SLide financial markets and institutions

OUTLINE Why study financial markets and institutions? Overview of financial markets Overview of financial institutions Chapter 1: Introduction Overview of Financial Markets Why Study Financial Markets and Institutions? A financial market is a market in which financial assets (securities) can be purchased or sold Financial markets and institutions are primary channels to allocate capital in our society Financial markets facilitate financing and investing by households, firms, and government agencies Proper capital allocation leads to growth in: Societal wealth Income Financial markets are one type of structure through which funds flow: Channels funds from person or business without investment opportunities (i.e., “Lender-Savers”) to one who has them (i.e., “Borrower-Spenders”) Economic opportunity Well functioning financial markets are key factors in producing high economic growth Improves economic efficiency Financial institutions are needed because of transactions costs, risk sharing, and asymmetric information •1-4 Financial Markets Funds Transferees Lender-Savers Borrower-Spenders Households Business firms Business firms Government Government Households Foreigners Foreigners Function of Financial Markets Segments of Financial Markets Direct Finance Borrowers borrow directly from lenders in financial markets by selling financial instruments which are claims on the borrower’s future income or assets Indirect Finance Borrowers borrow indirectly from lenders via financial intermediaries (established to source both loanable funds and loan opportunities) by issuing financial instruments which are claims on the borrower’s future income or assets Classification Financial markets can be distinguished along a variety of dimensions: primary versus secondary markets money versus capital markets debt versus equity markets Primary markets Markets in which users of funds (e.g., corporations) raise funds by issuing new financial instruments (e.g., stocks and bonds) Secondary markets Markets where existing financial instruments are traded among investors (e.g., exchange traded: NYSE and over-the-counter: NASDAQ) •1-9 Primary versus Secondary Markets Primary versus Secondary Markets Primary and Secondary Market Transfer of Funds Time Line Primary versus Secondary Markets Concluded How were primary markets affected by the financial crisis? We can further classify secondary markets as follows: Do secondary markets add value to society or are they simply a legalized form of gambling? Exchanges How does the existence of secondary markets affect primary markets? Trades conducted in central locations (e.g., New York Stock Exchange) Over-the-Counter Markets Dealers at different locations buy and sell Best example is the market for Treasury Securities Money Market Instruments Outstanding Money markets Markets that trade debt securities with maturities of one year or less (e.g., C D s and U.S Treasury bills) little or no risk of capital loss, but low return Capital markets Markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year substantial risk of capital loss, but higher promised return Money Market Instruments Outstanding, ($Tn) Money versus Capital Markets Source: Federal Board, “Financial Accounts of the United States,” Statistical Releases, Washington, D C, various issues, www.federalreserve.gov •114 Capital Market Instruments Outstanding Capital Market Instruments Outstanding, ($Tn) Debt markets versus Equity markets Debt Markets Short-Term (maturity < year) Long-Term (maturity > 10 year) Intermediate term (maturity in-between) Equity Markets Pay dividends, in theory forever Represents an ownership claim in the firm Source: Federal Reserve Board, “Financial Accounts of the United States,” Statistical Releases, Washington, DC, various issues www.federalreserve.gov Foreign Exchange (FX) Markets FX markets Trading one currency for another (e.g., dollar for yen) Spot FX the immediate exchange of currencies at current exchange rates Forward FX the exchange of currencies in the future on a specific date and at a pre-specified exchange rate Derivatives and the Crisis Subprime mortgage losses were large, reaching over $700 billion The “Great Recession” was the worst since the “Great Depression” of the 1930s Trillions $ global wealth lost, peak to trough stock prices fell over 50% in the U.S Lingering high unemployment and below trend growth in the U.S Sovereign debt levels in developed economies reached post-war alltime highs Derivative Security Markets Derivative security A financial security whose payoff is linked to (i.e., “derived” from) another, previously issued security such as a security traded in capital or foreign exchange markets Generally an agreement to exchange a standard quantity of assets at a set price on a specific date in the future The main purpose of the derivatives markets is to transfer risk between market participants Valuation of Securities in Financial Markets Securities are valued as the present value of their expected cash flows, discounted at a rate that reflects their uncertainty Market pricing of securities Different investors may value the same security differently based on their interpretation of information Impact of valuations on pricing Every security has an equilibrium market price at which demand and supply for the security are equal Favorable information results in upward valuation revisions; unfavorable information results in downward revisions Securities reach a new equilibrium price as new information becomes available •1-19 20 Non-Intermediated (Direct) Flows of Funds Overview of Financial Institutions Markets are imperfect Flow of Funds in a World without FIs Financial institutions are needed to resolve problems created by market imperfections Direct Financing Financial Claims (equity and debt instruments) Financial Institutions Institutions through which suppliers channel money to users of funds Access the long description slide •1-22 Percentage Shares of Assets of Financial Institutions in the United States, 1948–2016 Figure 1-7 Flow of Funds in a World with Fls Intermediated Flows of Funds Flow of Funds in a World with FIs Access the long description slide We describe and illustrate this flow of funds in Chapter Access the long description slide •123 •1-24 Indirect finance Financial intermediation is actually the primary means of moving funds from lenders to borrowers More important source of finance than securities markets (such as stocks) Needed because of transactions costs, risk sharing, and asymmetric information Source: Andreas Hackethal and Reinhard H Schmidt, “Financing Patterns: Measurement Concepts and Empirical Results,” Johann Wolfgang Goethe-Universitat Working Paper No 125, January 2004 The data are from 1970–2000 and are gross flows as percentage of the total, not including trade and other credit data, which are not available •26 Function of Financial Institutions: Indirect Finance Function of Financial Institutions: Indirect Finance Transactions Costs Risk sharing Financial intermediaries make profits by reducing transactions costs Reduce transactions costs by developing expertise and taking advantage of economies of scale FIs create and sell assets with lesser risk to one party in order to buy assets with greater risk from another party This process is referred to as asset transformation, because in a sense risky assets are turned into safer assets for investors Function of Financial Intermediaries: Indirect Finance Asymmetric information: Adverse selection and Moral hazard Another reason FIs exist is to reduce the impact of asymmetric information One party lacks crucial information about another party, impacting decision-making We usually discuss this problem along two fronts: adverse selection and moral hazard Adverse selection Asymmetric information: Adverse selection Before the After the transaction occur Asymmetric transaction occur information Moral hazard Function of Financial Intermediaries Adverse Selection Adverse selection Before the After the transaction occur Asymmetric transaction occur information Potential borrowers who are the most likely to produce an undesirable (adverse) outcome – the bad credit risks – are the most likely to be selected Moral hazard Before transaction occurs Potential borrowers most likely to produce adverse outcome are ones most likely to seek a loan Similar problems occur with insurance where unhealthy people want their known medical problems covered Function of Financial Intermediaries Asymmetric information: Moral hazard Moral Hazard Adverse selection Before the After the transaction occur Asymmetric transaction occur information Moral hazard After transaction occurs Hazard that borrower has incentives to engage in undesirable (immoral) activities making it more likely that won’t pay loan back Again, with insurance, people may engage in risky activities only after being insured Another view is a conflict of interest The risk (hazard) that the borrower might engage in activities that are undesirable (immoral) from the lender’s point of view Asymmetric Information: Adverse Selection and Moral Hazard Financial intermediaries reduce adverse selection and moral hazard problems, enabling them to make profits How they accomplish this is covered in many of the chapters to come Economies of Scope and Conflicts of Interest FIs are able to lower the production cost of information by using the information for multiple services: bank accounts, loans, auto insurance, retirement savings, etc This is called economies of scope But, providing multiple services may lead to conflicts of interest, perhaps causing one area of the FI to hide or conceal information from another area (or the economy as a whole) This may actually make financial markets less efficient! Types of Financial Institutions Financial Institutions are distinguished by: Whether they accept insured deposits Depository versus non-depository financial institutions Whether they receive contractual payments from customers Types of Financial Intermediaries Primary Assets and Liabilities of Financial Intermediaries • Depository institutions • Contractual savings institutions • Investment intermediaries Types of Financial Intermediaries Principal Financial Intermediaries and Value of Their Assets Money Market Securities (cont’d) Money Market Securities (cont’d) Treasury bills (cont’d) Treasury bills (cont’d) Treasury bill auction Treasury bill auction (cont’d) Investors submit bids on T-bill applications for the maturity of their choice Applications can be obtained from a Federal Reserve district or branch bank Financial institutions can submit their bids using the Treasury Automated Auction Processing System (TAAPS-Link) Weekly auctions include 13-week and 26-week T-bills 4-week T-bills are offered when the Treasury anticipates a shortterm cash deficiency Cash management bills are also occasionally offered Investors can submit competitive or noncompetitive bids The bids of noncompetitive bidders are accepted The highest competitive bids are accepted Any bids below the cutoff are not accepted Since 1998, the lowest competitive bid is the price applied to all competitive and noncompetitive bids Institutions must set up an account with the Treasury Payments to the Treasury are withdrawn electronically from the account Payments received from the Treasury are deposited into the account •9 •10 Money Market Securities (cont’d) Treasury bills (cont’d) Estimating the yield T-bills are sold at a discount from par value T-Bill Auctions The yield is influenced by the difference between the selling price and the purchase price If a newly-issued T-bill is purchased and held until maturity, the yield is based on the difference between par value and the purchase price •511 •12 Treasury bills (cont’d) Estimating the yield (cont’d) The annualized yield is: YT  SP  PP 365  PP n Estimating the T-bill discount The discount represents the percent discount of the purchase price from par value for newly-issued T-bills: T - bill discount  Example An investor purchases a 91-day T-bill for $9,782 If the T-bill is held to maturity, what is the yield the investor would earn? SP  PP 365  PP n 10,000  9,782 365   9,782 91  8.94% YT  Par  PP 360  Par n Money Market Securities (cont’d) Using the information from the previous example, what is the T-bill discount? Par  PP 360  Par n 10,000  9,782 360   10,000 91  8.62% T - bill discount  Commercial paper: Is a short-term debt instrument issued by well-known, creditworthy firms Is typically unsecured Is issued to provide liquidity to finance a firm’s investment in inventory and accounts receivable Is an alternative to short-term bank loans Has a minimum denomination of $100,000 Has a typical maturity between 20 and 270 days Is issued by financial institutions such as finance companies and bank holding companies Has no active secondary market Is typically not purchased directly by individual investors •16 Commercial paper (cont’d) Estimating the Commercial Paper Yield An investor purchases 120-day commercial paper with a par value of $300,000 for a price of $289,000 What is the annualized commercial paper yield? Volume of commercial paper: Has increased substantially over time Is commonly reduced during recessionary periods Placement Some firms place commercial paper directly with investors Most firms rely on commercial paper dealers to sell it Some firms (such as finance companies) create in-house departments to place commercial paper 300,000 - 289,000 360  289,000 120  11.42% Ycp  Estimating the yield The yield on commercial paper is slightly higher than on a T-bill The nominal return is the difference between the price paid and the par value •17 Negotiable certificates of deposit (NCDs) (cont’d) Money Market Securities (cont’d) Placement Negotiable certificates of deposit (NCDs): Directly Through a correspondent institution Through securities dealers Are issued by large commercial banks and other depository institutions as a short-term source of funds Have a minimum denomination of $100,000 Are often purchased by nonfinancial corporations Are sometimes purchased by money market funds Have a typical maturity between two weeks and one year Have a secondary market Premium NCDs offer a premium above the T-bill yield to compensate for less liquidity and safety Premiums are generally higher during recessionary periods Yield NCDs provide a return in the form of interest and the difference between the price at which the NCD was redeemed or sold and the purchase price If investors purchase a NCD and hold it until maturity, their annualized yield is the interest rate •19 Money Market Securities (cont’d) Repurchase agreements One party sells securities to another with an agreement to repurchase them at a specified date and price Essentially a loan backed by securities A reverse repo refers to the purchase of securities by one party from another with an agreement to sell them Bank, S&Ls, and money market funds often participate in repos Transactions amounts are usually for $10 million or more Common maturities are from day to 15 days and for one, three, and six months There is no secondary market for repos Repurchase agreements (cont’d) Placement Repo transactions are negotiated through a telecommunications network with dealers and repo brokers When a borrowing firm can find a counterparty to a repo transaction, it avoids the transaction fee Some companies use in-house departments Estimating the yield The repo yield is determined by the difference between the initial selling price and the repurchase price, annualized with a 360-day year Example: Estimating the Repo Yield Money Market Securities (cont’d) An investor initially purchased securities at a price of $9,913,314, with an agreement to sell them back at a price of $10,000,000 at the end of a 90-day period What is the repo rate? Federal funds SP  PP 360  PP n 10,000,000  9,913,314 360   9,913,314 90  3.50% Repo rate  The federal funds market allows depository institutions to lend or borrow short-term funds from each other at the federal funds rate The rate is influenced by the supply and demand for funds in the federal funds market The Fed adjusts the amount of funds in depository institutions to influence the rate All firms monitor the fed funds rate because the Fed manipulates it to affect economic conditions The fed funds rate is typically slightly higher than the T-bill rate Money Market Securities (cont’d) Money Market Securities (cont’d) Federal funds (cont’d) Banker’s acceptances: Two depository institutions communicate directly through a communications network or through a federal funds broker The lending institution instructs its Fed district bank to debit its reserve account and to credit the borrowing institution’s reserve account by the amount of the loan Commercial banks are the most active participants in the federal funds market Most loan transactions are or $5 million or more and usually have one- to seven-day maturities Banker’s acceptances (cont’d) Steps involved in banker’s acceptances First, the U.S importer places a purchase order for goods The importer asks its bank to issue a letter of credit (L/C) on its behalf Represents a commitment by that bank to back the payment owed to the foreign exporter The L/C is presented to the exporter’s bank The exporter sends the goods to the importer and the shipping documents to its bank The shipping documents are passed along to the importer’s bank An unknown importer’s bank may serve as the guarantor Exporters frequently sell an acceptance before the payment date Have a return equal to the difference between the discounted price paid and the amount to be received in the future Have an active secondary market facilitated by dealers Creation of a Banker’s Acceptance Money Market Securities (cont’d) Indicate that a bank accepts responsibility for a future payments Are commonly used for international trade transactions Institutional Use of Money Markets Institutional Use of Money Markets (cont’d) Financial institutions purchase money market securities to earn a return and maintain adequate liquidity Financial institutions with uncertain cash in- and outflows maintain additional money market securities Institutions issue money market securities when experiencing a temporary shortage of cash Institutions that purchase securities act as a creditor to the initial issuer Money market securities enhance liquidity: Some institutions issue their own money market instruments to obtain cash Newly-issued securities generate cash Institutions that previously purchased securities will generate cash upon liquidation Most institutions hold either securities that have very active secondary markets or securities with short-term maturities Many money market transaction involve two financial institutions Chapter Outline Background on bonds Treasury notes (T-notes) and bonds (T-bonds) Municipal bonds Corporate bonds Chapter 5: Bond Markets Institutional use of bond markets Background on Bonds Background on Bonds (cont’d) Bonds represents long-term debt securities that are issued by government agencies or corporations Bond yields The issuer’s cost of financing is measured by the yield to maturity The annualized yield that is paid by the issuer over the life of the bond Equates the future coupon and principal payments to the initial proceeds received Does not include transaction costs associated with issuing the bond Earned by an investor who invests in a bond when it is issued and holds it until maturity Interest payments occur annually or semiannually Par value is repaid at maturity Most bonds have maturities between 10 and 30 years Bearer bonds require the owner to clip coupons attached to the bonds Registered bonds require the issuer to maintain records of who owns the bond and automatically send coupon payments to the owners The holding period return is used by investors who not hold a bond to maturity Bond Market Instruments Outstanding, 1994–2016 Bond Market Instruments Outstanding, 1994 - 2016 Bond markets Bond markets are markets in which bonds are issued and traded Treasury notes (T-notes) and bonds (T-bonds) Municipal bonds Corporate bonds Treasury notes (T-notes) and bonds (T-bonds) The U.S Treasury issues Treasury notes or bonds to finance federal government expenditures Sources: Federal Reserve Board website, “Flow of Funds Accounts,” various issues www.federalreserve.gov T-notes and T-bonds Default risk free: backed by the full faith and credit of the U.S government Note maturities are usually less than 10 years Bonds maturities are 10 years or more An active secondary market exists The 30-year bond was discontinued in October 2001 Low returns: low interest rates (yields to maturity) reflect low default risk Interest rate risk: because of their long maturity, T-notes and Tbonds experience wider price fluctuations than money market securities when interest rates change Liquidity risk: older issued T-bonds and T-notes trade less frequently than newly issued T-bonds and T-notes T-Note and T-Bond Markets T-notes and T-bonds (cont’d) The primary market of T-notes and T-bonds is similar to that of T-bills; the U.S Treasury sells T-notes and T-bonds through competitive and noncompetitive Treasury auctions 2-, 3-, 5-, and 7-year notes are auctioned monthly 10-year notes and 30-year bonds are auctioned quarterly (Feb, May, Aug, and Nov) Most secondary trading occurs directly through brokers and dealers Issued in minimum denominations (multiples) of $100 May be either fixed principal or inflation-indexed Principal value used to determine the coupon on inflation-indexed bonds is adjusted to reflect inflation (measured by the CPI) In other words, the semiannual coupon payments and the final principal payment of inflation-indexed bonds are based on the inflation-adjusted principal value of the security Trade in very active secondary markets Prices are quoted as percentages of face value, while coupon rates are set at intervals of 0.125 (or 1/8 of 1) percent •6-9 T-notes and T-bonds (cont’d) T-notes and T-bonds (cont’d) Stripped Treasury bonds Inflation-indexed Treasury bonds One security represents the principal payment and a second security represents the interest payments In 1996, the Treasury started issuing inflation-indexed bonds that provide a return tied to the inflation rate The coupon rate is lower than the rate on regular Treasuries, but the principal value increases by the amount of the inflation rate every six months Inflation-indexed bonds are popular in high-inflation countries such as Brazil Investors who desire a lump sum payment can choose the PO part Investors desiring periodic cash flows can select the IO part Degrees of interest rate sensitivity vary Several securities firms create their own versions of stripped securities Merrill Lynch’s TIGRs The Treasury created the STRIPS program in 1985 11 12 Computing the Interest Payment of an Inflation-Indexed Bond T-notes and T-bonds (cont’d) Savings bonds A 10-year bond has a par value of $1,000 and a coupon rate of percent During the first six months after the bond was issued, the inflation rate was 1.3 percent By how much does the principal of the bond increase? What is the coupon payment after six months? Issued by the Treasury Have a 30-year maturity and no secondary market Series EE bonds provide a market-based interest rate Series I bonds provide a rate of interest tied to inflation Interest on savings bonds is not subject to state and local taxes Federal agency bonds Principal  $1,000  1.013  $1,013 Coupon Payment  5%  $1,013  $50 65 Ginnie Mae issues bonds and purchases mortgages that are insured by the FHA and the VA Freddie Mac issues bonds and purchases conventional mortgages Fannie Mae issues bonds and purchases residential mortgages 14 Municipal Bonds: Comparing Revenue and General Obligation Bonds Municipal Bonds Figure Issuance of Revenue and General Obligation Bonds, 1984–2012 (End of year) Municipal bonds can be classified as either general obligation bonds or revenue bonds General obligation bonds are supported by the municipal government’s ability to tax Revenue bonds are supported by the revenues of the project for which the bonds were issued Municipal bonds typically pay interest semiannually, with minimum denominations of $5,000 Municipal bonds have a secondary market Most municipal bonds contain a call provision 15 Municipal Bonds (cont’d) Municipal Bonds (cont’d) Tax-free municipal interest rate  taxable interest rate  (1  marginal tax rate) Credit risk NOT default-free (e.g., Orange County California -Defaults in 1990 amounted to $1.4 billion in this market) Less than percent of all municipal bonds issued since 1940 have defaulted Moody’s, Standard and Poor’s, and Fitch Investor Service assign ratings to municipal bonds Example: Suppose the rate on a corporate bond is 9% and the rate on a municipal bond is 6.75% Which should you choose? Suppose the rate on a corporate bond is 5% and the rate on a municipal bond is 3.5% Which should you choose? Your marginal tax rate is 28% 18 Municipal Bonds (cont’d) Municipal Bonds (cont’d) Variable-rate municipal bonds Trading and quotations Coupon payments adjust to movements in a benchmark interest rate Some variable-rate munis are convertible to a fixed rate under specified conditions Investors can buy or sell munis by contacting brokerage firms Electronic trading has become popular http://www.tradingedge.com Online quotations are available at http://www.munidirect.com and http://www.investinginbonds.com 19 20 Municipal Bonds (cont’d) Corporate Bonds Yields offered on municipal bonds Corporations issue corporate bonds to borrow for long-term periods Differs from the yield on a Treasury bond with the same maturity Typically lower than the Treasury yield curve because of the tax differential The municipal yield curve has a similar shape as the Treasury yield curve Corporate bonds have a minimum denomination of $1,000 Secondary market activity varies Financial and nonfinancial institutions as well as individuals are common purchasers Most corporate bonds have maturities between 10 and 30 years Interest paid by corporations is tax-deductible, which reduces the corporate cost of financing with bonds 21 22 Corporate Bonds (cont’d) Corporate Bonds (cont’d) Corporate bond yields and risk Corporate bond yields and risk (cont’d) Interest income earned on corporate represents ordinary income Yield curve Investor assessment of risk Investors may only consider purchasing corporate bonds after assessing the issuing firm’s financial condition and ability to cover its debt payments Investors may rely heavily on financial statements created by the issuing firm, which may be misleading Affected by interest rate expectations, a liquidity premium, and maturity preferences of corporations Similar shape as the municipal bond yield curve Bond ratings Default rate Bonds with higher ratings have lower yields Corporations seek investment-grade ratings, since commercial banks will only invest in bonds with that status Rating agencies will not necessarily detect any misleading information contained in financial statements Depends on economic conditions Less than percent in the late 1990s Exceeded percent in 2002 23 24 Corporate Bonds (cont’d) Corporate Bonds (cont’d) Characteristics of corporate bonds Characteristics of corporate bonds (cont’d) The bond indenture specifies the rights and obligations of the issuer and the bondholder A trustee represents the bondholders in all matters concerning the bond issue Sinking-fund provision Call provisions: Require the firm to pay a price above par value when it calls its bonds The difference between the call price and par value is the call premium Are used to: Issue bonds with a lower interest rate Retire bonds as required by a sinking-fund provision Are a disadvantage to bondholders A requirement to retire a certain amount of the bond issue each year Protective covenants: Are restrictions placed on the issuing firm designed to protect the bondholders from being exposed to increasing risk during the investment period Often limit the amount of dividends and corporate officers’ salaries the firm can pay 25 26 Corporate Bonds (cont’d) Corporate Bonds (cont’d) Bond collateral Low- and zero-coupon bonds: Are issued at a deep discount from par value Require annual tax payments although the interest will not be received until maturity Have the advantage to the issuer of requiring low or no cash outflow Typically, collateral is a mortgage on real property A first mortgage bond has first claim on the specified assets A chattel mortgage bond is secured by personal property Variable-rate bonds: Unsecured bonds are debentures Subordinated debentures have claims against the firm’s assets that are junior to the claims of mortgage bonds and regular debentures Allow investors to benefit from rising market interest rates over time Allow issuers of bonds to benefit from declining rates over time Convertibility Convertible bonds allow investors to exchange the bond for a stated number of shares of common stock Investors are willing to accept a lower rate of interest on convertible bonds 27 28 Corporate Bonds (cont’d) Corporate Bonds (cont’d) Trading corporate bonds Corporate bond quotations More than 2,000 bonds are traded on the NYSE with a market value of more than $2 trillion Corporate bond prices are reported in eighths Corporate bond quotations normally include the volume of trading and the yield to maturity Bonds are traded through brokers, who communicate orders to bond dealers A market order transaction occurs at the prevailing market price A limit order transaction will occur only if the price reaches a specified limit Bonds listed on the NYSE are traded through the automated Bond System (ABS) Online trading is possible at: http://www.schwab.com http://www.etrade.com 29 30 Corporate Bonds (cont’d) Corporate Bonds (cont’d) Junk bonds How corporate bonds facilitate restructuring (cont’d) Junk bonds have a high degree of credit risk About two-thirds of junk bonds are used to finance takeovers Size of the junk bond market Using bonds to revise the capital structure Currently about 3,700 junk bond offerings exist with a market value of $80 billion Debt is perceived to be a cheaper source of capital than equity as long as the corporation can meet its debt payments Sometimes, corporations issue bonds and use the proceeds for a debt-for-equity swap Corporations with an excessive amount of debt can conduct an equity-for-debt swap Risk premium of junk bonds The typical premium is between and percent above Treasury bonds with the same maturity Performance of junk bonds In the early 1990s, the popularity of junk bonds declined because of Insider trading allegations The financial problems of a few major issuers of junk bonds The financial problems in the thrift industry In the late-1990s, junk bonds performed well with few defaults 31 32 Institutional Use of Bond Markets All financial institutions participate in bond markets On any given day, commercial banks, bond mutual funds, insurance companies, and pension funds are dominant participants A financial institution’s investment decisions will often simultaneously affect bond market and other financial market activity 33 ... Classification Financial markets can be distinguished along a variety of dimensions: primary versus secondary markets money versus capital markets debt versus equity markets Primary markets Markets... make financial markets less efficient! Types of Financial Institutions Financial Institutions are distinguished by: Whether they accept insured deposits Depository versus non-depository financial. .. payment services Volcker Rule: Insured institutions may not engage in proprietary trading Regulation of Financial Institutions Globalization of Financial Markets and Institutions FIs are heavily regulated