Money and Banking: Lecture 6

Money and Banking: Lecture 6 provides students with content about: financial instruments; financial markets; roles; structure; financial institutions; primarily stores of value; primarily to transfer risk; over-the-counter markets;... Please refer to the lesson for details!

Money and Banking Lecture McGraw­Hill/Irwin Copyright © 2006 by The McGraw­Hill Companies, Inc. All rights reserved Review of the Previous Lecture • Financial Intermediaries • Financial Instruments • Uses • Characteristics • Value 3-2 Topics under Discussion • Financial Instruments • Examples • Financial Markets • Roles • Structure • Financial Institutions 3-3 Examples of Financial Instruments Primarily Stores of Value • Bank Loans • a borrower obtains resources from a lender immediately in exchange for a promised set of payments in the future • Bonds • a form of a loan, whereby in exchange for obtaining funds today a government or corporation promises to make payments in the future 3-4 Examples of Financial Instruments Primarily Stores of Value • Home Mortgages • A loan that is used to purchase real estate • The real estate is collateral for the loan, • it is a specific asset pledged by the borrower in order to protect the interests of the lender in the event of nonpayment • If payment is not made the lender can foreclose on the property • Stocks • an owner of a share owns a piece of the firm and is entitled to part of its profits 3-5 Examples of Financial Instruments Primarily to transfer risk • Insurance Contracts • the primary purpose is to assure that payments will be made under particular (and often rare) circumstances • Futures Contracts • an agreement to exchange a fixed quantity of a commodity, such as wheat or corn, or an asset, such as a bond, at a fixed price on a set future date • It is a derivative instrument since its value is based on the price of some other asset • It is used to transfer the risk of price fluctuations from one party to another 3-6 Examples of Financial Instruments Primarily to transfer risk • Options • Derivative instruments whose prices are based on the value of some underlying asset; • They give the holder the right (but not the obligation) to purchase a fixed quantity of the underlying asset at a predetermined price at any time during a specified period 3-7 Financial Markets • Financial Markets are the places where financial instruments are bought and sold • Enable both firms and individuals to find financing for their activities • Promote economic efficiency by ensuring that resources are placed at the disposal of those who can put them to best use • When they fail to function properly, resources are no longer channeled to their best possible use and the society suffers at large 3-8 Structure of Financial Markets • Primary vs Secondary Markets • In a primary market a borrower obtains funds from a lender by selling newly issued securities • Most companies use an investment bank, which will determine a price and then purchase the company’s securities in preparation for resale to clients; this is called underwriting • In the secondary markets people can buy and sell existing securities 3-9 Structure of Financial Markets • Centralized Exchanges vs Over-thecounter Markets • In the centralized exchange (e.g Karachi Stock Exchange www.kse.com.pk ), the trading is done “on the floor” • Over-the-counter (or OTC) market are electronic networks of dealers who trade with one another from wherever they are located 3-10 Structure of Financial Markets • Debt and Equity vs Derivative Markets • Equity markets are the markets for stocks, which are usually traded in the countries where the companies are based • Debt instruments can be categorized as • money market (maturity of less than one year) or • bond markets (maturity of more than one year 3-11 Financial Markets Characteristics of a well-run financial market Low transaction costs Information communicated must be accurate and widely available • • If not, the prices will not be correct prices are the link between the financial markets and the real economy Investors must be protected • A lack of proper safeguards dampens people’s willingness to invest 3-12 Market Size and Investor Protection 3-13 Summary • Financial Instruments • Examples • Financial Markets • Roles • Structure 3-14 Upcoming Topics • Financial Institutions • Time Value of Money • Future value, • Compound Interest • Present Value • Interest Rates 3-15 ... Markets • Financial Markets are the places where financial instruments are bought and sold • Enable both firms and individuals to find financing for their activities • Promote economic efficiency... will determine a price and then purchase the company’s securities in preparation for resale to clients; this is called underwriting • In the secondary markets people can buy and sell existing securities... Information communicated must be accurate and widely available • • If not, the prices will not be correct prices are the link between the financial markets and the real economy Investors must be