chapter 5 financial markets and institutions

7/27/2019 Chapter 5 Financial Markets and Institutions

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Chapter 5 Financial Markets

and Institutions



• Role of the financial market : allocate

scarce resources (capital) from savers

(suppliers) to investors (users).

• Suppliers: individuals and institutions with

excess funds.

• Users or demanders: individuals and

institutions who need to raise funds to

finance their investment opportunities



I. Financial Markets

• Financial Market: is market place for selling financialsecurities: stocks, bonds and derivatives.

• A security is a piece of paper that represents theinvestor’s rights to certain prospects or property and the

conditions under which he or she may exercise thoserights.

• Stock or share represents ownership right in thecorporation

• Bond is a debt instrument issued by corporations whoborrow money.

• Derivative: is a security that derives its value from thevalue of another security



• Types of Financial Markets:

• Spot vs. futures market:

• Spot Market: assets are delivered “immediately”.

• Futures markets: participants agree to today to buy or sell an assetat some future date.

• Money vs. capital markets• Money market: short term financial assets are traded

• Capital market: long-term financial assets are traded.

• Primary vs. secondary market:

• Primary market: market where financial securities are sold for the

first time.• Secondary market: market for previously owned financial assets.



Financial Institutions

• Commercial banks

• Investment banks

• Mutual savings banks• Credit unions

• Pension funds

• Life insurance companies• Mutual funds



Stock Market

• Auction market vs. Dealer market

(Exchanges vs. OTC)

NYSE vs. NASDAQ

Differences are narrowing



• Stock market transactions

• Google decides to issue additional stock with the

assistance of its investment bank. An investor

purchases some of the newly issued shares. Isthis a primary market transaction or a secondary

market transaction?

• What if instead an investor buys existing shares

of Google stock in the open market-is this a

primary or secondary market transaction?



What is an IPO?

• An initial public offering (IPO) is where acompany issues stock in the public marketfor the first time.

• “Going public” enables a company’sowners to raise capital from a wide varietyof outside investors. Once issued, te stocktrades in the secondary market.

• Public companies are subject to additionalregulations 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 (wall street Journal or the

local newspaper) and online sources

(Yhoo!Finance, CNNMoney, or MSNMoney Central).



Efficient Market Hypothesis

Securities are normally in equilibriumand

are “fairly priced”.

Investors cannot “beat the market” except

through good luck or better information.

Level of market efficiency

Weak-form efficiency

Semi-strong-form efficiency

Strong-form efficiency



• Weak-form efficiency: can’t profit by

looking at past trends.

• Semi-strong form: all publicly available

information is reflected in stock prices.

• Strong form: all information, even inside

information, is embedded in stock prices.



• Empirical studies suggest the stock market

is:

– Highly efficient in the weak form.

– Reasonably efficient in the semi-strong form.

– Not efficient in the strong from. Insiders have

made abnormal (and sometimes illegal)

profits.

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