Financial Markets & Institutions

Financial Markets & Institutions

1. Financial system

   • Role: channelling funds from units who have saved surplus to units who have a shortage of funds
   • Transfer of risks and provide a variety of payment mechanism
   • Comprises: financial markets, financial instruments, financial intermediaries

2. Financial instruments

   • Debt instruments: promise the payment of given sums to the investor (bond, notes, bills)
   • Equity instruments: claims to shares in the net income and assets of a firm, do not have a maturity date (common anf preferred stocks)
   • Derivatives: tools for transferring risk, offer the opportunities to diminish or increase exposure to uncertainties. Major use is for hedging
     • Future contracts: can be traded or exchanged, to buy or sell a specific amount or value of an asset in the future at a set price, for delivery and payment on a set date
     • Options: the right but not the obligation to buy or sell an underlying asset at a set price at a future date
     • Swaps: between two parties to exchange the instruments. These instruments can be almost anything, but most swaps involve cash flows based on a notional principal amount that both parties agree to.
     • Warrants: issued by banks, government or other institutions, same principle as an option
     • Forward contracts: binding promise to buy or sell a set amount or value of an underlying asset at a set future time. Forwards are not traded

3. Financial markets

   • Primary: new issues of financial instruments are sold to initial buyers
   • Secondary: securities that have been previously issued are resold
     • Exchange market: buyers and sellers (through their brokers) transact in one central location to conduct trades
     • Over-the-counter (OTC) market: dealers at different locations have an inventory of securities, and are ready to sell to anyone willing to accept their price

4. Financial intermediaries

   • Depository institutions: a significant proportion of funds come from customer deposits: commercial bank, saving institutions, credit unions
   • Contractual savings institutions: acquire funds at periodic intervals on a contractual basis: insurance company, pension funds
   • Investment intermediaries: mutual funds, finance companies, investment banks, securities firms