FINANCIAL MARKET

• Firms that require funds from external sources can obtain them in three ways:

  1. through a financial institution
  2. through financial markets
  3. through private placements
• •Financial institutions are intermediaries that channel the savings of individuals, businesses, and governments into loans or investments.
• •The key suppliers and demanders of funds are individuals, businesses, and governments..
• •In general, individuals are net suppliers of funds, while businesses and governments are net demanders of funds
• •Commercial banks are institutions that:

  –provide savers with a secure place to invest their funds

  –offer loans to individual and business borrowers
• •Investment banks are institutions that:

  –assist companies in raising capital

  –advise firms on major transactions such as mergers or financial restructurings

  –engage in trading and market making activities
• •The Glass-Steagall Act was an act of Congress in 1933 that created the federal deposit insurance program and separated the activities of commercial and investment banks. It was repealed it 1999 by Congress.
• •The shadow banking system describes a group of institutions that:

  –engage in lending activities, much like traditional banks

  –but do not accept deposits

  –are not subject to the same regulations as traditional banks
• Financial markets are forums in which suppliers of funds and demanders of funds can transact business directly.
• •Transactions in short term marketable securities take place in the money market while transactions in long-term securities take place in the capital market.
• •A private placement involves the sale of a new security directly to an investor or group of investors.
• •Most firms, however, raise money through a public offering of securities, which is the sale of either bonds or stocks to the general public.
• •The primary market is the financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction.
• •Secondary markets are financial markets in which preowned securities (those that are not new issues) are traded.
• •The money market is created by a financial relationship between suppliers and demanders of short-term funds.
• •Most money market transactions are made in marketable securities which are short-term debt instruments, such as:

  •U.S. Treasury bills issues by the federal government

  •commercial paper issued by businesses

  •negotiable certificates of deposit issued by financial institutions
• •Investors generally consider marketable securities to be among the least risky investments available.
• •The international equivalent of the domestic (U.S.) money market is the Eurocurrency market.
• •The Eurocurrency market is a market for short-term bank deposits denominated in U.S. dollars or other marketable currencies
• .•The Eurocurrency market has grown rapidly mainly because it is unregulated and because it meets the needs of international borrowers and lenders.
• •Nearly all Eurodollar deposits are time deposits.
• •The capital market is a market that enables suppliers and demanders of long-term funds to make transactions.
• •The key capital market securities are bonds (long-term debt) and both common and preferred stock (equity, or ownership).
• –Bonds are long-term debt instruments used by businesses and government to raise large sums of money, generally from a diverse group of lenders.
• –Common stock are units of ownership interest or equity in a corporation.
• –Preferred stock is a special form of ownership that has features of both a bond and common stock.
• Broker markets are securities exchanges on which the two sides of a transaction, the buyer and seller, are brought together to trade securities.
• •Dealer markets, such as Nasdaq, are markets in which the buyer and seller are not brought together directly but instead have their orders executed by securities dealers that “make markets” in the given security.
• •As compensation for executing orders, market makers make money on the spread (bid price – ask price).
• •In the Eurobond market, corporations and governments typically issue bonds denominated in dollars and sell them to investors located outside the United States.
• •The foreign bond market is a market for bonds issued by a foreign corporation or government that is denominated in the investor’s home currency and sold in the investor’s home market.
• •The international equity market allows corporations to sell blocks of shares to investors in a number of different countries simultaneously.
• According to the World Federation of Exchanges, in 2012:

  1. NYSE Euronext is the largest stock market in the world, as measured by the total market value of securities listed on that market. NYSE Euronext has listed securities worth more than $14.1 trillion in the U.S. and $2.1 trillion in Europe.
  2. The second largest exchange is Nasdaq, with listed securities valued at $4.6 trillion.
  3. The Tokyo Stock Exchange has securities valued at $3.5 trillion.
  4. The fourth largest exchange, the London Stock Exchange, has securities valued at $3.3 trillion.
• •From a firm’s perspective, the role of capital markets is to be a liquid market where firms can interact with investors in order to obtain valuable external financing resources.
• •From investors’ perspectives, the role of capital markets is to be an efficient market that allocates funds to their most productive uses.
• •An efficient market allocates funds to their most productive uses as a result of competition among wealth-maximizing investors and determines and publicizes prices that are believed to be close to their true value.
• •Advocates of behavioral finance, an emerging field that blends ideas from finance and psychology, argue that stock prices and prices of other securities can deviate from their true values for extended periods.
• •Securitization is the process of pooling mortgages or other types of loans and then selling claims or securities against that pool in a secondary market.
• Mortgage -backed securities represent claims on the cash flows generated by a pool of mortgages and can be purchased by individual investors, pension funds, mutual funds, or virtually any other investor.
• •A primary risk associated with mortgage-back securities is that homeowners may not be able to, or may choose not to, repay their loans.