IFM chapter 1 - Why study Financial Markets and Institutions

what are the three thing financial markets do?

Financial markets are platforms that facilitate the buying and selling of financial securities, such as stocks, bonds, and currencies, enabling capital allocation and investment.

1. Transfer funds from people with an excess of available funds to those that have a shortage.

2. Promote greater economic efficiency by channeling funds from people who dont have a productive use for them to those who do

3. Produce economic growth

What is an asset?

=Anything of value owned by a person or firm

=any financial claim or piece of property subject to ownership

What is a real asset?

Gold, house, painting

What is a financial asset?

An asset that represents a claim on someone else for payment

• claim on future financial cash flow

• Instrument that is being issued (created) by an issuer (borrower), that is bought/invested in by an investor (lender) who wants to use its money productively

• Ex. Bank checkings account

What is a security?

= financial asset that can be bought and sold in a financial market

= a (tradable) investment instrument such as stocks, bonds, financial derivatives; etc.

=financial instrument

= a claim on the issuers future income or assets

What is a financial market?

A place or channel for buying or selling securities (eg. Bonds, stocks)

What is money?

Anything that is generally accepted in payment for goods and services or to pay off debts

What’s the money supply?

Total quantity of money

What’s a bond?

Debt security that promises to make payments periodically for a specified period of time.

Financial security issued by a corporation or a government that represents a promise to repay a fixed amount of money.

What’s interest?

Cost of borrowing funds (or payment for lending funds) (%)

What are coupons?

Typically interest that is paid as fixed amounts

What is maturity?

The end of the lifetime of a bond, point at which the seller of the bond repays the principle

How long are short term and long term maturities?

Short: <1 year

Long: >10 years

What are common stocks?

Stocks are financial instruments that represent an ownership share in a company, allowing investors to benefit from the company's success through dividends and capital gains.

what are dividens

Dividends are payments made by a corporation to its shareholders, usually as a distribution of profits. They can be in the form of cash or additional shares.

What are retained earnings?

Profits kept in the firm

What is foreign exchange?

Foreign exchange, also known as Forex, refers to the global marketplace for trading national currencies against one another. It is the mechanism by which currencies are bought and sold, enabling international trade and investment.

What is securitization?

The process of converting loans and other financial assets that are not tradable into securities (that are traded)

What is a step-by-step example of securitization?

1. Origination: A bank or financial institution provides loans to borrowers, such as mortgages or auto loans.

2. Pooling: These loans are gathered together into a pool to create a financial asset that can be sold.

3. Creation of Securities: The pool of loans is then converted into securities, often by creating different tranches with varying risk levels and returns.

4. Issuance: These securities are sold to investors in the financial markets, allowing the originating institution to recover capital.

5. Servicing: The pool of loans is managed, and payments from borrowers are collected and distributed to the investors holding the securities.

6. Payment: Investors receive periodic payments based on the cash flows generated by the underlying loans.

What is financial liability? Give ex.

A financial claim owed by a person or a firm

Ex. Asset to a bank or liability to a borrower

what are debt markets?

Debt markets are financial markets where participants can issue and trade debt securities, primarily bonds. They enable the borrowing and lending of funds, allowing governments, corporations, and other entities to finance operations and projects over time. It is where interest rates are determined

How do interest rates affect the personal level and the overall health of the economy?

Interest rates influence borrowing costs for individuals and businesses; lower rates encourage spending and investment, while higher rates can slow economic growth by increasing loan costs. Overall, they affect consumer behavior, inflation, and economic stability.

Give 3 characteristics of interest rates

1. Tendency to move in unison

2. Often differ substantially

3. Spreads between them fluctuate

What’s the stock market?

Market where stocks are traded

• companies initially sell stock (in the primary market) to raise money

• After, the stocks are traded among investors

• The stock market receives the most attention from media

Why is it good for a firm to have higher priced shares?

It can raise larger amounts of funds and/or buy more production facilities and equipment

What are commercial banks and what do they do?

Commercial banks are financial institutions that accept deposits, offer checking and savings accounts, and provide loans to individuals and businesses. They facilitate transactions, provide credit, and help in the management of financial resources.

What are savings banks?

Savings banks are financial institutions that primarily accept savings deposits and provide loans, often aimed at helping individuals save and achieve financial goals. They typically offer higher interest rates on savings accounts compared to commercial banks.

(Similar but legally different from commercial banks)

What are credit unions?

Credit unions are member-owned financial cooperatives that provide savings accounts, loans, and other financial services to their members. They often offer higher interest rates on savings and lower rates on loans compared to commercial banks.

what are mutual funds

Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities. They offer individual investors the ability to invest in a managed fund with professional oversight.

what are hedge funds ?

Hedge funds are private investment funds that employ various strategies to generate high returns for their investors. They often invest in a wide range of assets and use techniques such as leverage, short selling, and derivatives. They are higher risk than mutual funds and charge higher fees. More risk more reward for wealthy individuals)

what are investment banks?

Investment banks are financial institutions that assist companies in raising capital by underwriting and issuing securities. They also provide advisory services for mergers and acquisitions, market making, and asset management. They are also involved in securitisation of (mortgage) loans

What do insurance companies do?

• write contract to protect policy holders from risk of financial losses at certain events (accident, fire)

• Collects premiums

• Invest to obtain the funds necessary to pay claims to policyholders and to cover their costs

What do pension funds do?

Pension funds are investment pools that collect and manage money from employers and employees to provide retirement income to employees, ensuring they can meet future payment obligations to retirees.

What is underwriting?

Underwriting is the process by which an individual or institution evaluates the risk of insuring or lending to a person or entity. An example of underwriting is when a bank assesses a borrower's creditworthiness before approving a mortgage loan.