1. Role of Financial Markets and Institutions1
Role of Financial Markets and Institutions
Background: FIN301 - Chapter 4 – Financial Environment:
© 2003 South-Western/Thomson Learning

2. Chapter Objectives Describe the types of financial markets
Describe the role of financial institutions with financial markets
Identify the types of financial institutions that facilitate transactions

3. Overview of Financial Markets
Financial Market: a market in which financial
assets (securities) such as stocks and bonds
can be purchased or sold
Financial markets provide for financial intermediation--financial savings (Surplus Units) to investment (Deficit Units)
Financial markets provide payments system
Financial markets provide means to manage risk

4. Overview of Financial Markets
Broad Classifications of Financial Markets
Money versus Capital Markets
Primary versus Secondary Markets
Organized versus Over-the-Counter Markets
Public vs. Corporate

5. Primary vs. Secondary Markets
New Issue of Securities
Exchange of Funds for Financial Claim
Funds for Borrower; an IOU for Lender
SECONDARY
Trading Previously Issued Securities
No New Funds for Issuer
Provides Liquidity for Seller

6. Money vs. Capital Markets
Short-Term, < 1 Year
High Quality Issuers
Debt Only
Primary Market Focus
Liquidity Market--Low Returns
Capital
Long-Term, >1Yr
Range of Issuer Quality
Debt and Equity
Secondary Market Focus
Financing Investment--Higher Returns

7. Organized vs. Over-the-Counter Markets
Visible Marketplace
Members Trade
Securities Listed
New York Stock Exchange
OTC
Wired Network of Dealers
No Central, Physical Location
All Securities Traded off the Exchanges

8. Securities Traded in Financial Markets
Money Market Securities
Debt securities Only
Capital market securities
Debt and equity securities
Derivative Securities
Financial contracts whose value is derived from the values of underlying assets
Used for hedging (risk reduction) and speculation (risk seeking)

9. Financial Markets Video Clip – Types Financial Markets
Vidoe Clip - Derivatives

10. Debt vs. Equity Securities
Debt Securities: Contractual obligations (IOU) of Debtor (borrower) to Creditor (lender)
Investor receives interest
Capital gain/loss when sold
Maturity date
Equity Securities: Claim with ownership rights and responsibilities
Investor receives dividends if declared
Capital gain/loss when sold
No maturity date—need market to sell

11. Valuation of Securities
Value a function of:
Future cash flows
When cash flows are received
Risk of cash flows
Present value of cash flows discounted at the market required rate of return
Value determined by market demand/supply
Value changes with new information

12. Financial Market Efficiency
Security prices reflect available information
New information is quickly included in security prices
Investors balance liquidity, risk, and return needs

13. Financial Market Regulation
To Promote Efficiency
High level of competition
Efficient payments mechanism
Low cost risk management contracts
Why Government Regulation?

14. Financial Market Regulation
Why Government Regulation?
To Maintain Financial Market Stability
Prevent market crashes
Circuit breakers
Federal Reserve discount window
Prevent Inflation--Monetary policy
Prevent Excessive Risk Taking by Financial Institutions

15. Financial Market Regulation
Why Government Regulation?
To Provide Consumer Protection
Provide adequate disclosure
Set rules for business conduct
To Pursue Social Policies
Transfer income and wealth
Allocate saving to socially desirable areas
Housing
Student loans

16. Financial Market Globalization
Increased international funds flow
Increased disclosure of information
Reduced transaction costs
Reduced foreign regulation on capital flows
Increased privatization
Results: Increased financial integration--capital flows to highest expected risk-adjusted return

17. Role of Financial Institutions in Financial Markets
Information processing
Serve special needs of lenders (liabilities) and borrowers (assets)
By denomination and term
By risk and return
Lower transaction cost
Serve to resolve problems of market imperfection

18. Role of Financial Institutions in Financial Markets
Types of Depository Financial Institutions
Commercial
Banks
$5 Trillion
Total Assets
Savings
Institutions
$1.3 Trillion
Total Assets
Credit Unions
$.5 Trillion
Total Assets

19. Types of Non-depository Financial Institutions
Finance companies
Mutual funds
Securities companies
Insurance companies
Pension funds
Security pools

20. Role of Non-depository Financial Institutions
Focused on capital market
Longer-term, higher risk intermediation
Less focus on liquidity
Less regulation
Greater focus on equity investments

21. Trends in Financial Institutions
Increased competition between financial Institutions
In the 60’s & 70’s, heavy regulation prevented competition
In the late 70’s & 80’s, the development of mutual funds and deregulation led to increased flexibility and competition. This continued through to the 90’s and into today.
Increased consolidation of financial institutions via mergers has resulted in the growth of financial conglomerates e.g. Cayman National Corporation

22. Cayman Financial Corporation

23. Cayman National Corporation - Holding Company
CNB – Cayman National Bank – Banking
CNP – Cayman National Property Holding – Property Holding
CNT – Cayman National Trust - Company & Trust Management
CNS – Cayman National Securities - Securities Brokerage
Caymanx – Caymanx Trust Company Limited – Banking, company and trust management
CNI – Cayman National Investments – Investment in a merchant bank
CNIB – Cayman National Insurance Brokers – Insurance brokerage
CGI – Cayman General Insurance – General (property & casualty) and heath insurance
CNIM – Cayman National Insurance Management - General (property & casualty) and heath insurance

24. Global Expansion by Financial Institutions
International expansion through mergers and emerging markets
The single European currency – Euro, €, helped to eliminate concerns about foreign exchange risks