealers)Assisting in creation of financial assets for their customers and then selling those financial assets to other market participants. (Underwriting)Providing investment advice to other market participants.Managing portfolios of other market participants.
8 Role of Financial Intermediaries Obtain funds by issuing financial claims against themselves to market participants, then investing those funds.Direct investments- investments made by the financial intermediaries. (assets can be loans /or securities)Transform financial assets that are less desirable for a large part of the public into other financial assets(their own liabilities ) which are more widely preferred by the public.
9 Role of Financial Intermediaries This transformation involves four basic economic functions:Maturity intermediationRisk reduction and diversificationReducing the costs of contracting and information processingProviding a payment mechanism
10 Nature of Liabilities Liability Type Amount of cash outlay Timing of cash outlayType IKnownType IIUncertainType IIIType IV
11 Nature of Liabilities Type I liabilities: Fixed deposit account Guaranteed investment contract (GIC) issued by the insurance companiesType II:Life insurance policy
12 Nature of Liabilities Type III liabilities: Floating rate Certificate of deposits issued by the depository institutionsType IV liabilities:Automobile and home insurance policies
13 Liquidity Needs Uncertainty about timing and amount of cash outlays Potential for the depositor or policy holder to withdraw cash early.
14 Liquidity Needs Reduction in cash inflows: Depository institutions- inability to obtain depositsInsurance companies- reduced premium because of the cancellation of policiesInvestment companies- not being able to find new buyers for shares.
15 Regulation OF Financial Markets Disclosure RegulationFinancial Activity RegulationRegulation of Financial InstitutionsRegulation of Foreign Participants
16 Financial Innovation Categorizations of Financial Innovation Market-broadening Instruments- Increase liquidity of markets and availability of funds by attracting new investors and offering new opportunities for borrowersRisk- management instrumentsreallocate risk to those who are less risk averse.
17 Financial InnovationArbitraging instruments and processes- enable investors and borrowers to take advantage of differences in costs and returns between markets.
18 Motivation for Financial Innovation Causes of Financial InnovationIncreased volatility of interest rates , inflation , equity prices and exchange ratesAdvances in computer and telecommunication technologiesGreater sophistication and educational training among professional market partcipantsFinancial intermediary competitionIncentives to get around existing regulation and tax lawsChanging global patterns of financial wealth..