1. Financial Markets and Institutions 6th Edition
PowerPoint Slides for:
Financial Markets and Institutions 6th Edition
By Jeff Madura
Prepared by
David R. Durst
The University of Akron

2. Role of Financial Markets and Institutions1
© 2003 South-Western/Thomson Learning

3. 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

4. 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

5. Overview of Financial Markets
Broad Classifications of Financial Markets
Money versus Capital Markets
Primary versus Secondary Markets
Organized versus Over-the-Counter Markets

6. 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

7. 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

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

9. 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)

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

11. Debt vs. Equity Securities
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

12. 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

13. Investor Assessment of New Information
Economic Conditions
Impact of Future Cash Flows
Evaluation of Security Pricing
Investor Decision to Trade
Industry Conditions
Firm Specific Information
Exhibit 1.3

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

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

16. Financial Market 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
Why Government Regulation?

17. Financial Market 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
Why Government Regulation?

18. 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

19. 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

20. 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

21. Types of Nondepository Financial Institutions
Insurance companies
Mutual funds
Pension funds
Securities companies
Finance companies
Security pools

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

23. Trends in Financial Institutions
Rapid growth of mutual funds and pension funds
Increased consolidation of financial institutions via mergers
Increased competition between financial Institutions
Growth of financial conglomerates

24. Global Expansion by Financial Institutions
International expansion
International mergers
Impact of the single European currency
Emerging markets