Role of Financial Markets and Institutions

1
Chapter1

• Role of Financial Markets and Institutions

2
Outline

• Financial Institutions
• Financial Markets

3
The Financial SectorProvides for the efficient
allocation of resources- connects savers and
borrowers
4
Financial Sector

• Surplus Spending Unit (SSU)
• Has more inflows than outflows
• Other terms for surplus unit are saver,
  lender, investor
• Households are surplus units

5
Financial Sector

• Deficit Spending Units
• More outflows than inflows
• Other terms for deficit spending unit are
• borrower, demander of loanable funds, seller of
  securities.

6
Transferring Funds from SSUs to DSUs

• Direct Financing
• Semi-Direct Financing
• Indirect Financing (Financial Intermediation)

7
Direct Financing

• Funds are transferred directly from ultimate
  savers to ultimate borrowers
• Saver ? Borrower

8
Semi-Direct Financing

• Ultimate borrowers and savers are brought
  together by a facilitator e.g.
• Brokers, Dealers, Investment Banks
• Saver ? Facilitator ? Borrower
• (No transformation)

9
Indirect Financing or Financial Intermediation

• A financial "intermediary" transforms financial
  claims with one set of characteristics into
  financial claims with other characteristics e.g.
  deposits are used to make loans.
• Saver? Intermediary?Borrower
• (Transformation)

10
Indirect Financing or Financial Intermediation

• Benefits of Financial Intermediation
• Economies of scale from specialization
• Transaction and search costs are lowered for SSUs
  and DSUs.
• Financial intermediaries may be able to gather
  information more effectively and discreetly.

11
Types of Financial Intermediaries

• Depository Institutions
• Commercial Banks
• Savings and Loan Associations
• Credit Unions

12
Types of Financial Intermediaries

• Nondepository Institutions
• Life Insurance Companies
• Property/Casualty Insurance Companies
• Pension Funds
• Securities Firms

13
Types of Financial Intermediaries

• Mutual Funds
• Finance Companies
• Bottomline

14
Types of Financial Markets

• Markets may be differentiated by maturity of the
  securities.
• Long-term (greater than one-year)
• High quality short-term (less than one-year)

15
Types of Financial Markets

• Markets may be differentiated by whether
  securities are new or used
• Primary markets
• Secondary markets

16
Types of Financial Markets

• Markets may be differentiated by how or where
  securities are traded.
• Organized markets
• Over-the-counter (OTC).

17
Types of Financial Markets

• Markets may be differentiated by variations in
  timing- now versus later
• Spot
• Futures

18
Types of Financial Markets

• Other differentiations
• Options markets
• Foreign exchange markets

19
Market Efficiency

• Types of efficiency
• Allocational efficiency
• Informational
• Weak form
• Semi-strong form
• Strong form
• Operational

20
Summary

• Financial institutions facilitate the transfer of
  funds from savers to borrowers
• On average, households are net savers- business
  and governments are net dissavers
• Trend is toward financial department stores

21
Summary

• Financial markets make it easy for borrowers and
  savers to meet their respective needs
• Financial markets are becoming more global
• Efficiency is critical to participants in
  financial markets