FUNDAMENTALS OF FINANCIAL MARKETS

Financial Market - is not just a place where buyers and sellers meet
→ it's a complex system that impacts every aspect of our Lives from the prices of goods
and services to our employment prospects
→ lifeblood that keeps the economic body

Financial System - is like the bloodline of an economy

→ it's the complex, interlocking network of financial institutions, markets, and products that transfer
funds from those with surplus capital to those who need it
→ invisible machine that powers our daily transactions big or small personal or corporate
→ engine that drives economic activity turning the cogs of production consumption and investment
→ ensures a smooth flow of funds enabling savings to become investments and investments to
generate wealth
FOUR MAIN ELEMENTS:
1.) Financial Institutions – banks, insurance companies, mutual funds, and pension funds
→ act as intermediaries, linking savers who deposit funds and borrowers who take out loans
→ lifeblood of the system facilitating the flow of money through the economy
2.) Financial Market – marketplace where buyers and sellers meet to trade financial instruments
→ TYPES: stock market & bond market right (where securities are bought and sold
3.) Financial Services – encompasses a wide array of services provided by the finance industry
→ include fund management, investment banking, and insurance services
→ help manage risk, provide investment options, and facilitate financial transactions
4.) Financial Instruments – tools used in the financial markets like stocks bonds and derivatives
→ represent a claim to the payment of certain sums of money in the future under specified
conditions

➢ together these elements form the backbone of our financial system, each playing a crucial role in
keeping the economic wheel turning

TWO MAIN TYPES OF FINANCIAL MARKETS:

1.) Capital Market – where long-term securities such as stocks and bonds are traded
→ place where companies and governments can raise long-term funds
→ divided into 2 segments:
o Primary Market – where new securities are issued and sold for the first time
o Secondary Market – where already issued securities are bought and sold
2.) Money Market – wholesale market of short-term financial assets it's a place for highly liquid and
short-term instruments (securities that mature in less than one year)
→ here financial institutions and money managers trade to control short-term liquidity

Capital Market Money Market

for long-term investments for short-term financial needs
helps in generating wealth as it tends to rise in helps manage liquidity and short-term
value over time borrowing or lending needs

➢ By understanding these two markets you can decide where to invest based on your financial goals
and risk tolerance
➢ Remember every financial decision should align with your goals and your ability to bear risks
understanding these
 IMPORTANCE OF FINANCIAL INTERMEDIARIES
Financial Intermediaries - these entities are vital players in our economy acting as bridges bet. investors
and those who need funds
→ manage risk, ensuring that we don't put all our eggs in one basket
→ provide liquidity, making sure we can access our money when we need it
→ help allocate resources efficiently, directing funds where they can yield the most benefits
→ play a crucial role in our economy ensuring the smooth operation of financial transactions
DIFFERENT TYPES:
1.) Banks - workhorses of the financial World
→ accept deposits from individuals and businesses and then they turn around and lend that
money out ( this is how they create liquidity in the market
2.) Insurance Companies – manage risk
→ they pull premiums from policyholders and pay out claims when needed
→ this spreads the risk across a large group making it more manageable
→ from car accidents to health issues insurance, companies are there to soften the financial blow
3.) Mutual Funds - pulls money from many investors to purchase a diversified portfolio of stocks bonds
or other assets
→ by doing this they provide access to a wide range of Investments that individual investors
might not be able to afford on their own
→ offer professional management of these assets
4.) Pension funds – manage the retirement Savings of millions of people
→ take contributions from employees and employers, invest them, and then provide income
during retirement

➢ help create liquidity

➢ manage risk
➢ diversify Investments
➢ secure our futures

OTHER KEY PLAYERS IN THE FINANCIAL MARKET:

1.) Investors – the ones who provide capital with the expectation of getting a return on their
investment
→ they interact directly with financial intermediaries, purchasing stocks bonds or other financial
products
2.) Borrowers – individuals or businesses who need funds to finance their operations or consumption
→ they rely on financial intermediaries for loans and other types of credit
3.) Regulators – play a crucial role in maintaining the stability and integrity of the financial market
→ they set rules, monitor market activities, and enforce laws to protect investors and ensure fair
and transparent trading

➢ Together these participants form a dynamic ecosystem interacting with each other and the financial
intermediaries
➢ These participants along with financial intermediaries create the vibrant and complex Financial
Market we interact with every day
➢ Remember understanding these elements of our financial system can help us make informed
decisions about our financial future
 FINANCIAL REGULATIONS: RISKS, POLICIES AND REGULATORS
Financial markets - are complex, dynamic, and fraught with risk
→ without regulations, these risks can spiral out of control leading to economic instability and financial
disaster

ROLE OF FINANCIAL REGULATORS:

→ is crucial to maintaining a healthy and stable Financial Market
→ ensure fairness transparency and efficiency in the marketplace
→ protect consumers, maintain confidence in the financial system, and reduce the risk of financial
crises
→ it's a delicate balancing act that requires constant vigilance and adaptation

FORMS OF RISKS THAT REGULATORS ARE SO KEEN TO CONTROL:

1.) Market Risk – refers to the potential for financial loss due to changes in market prices or rates
2.) Credit Risk – the risk that a borrower will not repay a loan or meet contractual obligations
→ if too many borrowers default on their loans, it could lead to a banking crisis
3.) Liquidity Risk - the risk that an entity will not be able to meet short-term Financial demands
→ this can occur when an institution cannot easily sell an investment without causing a
significant movement in the price
4.) Operational Risk – the risk of loss resulting from inadequate or failed internal processes, people or
systems or from external events

➢ Each of these risks poses a unique challenge to financial stability

➢ Regulators must understand and manage these risks to prevent a domino effect that could lead to a
financial meltdown

FACTORS THAT AFFECT MONETARY AND FISCAL POLICY:

Monetary Policy - revolves around the management of interest rates and the total supply of money in
circulation and is generally carried out by the central banks
• inflation
• rates exchange rates
• economic growth
Fiscal Policy - involves the government changing tax rates and levels of government spending to influence
aggregate demand in the economy
• political considerations
• economic conditions
• public sentiment

Financial Regulations - play a critical role in maintaining stability in the financial markets
→ help to manage different types of risks and influence monetary and fiscal policy
→ without them we would be at the mercy of a volatile and unpredictable Financial System
→ are not just about rules and restrictions, they are about creating a safer more reliable and fairer
Financial System for everyone
→ crucial for maintaining stability and confidence in the financial markets

DEBT SECURITIES MARKET

Debt Securities Market - a platform where debt instruments are bought and sold is a key component in
the world of finance
 → it provides governments, municipalities, and corporations with the funds they need to operate while
offering investors a way to earn interest on their money

Debt Instruments - essentially they are IUS issued by entities like governments and corporations
→ each one represents a promise to repay borrowed money with interest over a specified period

TYPES OF LONG-TERM DEBT SECURITIES:

1.) Government Bonds - are issued by national governments
→ often considered the safest type of investment as they're backed by the full faith and credit
of the respective government
2.) Municipal Bonds - are issued by States cities or other local entities these bonds are typically tax
exempt making them attractive to investors in high tax brackets
3.) Corporate Bonds - corporations issue these bonds to fund operations expansions or other projects
→ they tend to have higher yields than government or municipal bonds due to their higher risk
4.) Mortgage-Backed Securities - these are somewhat complex instruments backed by a pool of
mortgages
→ the income from the underlying mortgages is used to pay the interest and principle on these
securities
HOW ARE THESE SECURITIES VALUED:
a) Using the present value of future cash flows
→ the most common method
→ this involves discounting the future payments back to the present using a discount rate often
they yield to maturity
→ essentially this method calculates what the future payments are worth in today's dollars
b) Relative Valuation
→ Involves comparing the security to similar securities in the market
→ by reviewing the prices of comparable bonds, one can determine if the bond in question is
over or underpriced

→ Understanding these principles can aid in making informed investment decisions potentially leading
to higher yields

MASTERING THE STOCK MARKET

TWO MAIN TYPES OF STOCKS:
1.) Common Stocks - the most prevalent giving shareholders voting rights in the company and the
potential for dividends (dividends - a portion of the company's earnings distributed to shareholders)
2.) Preferred Stocks - offer no voting rights but come with a fixed dividend (preferred shareholders
receive their dividends before common shareholders)

HOW ARE STOCKS VALUED/ METHODS USED BY INVESTORS AND ANALYSTS:

1.) Price to Earnings Ratio or PE ratio
→ This valuation tool compares a company's current share price to its per share earnings
→ it essentially tells you what the market is willing to pay for a company's earnings

2.) Dividend Discount Model or DDM

→ this approach values a stock by assuming that its worth should be equal to the sum of all its
future dividend payments discounted back to their present value
3.) Price to Sales Ratio or Ps ratio
→ this Compares a company's stock price to its revenues
 → it's particularly useful for valuing stocks of companies that are not yet profitable or are
experiencing earning swings
4.) Book Value Method
→ this value stocks based on the different between a company's total assets and its total
liabilities
5.) Price to Earnings Growth Ratio or PEG ratio
→ This valuation tool takes the PE Ratio and adjusts it for expected earnings growth
→ it provides a more nuanced view of a company's growth prospects

Stock Valuation - is a complex process that involves numerous variables

→ it's not an exact science but a blend of financial analysis, strategic analysis and Market intuition

NAVIGATING RISK: A GUIDE TO INTERNATIONAL FINANCIAL MARKETS

DIFFERENT TYPES OF FINANCIAL INSTRUMENTS:
1. Financial Instruments - are contracts that give rise to both a financial asset to one entity and a financial
liability to another
→ they're the building blocks of any Financial Market and understanding them is crucial to navigating
the financial landscape successfully
2. Debt-based Financial Instruments (such as bonds and debentures) – are essentially loans where one
party lends money to another under specific terms
→ this type of instrument is often attractive to conservative investors providing a steady stream of in
income with a lower risk profile
3. Equity-based Financial Instruments (like stocks) - these offer a stake in a company giving the holder
part ownership and potentially a share in the company's profits
→ while they can offer higher returns they come with a higher risk as their value can fluctuate
significantly
4. Derivative Instruments (such as futures options and swaps) - these are a bit more complex as their
value is derived from other financial instruments
→ they are often used for hedging risk but can also be used for speculative trading which can be risky

➢ it's equally important to understand the risks associated with them

TOOLS USED TO MEASURE AND MANAGE THESE RISKS:

1.) Value at Risk or VR – estimates the potential loss that could occur in an Investment Portfolio over
a specific period
2.) Standard Deviation – measures the volatility of an investment

International Agencies
→ International financial markets are also influenced by various International Agencies
→ these agencies such as the International Monetary Fund and the World Bank can have a significant
impact on the markets through their policies and interventions
→ they play a crucial role in maintaining Financial stability, promoting economic growth and reducing
poverty
➢ the international financial markets and risk management is critical to making informed investment
decisions
➢ remember knowledge is power especially when it comes to finance so arm yourself with the right
information and you'll be well on your way to navigating the world of international finance like a pro
 FINANCIAL SYSTEM AND FINANCIAL MARKET
Financial Resources - are vital in every company
→ this is considered as the company's lifeblood
→ these resources can be generated in different ways, media and system

Financial Management - is a key branch of management that enable the company to improve its
monetary resources in different forms to attain two broad goals profit maximization and wealth
maximization
Venue – Financial Market

Financial System - understanding the financial system requires knowing the sources of wealth which can
be generated through various needs
➢ initially individuals rely on family support for basic needs
➢ education lays the foundation leading to employment
➢ getting salaries or wages through Labor
➢ earnings enable savings by getting interest from deposits or capital
➢ then asset acquisition such as land generates wealth via rent or business use with profitable ventures
➢ individuals become investors infusing capital for higher returns or profit through entrepreneurship
➢ successful Ventures may transition investors into entrepreneurs, fostering growth and profit
accumulation, diversification, and expansion sustain the cycle integrating finance into the business
system

→ allows households companies and the government who have available funds to invest these funds in
more potentially productive vehicles that can result in faster growth in the economy
→ encourages fund savings from its stakeholders and transform these savings efficiently into
investment vehicles that help the economy grow faster
→ is a set of arrangements or conventions embracing The Lending and borrowing of funds by non
Financial economic units and the intermediation of this function by Financial intermediaries in order
to facilitate the transfer of funds to create additional money when required and to create markets in
debt and equity instruments and their derivatives so that the price and allocation of funds are
determined efficiently
Lenders →Financial Intermediaries → Borrowers

→ is composed of network of interrelated systems of financial markets, intermediaries and services

→ financial System of a country carries out the essential economic function that transfers funds from
parties that have available funds to parties that need funds
→ in a country there are (lenders/savers) households, companies and government agencies who
have available funds because they spend less than their income [fund providers]
→ there are also (borrowers/spenders) households companies and government agencies that have
fund shortage because of deciding to spend more than their income [fund demanders]
→ matching the difference in spending excess funds from one party to the fund gap of another party is
the main reason for the existence of a Financial system
→ permits an efficient method to move funds between entities who have funds and entities who need
funds

2 ROUTES WHERE FUNDS CAN FLOW FROM LENDER/SAVERS TO THE

BORROWER/SPENDERS:
1.) Direct Financing Route – the borrower/spenders borrow and deal directly with lenders through
selling financial instruments or securities
financial instruments - represent claims on the future income or assets of the borrower
 borrowers recognize financial instruments as liabilities
lenders recognize these as an asset
→ buying stocks directly from a company is also considered as direct financing
2.) Indirect Financing Route - the borrowing activity between both parties still happens though
indirectly through the intervention of a financial intermediary
➢ the difference bet. the two routes is financial intermediaries

7 ESSENTIAL ELEMENTS THAT MAKE UP A COUNTRY'S FINANCIAL SYSTEM:

1.) Lenders (supply funds) and borrowers (demand them)
2.) Financial intermediaries (bridge the gap between the facilitating transactions
3.) Financial instruments (represent contractual obligation traded in markets like money and capital
markets)
4.) Financial markets
5.) Regulatory environment (ensures compliance typically managed by central banks)
6.) Money creation (occurs through financial flows enhancing economic activity)
7.) Price Discovery (determines instrument value based on risk)
➢ These elements synergize to fuel economic growth and ensure financial stability forming the
backbone of a nation's Financial infrastructure

Financial Market- refers to channels or places where funds and financial instruments such as stocks bonds
and other securities are exchanged between willing individuals and or entities
→ also includes the existing mechanisms and conventions to facilitate transfer of funds and or
financial instruments between market participants
→ intend to establish a consistent, efficient, and cost effective bridge between fund providers and
fund demanders
→ participant in the financial markets include ultimate lenders and borrowers such as household
government and businesses, financial intermediaries, broker and dealers, regulators, fund
managers and financial exchanges

3 MAJOR ECONOMIC FUNCTIONS OF THE FINANCIAL MARKET:

1.) Price Discovery - involves the interaction between buyers and sellers to determine the price of
traded financial instruments based on their willingness to buy or sell
→ Fund providers set the required return influencing fund allocation
2.) Liquidity - enables easy conversion of instruments to cash crucial for investors needs
3.) Reduction in Transaction Costs - including search and information costs is vital for efficient markets
where prices accurately reflect gathered information minimizing costs
➢ these functions collectively contribute to resource allocation risk management and economic growth

Financial Market may be classified as follows:

1.) Based on tenor of financial instruments traded - Money Market or Capital Market
2.) Based on Market type - Primary Market or Secondary Market
3.) Based on Country’s perspective – Internal Market or External Market
4.) Based on financial intermediation – Dealer Market or Broker Market

➢ financial markets are classified depending on the transactions that are being observed or the
exchange that is done to whom it is traded or the market, where it is traded the manner in which it
is traded and the perspective of the country
 FINANCIAL INTERMEDIARIES AND OTHER MARKET PARTICIPANTS
Financial Intermediaries
→ were formed during the time when market conditions make it hard for lenders of funds to transact
directly with borrowers of funds
→ examples of financial intermediaries are depository institutions, insurance companies, asset
management firms, regulated investment companies, and investment banks
→ most of them provide services to suppliers and demanders of funds
→ the assets of these Financial intermediaries are not limited to the portfolio they are managing but
the information they gain to facilitate and support their clients

Financial Intermediation
→ is the process of indirect financing using financial intermediaries as the main route to transfer funds
from lenders to borrowers
examples of financial intermediaries are depository institutions, insurance companies, asset
management firms, regulated investment companies, and investment banks

Financial intermediaries generally provide these services:

1.) ENABLE trading of financial assets ass for the customers of the financial intermediary through
brokering arrangements
2.) ENABLE trading of financial assets through its own capital by buying a stake in a financial asset that
its customers want to transact in
3.) ASSIST IN forming financial assets needed by its customers and distribute these to its customers
and other market participants as well
4.) PROVIDE investment advice and consultation services to customers
5.) MANAGE financial assets of customers
6.) FACILITATE payment mechanism between merchants and customers

BENEFITS OF FINANCIAL INTERMEDIARIES:

✓ acceleration of flow of funds between entities
✓ efficient allocation of funds
✓ creation of money
✓ support in price discovery
✓ improved liquidity for lenders
✓ reduced price risk for lenders
✓ diversification of lenders
✓ economies of scale
✓ payment system
✓ risk mitigation
✓ implementation of monetary policy function
✓ maturity intermediation
✓ risk reduction through diversification
✓ cost reduction for contracting and information

CLASSIFICATION OF FINANCIAL INTERMEDIARIES:

1.) Depository Institutions/Banks - which may be
→ Commercial Banks
→ Thrift Banks
→ Savings Banks
2.) Investment Intermediaries
 • Asset Management firms which may be
→ Regulated investment companies (REC)
→ Exchange Traded Funds (ETF)
→ Hedge funds
→ Separately managed accounts
• Insurance Companies
• Investment Banks
• Finance Companies
3.) Insurance companies - sells various life and non-life insurance products such as life insurance, health
insurance, property casualty insurance, liability insurance, disability insurance, long-term Insurance
structured settlements, and financial guarantee insurance
4.) Investment Banks – highly leveraged institutions that have significant influence on how primary and
secondary markets work

Activities that an Investment Bank can offer:

1.) Public offering of Securities
2.) Private Placement of Securities
3.) Trading of Securities
4.) Advisory services for mergers, acquisitions and financial restructuring
5.) Merchant banking
6.) Securities Finance and Prime Brokerage Service
7.) Asset Management
8.) Research

Financial Market participants

→ Household Sector
→ Government
→ Corporate Sector/Non-Financial Corporations
→ Foreign Sector
→ Non-profit organizations