Chap 1

• Private sector banks intermediate between all sectors of the economy and other financial intermediaries and institutions, and some of them provide the payment system. 
• Lenders (surplus economic units) and Borrowers (deficit economic units)
• Household Sector: Individuals
• Corporate Sector: Companies private and government owned
• Government Sector- all levels of government (local, provincial and central)
• Foreign Sector: Any foreign entity ( foreign households, corporations, governments)
• Financial Intermediaries (middle man): They interpose themselves between the ultimate lenders and borrowers to maximize profits from the differential between what they pay for liabilities and earn on assets. In this case, the banks are called Bank Margin. 
• Financial Instruments (Securities) are created to satisfy the financial requirements of the various participants. They may be marketable (can be easily bought or sold in the open market and have short maturity period) or non- marketable (cannot be easily bought or sold in the open market). These are assets that can be traded.)
• They are the evidences of debts or shares and also represent claims on the issuers/borrowers. 
• Two categories of financial instruments:

  1. Debts and deposits

  2. Shares 
• Creation of Money: Central bank control the growth rate in money creation (new bank deposits resulting from new bank loans).
• Financial Markets is the institutional arrangements and conventions that exist for the issue and trading of the financial instruments or in short, this is where people trade financial securities and derivatives at low transaction costs. 
• Money markets are where investors can buy and sell short-term debt securities. It should be defined as the short-term debt market 
• Bond markets are where investors can buy and sell long-term debt securities. It is the marketable arm of the long-term debt market. 
• Foreign Exchange Market is not a financial market, because lending and borrowing do not take place in this market. 
• Two market types Primary market where all securities are issued as the issuer receives the money paid by the lender/buyer. Secondary market is where the marketable ones are traded as the seller receives the money paid by the buyer. They are either Over-the- Counter (OTC) which also called "informal markets" where no exchange is involved or it is also called Exchange-driven markets such as the share or stock exchange. 
• Price Discovery is where the price of shares (or value of shares of stocks in a company) and price of debt are discovered, made, and determined in the financial markets
• INFORMATION COSTS refer to the expenses incurred during the gathering of information required to make informed financial decisions. 
• Search Costs are incurred whenever a transaction between two parties is done. The borrower is not concerned with the quality of the lender, but the lender is concerned with the quality of the borrower. (negotiation and  gathering of information).
• Verification Costs are incurred because the bank is obliged to verify the information gathered. Banks here are concerned with the well-known problem of asymmetric information (a gap in knowledge between lender and borrower) which can give rise to the problems of adverse selection (poor selection prior to the loan) and moral hazard (financially- immoral behavior by the borrower after the loan is made. 
• Monitoring Costs are incurred by the bank because once the money is lent, the bank has an incentive to monitor the client. 
• Enforcement Costs are incurred when the borrowers do not adhere to the terms of the contract. 
• Broad Functions of Banks • Facilitation of flow of funds • Efficient allocation of funds • Assistance in price discovery • Money creation • Enhanced liquidity • Price risk lessened for the ultimate lender • Improved diversification • Economies of scale • Payments system • Monetary policy function
• Securities


  Also called financial instruments, issued by the borrowers, evidence of debt/share, represents claims on the issuers/borrowers
• Surplus funds


  Excess funds/income that can be used as investments by the lenders
• Direct investment/financing


  • Lenders and borrowers directly do business with each other, has no intermediary, terms and conditions are recorded on one instrument only (contract between the 2 parties)
• Indirect investment/financing


  • Borrowers borrow money from the financial market (e.g. banks, other intermediaries), intermediaries on the other hand, pools the money from their depositors, has 2 instruments (1. Agreement between the bank and the depositor, 2. Contract between the borrower and the bank)
• 2 Main Types of Financial Markets

  • Short-Term (ST) Debt Market
  • Long-Term Market
• Short-Term (ST) Debt Market


  Facilitates short-term transactions (lending/borrowing/investing) usually within 12 months, offers more liquid type of assets and has a lower risk. This is the market choice for borrowers that seeks to provide support for their business' short-term and low value credits.
• Long-Term Market


  Provides long-term lending, borrowing, and investing transactions (over 12 months) offers low liquidity type of asset and has a higher risk but can give higher gains. This is the market choice for borrowers that wants to provide capital and other big investments for their business.
• In the Primary Market, the Borrowers refers to the Companies that issues new securities for the first time to the public/investors. While the Lenders refers to the Investors that purchases these securities and provides funds to the company/issuer.
• While in the Secondary Market, those investors that purchased new securities in the Primary Market, then trades their securities to other investors. In short, only Investor-Investor transactions happen in the Secondary Market without the involvement of the companies.