(W2) Financial Markets and Institutions

What are primary financial markets? Who uses it?

The market where new securities are issued directly by issuers to investors to raise capital

• Used by corporations and governments to issue new financial instruments (Stocks, bonds)

What are secondary markets? What is its purpose?

The market where investors trade securities among themselves

• Provides liquidity and diversification benefits for investors

What are money markets?

Market where debt securities or instruments with maturities of one year or less are traded

What are capital markets?

Market where stocks and long-term debts with maturities greater than one year are traded

What is the purpose of financial institutions?

They are intermediaries that facilitate the flow of money from savers to borrowers

What services can commercial banks offer?

Deposits: Accept savings or fixed deposits from customers

Loans: Mortgages, personal loans, business credit

Payment services: Facilitate transactions via credit/debit cards

How do commercial banks make money?

Interest spread: Charge higher interest on loans than they pay on deposits

Fees: Collect fees for account maintenance, ATM usage, transactions

What is the purpose of investment banks?

Financial intermediaries that help corporations, governments and institutions raise capital, manage financial risk and execute M&A

How do investment banks make money?

Fees: Earn fees for advisory services and underwriting

Trading Profits: Profit from trading securities or currencies

What is the purpose of insurance companies?

Provide financial protection and risk management by transferring potential financial losses from individuals and businesses to a shared pool, paying out claims for unexpected events

How do insurance companies make money?

Premiums: Collect regular payments from moneyholders

Investment returns: Earn returns on invested premiums

What is the purpose of asset management companies?

Invest pooled capital from clients into diversified portfolios to maximise returns while managing risk

How do asset management companies make money?

Management fees (A percentage of assets under management)

What is the principal-agent problem?

Occurs when agents acting on behalf of principals pursue their own interests rather than maximising the principal’s wealth, it arisres from asymmetric information

What are 4 key roles of financial intermediaries?

1. Liquidity provision

2. Risk management

3. Cost reduction

4. Payment systems

What is included in liquidity provision?

• Size transformation - FIs pool small savings from many individuals to provide large loans to businesses or governments

• Maturity transformation - FIs balance the needs of short-term savers with long-term borrowers