Chapter 2: Financial Markets and Institutions

Types of financial claims classifications

Fixed-income market (AKA debt market) and Stock market (AKA equity market)

Classifications based on whether the financial assets are newly issued

Primary market (market where securities are newly issued) and Secondary market (market where previously issued securities are traded)

How are financial markets classified?

based on the type of financial claim and, maturity of financial assets, and whether the financial assets are newly issued.

Types of financial markets

stock, fixed-income, money, capital, commodities, foreign exchange, and derivative

Seasoned offerings

the new issuance of securities by a firm that is already publicly traded

Functions of financial markets and intermediaires

1. Transporting cash across time and investors, risk transfer and diversification, 2. risk transfer and diversification, 3. increase liquidity, 4. payment mechanism, 5. reducing the costs of contracting and information processing, and 6. information

Financial institution

A financial intermediary that also provides payment, investing, lending, and risk management services.

Financial markets

A market where securities are issued and traded

Hedge Funds

A private investment pool, open to wealthy (minimum of $1 million) or institutional investors ($5 million) only. Its lightly regulated so they often use more speculative investment strategies than mutual funds do.

Initial public offering (IPO)

AKA initial sale of securities is a receipt of cash to the corporation is sold in the primary market.

Pension Funds

An investment plan set up by an employer or multiple employers to provide retirement benefits for the employees. They are designed for making long-run investment due to the nature of pension funds.

Financial intermerdairy

An organization that raises money from investors and provides financing for individuals, corporations, and etc.

Types of financial institutions

Banks and Insurance companies

You are a beginning investor with only $5,000 in savings. How can you achieve a widely diversified portfolio at a reasonable cost?

Buy shares in a mutual fund. Mutual funds pool savings from many individual investors and then invest in a diversified portfolio of securities. Each individual investor then owns a proportionate share of the mutual fund's portfolio.

Summarize the differences between a commercial bank and an investment bank.

Commercial banks accept deposits and provide financing primarily for businesses. Investment banks do not accept deposits and do not loan money to businesses and individuals. Investment banks may make bridge loans as temporary financing for a takeover or acquisition. In addition, investment banks trade many different financial contracts, such as bonds and options, whiling providing investment advice and portfolio management for institutional and individual investors.

What are the tax implications of pension funds?

Contributions are tax-deductible for employers and investment returns are tax-deferred for employees.

What 3 investment strategies do hedge funds invest in?

High leverage, derivatives, and short selling

The flow of savings to corporations

Households and foreign investors provide most of the savings for corporate financing. Financial markets and institutions provide the process and contracts to channel funds from savers to corporations for real investment, In large corporation, savings may flow through financial markets, intermediaries, institutions or used to reinvest

What does an IPO result in?

Increases both the amount of cash held by the company and the number of shares held by investors

Mutual Funds

Investment companies that issue shares to savers and invest in a variety of portfolios of financial assets, providing professional management and diversification, Investors who own shares issued by a mutual fund are shareholders, who are owners of this fund

Securities traded in active financial markets are liquid assets. Explain why liquidity is important to individual investors and to mutual funds.

Liquidity is important because investors want to be able to convert their investments into cash quickly and easily when it becomes necessary or desirable to do so. Should personal circumstances or investment considerations lead an investor to conclude that it is desirable to sell a particular investment, the investor prefers to be able to sell the investment quickly and at a price that does not require a significant discount from market value. Liquidity is also important to mutual funds. When the mutual fund's shareholders want to redeem their shares, the mutual fund is often forced to sell its securities. In order to maintain liquidity for its shareholders, the mutual fund requires liquid securities.

Types of maturity financial assets classifications

Money market (less than 1 year) Capital market (more than 1 year)

If the Department of Treasury issues a new 30-day Treasury Bond, the bond will be issued in the what market?

Money market and fixed-income market

Types of financial intermediaries

Mutual and pension funds

Why are mutual funds called financial intermediaries? Why does it make sense for an individual to invest her savings in a mutual fund rather than directly in financial markets?

Mutual funds collect money from small investors and invest the money in corporate stocks or bonds, thus channeling savings from investors to corporations. For individuals, the advantages of mutual funds are diversification, professional investment management and record keeping.

Major stock markets

NYSE and NASDAQ

NASDAQ

National Association of Securities Dealers Automated Quotations

NYSE

New York Stock Exchange

Why are financial markets and financial institutions important?

Provide financing to the corporation's growth. A modern financial system offers financing in many different forms, depending on the company's age, growth rate, and nature of its business

Banks are liquid; you can withdraw money on demand. How can the bank provide this liquidity and at the same time make illiquid loans to businesses?

The key to the bank's ability to provide liquidity to depositors is the bank's ability to pool relatively small deposits from many investors into large, illiquid loans to corporate borrowers. A withdrawal by any one depositor can be satisfied from any of a number of sources, including new deposits, repayments of other loans made by the bank, bank reserves, and the bank's debt and equity financing.

How can a small, private firm finance its capital investments? Give 3 examples.

Three examples of financing sources: equity investments by the founders of the company, reinvested earnings of the company, and loans from banks and other financial institutions.

Security

Traded financial asset

Is an insurance company also a financial intermediary? How does the insurance company channel savings to corporate investment?

Yes, an insurance company is a financial intermediary. Insurance companies sell policies and then invest part of the proceeds in corporate bonds and stocks and in direct loans to corporations. The returns from these investments help pay for losses incurred by policyholders.