FNA 8111: FINANCIAL INSTITUTIONS AND MARKETS
Lecture no. 1: Introduction
Saed A. Sulub, PhD ACCA
Reference: Mishkin, Frederic S. & Eakins, Stanely G. (2018). Financial Markets and Institutions. 9th Edition, Pearson Education Ltd
FNA 8111 Main Textbook
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Course E-Classroom
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Lecture Preview
■ Importance of Financial Institutions & Markets
■ Function and Structure of Financial Markets
■ Internationalization of Financial Markets
■ Types and Functions of Financial Intermediaries
■ Regulation of the Financial System
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Why Study Financial Markets?
Financial markets, such as bond and stock
markets, are crucial in our economy.
1. These markets channel funds from savers
to investors, thereby promoting economic
efficiency.
2. Market activity affects personal wealth, the
behavior of business firms, and economy as
a whole
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Why Study Financial Markets?
▪ Well functioning financial markets, such as
the bond market, stock market, and foreign
exchange market, are key factors in
producing high economic growth.
▪ We will briefly examine each of these
markets, key statistics, and how we will
examine them throughout this course.
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Why Study Financial Markets?
Debt Markets & Interest Rates
▪ Debt markets, or bond markets, allow
governments, corporations, and individuals to
borrow to finance activities.
▪ In this market, borrowers issue a security,
called a bond, that promises the timely
payment of interest and principal over some
specific time horizon.
▪ The interest rate is the cost of borrowing.
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Why Study Financial Markets?
The Stock Market
■ The stock market is the market where common
stock (or just stock), representing ownership in
a company, are traded.
■ Companies initially sell stock (in the primary
market) to raise money. But after that, the
stock is traded among investors (secondary
market).
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Stock Market
Why Study Financial Markets?
The Foreign Exchange Market
▪ The foreign exchange market is where
international currencies trade and exchange
rates are set.
▪ It has a daily volume of around $1 trillion!
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Foreign Exchange Market
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Why Study Financial Institutions?
1. Structure of the Financial System
■ Helps get funds from savers to investors
2. Financial Crises
■ The financial crises of 2007–2009 was the worst
financial crisis since the Great Depression. Why
did it happen?
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Why Study Financial Institutions?
3. Banks and Other Financial Institutions
─ Includes the role of insurance companies,
mutual funds, pension funds, etc.
4. Financial Innovation
─ Focusing on the improvements in technology
and its impact on how financial products are
delivered
5. Managing Risk in Financial Institutions
─ Focusing on risk management in the
financial institution.
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Function of Financial Markets
■ Channels funds from person or business
without investment opportunities (i.e.,
“Lender-Savers”) to one who has them (i.e.,
“Borrower-Spenders”)
■ Improves economic efficiency
Financial Markets Funds Transferees
Lender-Savers
1. Households
2. Business firms
3. Government
4. Foreigners
Borrower-Spenders
1. Business firms
Segments of Financial Markets
1. Direct Finance
• Borrowers borrow directly from lenders in
financial markets by selling financial instruments
which are claims on the borrower’s future income
or assets
2. Indirect Finance
• Borrowers borrow indirectly from lenders via
financial intermediaries (established to source
both loanable funds and loan opportunities) by
issuing financial instruments which are claims on
the borrower’s future income or assets
Function of Financial Markets
Importance of Financial Markets
▪ Financial markets are critical for producing an
efficient allocation of capital, allowing funds to
move from people who lack productive
investment opportunities to people who have
them.
▪ Financial markets also improve the well-being
of consumers, allowing them to time their
purchases better.
Structure of Financial Markets
1. Debt Markets
─ Short-Term (maturity < 1 year)
─ Long-Term (maturity > 10 year)
─ Intermediate term (maturity in-between)
─ Represented $52.4 trillion at the end of 2009.
2. Equity Markets
─ Pay dividends, in theory forever
─ Represents an ownership claim in the firm
─ Total value of all U.S. equity was $20.5 trillion at
the end of 2009.
Structure of Financial Markets
1. Primary Market
─ New security issues sold to initial buyers
■ Who does the issuer sell to in the Primary
Market?
3. Secondary Market
─ Securities previously issued are bought
and sold
■ Examples include the NYSE and Nasdaq
■ Who trades?
Structure of Financial Markets
Even though firms don’t get any money, per se,
from the secondary market, it serves two
important functions:
■Provide liquidity, making it easy to buy and sell
the securities of the companies
■Establish a price for the securities
Structure of Financial Markets
We can further classify secondary markets as
follows:
1. Exchanges
─ Trades conducted in central locations (e.g., New
York Stock Exchange)
2. Over-the-Counter Markets
─ Dealers at different locations buy and sell
Classifications of Financial Markets
We can also further classify markets by the
maturity of the securities:
1. Money Market: Short-Term
(maturity <= 1 year)
2. Capital Market: Long-Term
(maturity > 1 year) plus equities
Internationalization of Financial Markets
▪ International Bond Market & Eurobonds
■ Foreign bonds
■ Denominated in a foreign currency
■ Targeted at a foreign market
■ Eurobonds
■ Denominated in one currency, but sold in a different market
■ now larger than U.S. corporate bond market)
■ Over 80% of new bonds are Eurobonds.
Internationalization of
Financial Markets
■ Eurocurrency Market
■ Foreign currency deposited outside of home country
■ Eurodollars are U.S. dollars deposited, say, London.
■ Gives U.S. borrows an alternative source for dollars.
■ World Stock Markets
■ U.S. stock markets are no longer always the
largest—at one point, Japan’s was larger
Internationalization
of Financial Markets
Function of Financial Intermediaries:
Indirect Finance
Function of Financial Intermediaries:
Indirect Finance
Instead of savers lending/investing directly
with borrowers, a financial intermediary
(such as a bank) plays as the middleman:
▪ the intermediary obtains funds from
savers
▪ the intermediary then makes loans/
investments with borrowers
Function of Financial Intermediaries:
Indirect Finance
▪ This process, called financial intermediation,
is actually the primary means of moving
funds from lenders to borrowers.
▪ More important source of finance than
securities markets (such as stocks)
▪ Needed because of transactions costs, risk
sharing, and asymmetric information
Types of Financial Intermediaries
Regulatory Agencies
▪ Stock Exchange Regulators (SEC in the US)
▪ Central Banks
▪ AAOIFI/IFSB
Regulation of Financial Markets
▪ Main Reasons for Regulation
1. Increase Information to Investors
■ Decreases adverse selection and moral hazard problems
■ SEC in the US, for example, forces corporations to disclose
information
2. Ensuring the Soundness of Financial Intermediaries
■ Prevents financial panics
■ Chartering, reporting requirements, restrictions on assets and
activities, deposit insurance, and anti-competitive measures
3. Improving Monetary Control
■ Reserve requirements
■ Deposit insurance to prevent bank panics
Lecture Summary
▪ Importance of Financial Markets & Institutions
▪ Function of Financial Markets.
▪ Structure of Financial Markets
▪ Internationalization of Financial Markets
▪ Function of Financial Intermediaries
▪ Types of Financial Intermediaries
▪ Regulation of the Financial System
