Overview of Financial Markets and investment products
What is a market?
A market is a venue where goods and services are exchanged. A financial market is a place where
individuals and organizations wanting to borrow funds are brought together with those having a surplus
of funds.
Types of Financial Markets
1. Physical assets vs. financial assets
2. Spot vs. Futures
3. Money vs. Capital
4. Primary vs. Secondary
5. Public vs. Private
Types of Financial Institutions
1. Commercial banks
2. Investment banks
The Capital Allocation Process
In a well-functioning economy, capital flows efficiently from those who supply capital to those
who demand it.
Suppliers of capital: individuals and institutions with “excess funds.” These groups are saving money and
looking for a rate of return on their investment.
Demanders or users of capital: individuals and institutions who need to raise funds to finance them
investment opportunities. These groups are willing to pay a rate of return on the capital they borrow.
How is capital transferred between savers and borrowers?
1. Direct transfers
2. Investment banks
3. Financial intermediaries
Securitization and Its Importance to a Bank
Solution to banks’ limited funds and local market conditions
Help banks to diversify their risks
An agent bank buy a large no. of loans from other banks
Issue securities backed by these loan payments
What is an IPO?
An initial public offering occurs when a company issues stock in the public market for the first time.
“Going public” enables a company’s owners to raise capital from a wide variety of outside investors.
Once issued, the stock trades in the secondary market. Public companies are subject to additional
regulations and reporting requirements.
Where can you find a stock quote, and what does one look like?
Stock quotes can be found in a variety of print sources (The Wall Street Journal or the local newspaper)
and online sources (Yahoo! Finance, CNNMoney, or MSN MoneyCentral).
Types of Financial Institutions
• Pension funds
• Mutual funds
• Exchange traded funds (ETFs)
• Hedge funds
• Private equity companies
What is meant by stock market efficiency?
Securities are normally in equilibrium and are “fairly priced.” Investors cannot “beat the market” except
through good luck or better information. Efficiency continuum.
Highly Efficient: Large companies followed by many analysts. Good communications with investors.
Highly Inefficient: Small companies not followed by many analysts. Not much contact with investors.
What are derivatives? How can they be used to reduce or increase risk?
A derivative security’s value is “derived” from the price of another security (e.g., options and futures).
Can be used to “hedge” or reduce risk. For example, an importer, whose profit falls when the dollar
loses value, could purchase currency futures that do well when the dollar weakens. Also, speculators can
use derivatives to bet on the direction of future stock prices, interest rates, exchange rates, and
commodity prices. In many cases, these transactions produce high returns if you guess right, but large
losses if you guess wrong. Here, derivatives can increase risk.
The firm’s primary financial goal is to maximize shareholders’ wealth or value which is ultimately
determined in the financial markets. Hence, financial managers should make sound decisions keeping in
mind how financial markets work and operate. In investors’ perspective, individuals or entities make
investment decisions; that should be anchored to the knowledge and understanding about financial
institutions that operate within the financial market.
