Financial Markets & Institutions

Week 1 & 2

Financial Institutions

Organizations that act as intermediaries between savers and borrowers by investing and issuing financial instruments

(Example: Commercial banks, investment banks, insurance companies, pension funds, and mutual funds. )

Financial Markets

Where financial instruments are traded and funds are channeled from savers to borrowers.

(Example: The New York Stock Exchange (stocks), the U.S. Treasury market (bonds), and the foreign exchange market (currencies) )

Financial Instruments

A financial claim/asset

( Example: Stocks (equity claims), bonds (debt claims), and derivatives like options and futures.)

Capital market

Markets where long-term financial instruments, those with a maturity greater than 1 year (or no maturity at all like stocks), are traded. They allow governments and corporations to raise funds for long-term investment such as expansion, infrastructure, and R&D

( Instruments: Stocks, corporate bonds, Treasury notes and bonds, municipal bonds, mortgages.
Key features: Higher risk and higher expected returns, and prices are more sensitive to interest rate changes because of the longer time horizon.
Example: Apple issuing 10-year bonds, or an investor buying shares on the NASDAQ. )

Money market

Markets where short-term, highly liquid debt instruments with maturities of one year or less are traded. They let governments, banks, and corporations manage short-term cash needs, borrowing temporarily or parking surplus cash.

( Instruments: Treasury bills, commercial paper, negotiable certificates of deposit, repurchase agreements (repos), federal funds, banker’s acceptances.
Key features: Low risk, low returns, high liquidity, and typically large denominations, so they are dominated by institutions rather than individual investors.
Example: A corporation issuing 90-day commercial paper to cover payroll, or a bank lending reserves overnight in the federal funds market. )

Primary market

Markets where funds are raised; where new securities are issued and sold for the first time, with the proceeds going directly to the issuer (a corporation or government)

(Examples: An IPO (initial public offering), a company issuing new bonds, a seasoned equity offering (SEO), or the U.S. Treasury auctioning new T-bills.)

Secondary market

Markets where previously issued securities are bought and sold among investors. The issuer does not receive any proceeds from these trades; money simply changes hands between investors.

(Key features: Provide liquidity (investors can easily sell), establish ongoing market prices, and make primary market securities more attractive since buyers know they can resell. Include both exchanges and over-the-counter (OTC) markets.

Examples: Trading Apple shares on the NASDAQ, buying a used Treasury bond through a broker, or trading on the NYSE.)

Debt market

Markets where borrowers issue and investors trade bonds and loans packaged as securities. The issuer promises to repay the principal plus interest, and the investor becomes a creditor with no ownership stake.

( Instruments: Treasury securities, corporate bonds, municipal bonds, mortgages, commercial paper, and other loans.
Key features: Fixed or predictable payments (interest/coupons) and a set maturity date. Creditors have priority over shareholders if the issuer goes bankrupt. Returns are generally lower and more stable, and prices move inversely with interest rates.
Examples: The U.S. Treasury market, the corporate bond market, the mortgage market. )

Equity market

Markets where shares of ownership in corporations (stocks) are issued and traded. Investors become part owners with a residual claim on the firm’s assets and earnings.

( Key features: Returns come from dividends and capital gains, with no guaranteed payments and no maturity date. Shareholders are paid after creditors, so risk and potential return are higher. Shareholders usually get voting rights.
Examples: The NYSE, NASDAQ, and the London Stock Exchange.)

Nominal interest rate

The interest rate actually quoted or paid on a loan or security, not adjusted for inflation. It is the stated percentage return the lender earns (or the borrower pays) on the funds.

( A savings account advertises 5% interest. If inflation is 3%, the real return is only about 2%.)

Nominal rate calculation

(_____) = Real rate + Expected inflation (the Fisher effect).

Loanable funds

The total pool of money available to be borrowed and lent in the economy at a given time. It is the supply of funds from savers and the demand for funds from borrowers.

(Example: If businesses want to borrow more to expand, demand for (_____) rises, pushing interest rates up. )

Net suppliers of funds

A sector of the economy that supplies more funds to financial markets (through saving and lending) than it borrows from them