Islamic and Conventional Financial Markets and Institutions

Overview of Financial Intermediation

• Learning Objectives At the end of the chapter, you should be able to:

  • Understand the significance of financial markets and financial institutions.

  • Identify who constitutes a productive society.

  • Recognize the impact of financial markets and institutions on financial well-being.

Importance of Studying Financial Markets

• Role in Resource Mobilization

  • Financial markets mobilize resources for long-term investments via financial intermediation.

  • Money markets facilitate trading activities.

  • Significant users of funds include governments, banks, and similar institutions.

• Types of Financial Institutions

  • Diverse institutions operate in money markets such as:

    • Merchant banks

    • Commercial banks

    • Central banks

    • Other dealers

• Economic Efficiency

  • Financial markets (e.g., bond, stock, foreign exchange) channel funds from savers to investors, which boosts economic efficiency.

  • Market activities influence personal wealth and business behavior.

  • Well-functioning financial markets are critical for high economic growth.

Understanding Indirect Finance

• Lender-Savers

  • Groups include:

    • Households

    • Business firms

    • Government

    • Foreigners

• Financial Intermediaries

  • Facilitate the flow of funds from savers to borrowers in the economy, allowing for both direct and indirect finance.

• Borrower-Spenders

  • Classes include:

    • Business firms

    • Government

    • Households

    • Foreigners

Debt Markets and Interest Rates

• Definition of Debt Markets

  • Also known as bond markets, used by governments and corporations to borrow funds.

  • Borrowers issue a bond, guaranteeing timely interest and principal payment over a specified horizon.

• Interest Rates Overview

  • Interest rates represent the cost of borrowing.

  • Variants include:

    • Mortgage rates

    • Car loan rates

    • Credit card rates

  • Example: Mortgage rates peaked at over 13% in 1983; as of 2022, average for a 30-year fixed mortgage is approximately 7.32%.

Historical Interest Rates

• Interest Rate Trends

  • Understanding the historical context helps in comprehending the overall financial landscape.

  • Key interest categories include:

    • Long-Term U.S. Government rates

    • Short-Term U.S. Government rates

    • Corporate rates

• Historical Chart

  • A chart illustrates interest rates (1950-2010) across different bond sectors.

The Stock Market

• Functionality of Stock Markets

  • The market for trading common stock, representing ownership in companies.

  • Initial sales of stock happen in the primary market; subsequent trading occurs in the secondary market.

  • Stock market activity garners substantial media attention due to its economic impact.

• Corporate Perspectives

  • Companies monitor the market for trends and opportunities for additional funding post-public offering.

• Volatility of Stock Prices

  • The Dow Jones Industrial Average's volatility is notable, particularly over the last five years.

The Foreign Exchange Market

• Market Overview

  • An essential financial market where currencies are traded and exchange rates determined, with a daily volume of near $1 trillion.

• Impact of Currency Fluctuations

  • Fluctuations affect purchasing power overseas, impacting consumer costs (e.g., European travel costs rise with a weaker dollar).

Significance of Financial Institutions

• Role in the Marketplace

  • Financial institutions enhance economic efficiency and act as conduits in the financial system (commonly referred to as “marketplaces”).

• Functions of Financial Institutions

  • Act as intermediaries in channeling funds from savers to investors.

  • Central banks influence monetary policy and interest rates, while international capital flows affect domestic economies.

• Integration of Technology and Risk Management

  • Financial innovation and technology improve product delivery in the financial sector.

  • Risk management focuses on mitigating financial risks within institutions.