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Role of Financial Markets and Institutions
Background: FIN301 - Chapter 4 – Financial Environment:
© 2003 South-Western/Thomson Learning
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Chapter Objectives
1.
Describe the types of financial markets
2.
Describe the role of financial institutions
with financial markets
3.
Identify the types of financial institutions that
facilitate transactions
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Overview of Financial Markets
Financial Market: a market in which financial
assets (securities) such as stocks and bonds
can be purchased or sold
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Financial markets provide for financial
intermediation--financial savings (Surplus Units) to
investment (Deficit Units)
Financial markets provide payments system
Financial markets provide means to manage risk
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Overview of Financial Markets
Broad Classifications of Financial Markets
Money versus Capital Markets
Primary versus Secondary Markets
Organized versus Over-the-Counter Markets
Public vs. Corporate
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Primary vs. Secondary Markets

PRIMARY

SECONDARY
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New Issue of Securities

Trading Previously
Issued Securities

Exchange of Funds for
Financial Claim

No New Funds for Issuer

Funds for Borrower; an
IOU for Lender

Provides Liquidity for
Seller
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Money vs. Capital Markets

Money

Capital
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Short-Term, < 1 Year
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Long-Term, >1Yr
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High Quality Issuers

Range of Issuer Quality
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Debt Only
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Debt and Equity

Primary Market Focus

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Liquidity Market--Low
Returns

Secondary Market
Focus
Financing Investment-6
Higher Returns
Organized vs. Over-the-Counter
Markets

Organized

Visible Marketplace

Members Trade

Securities Listed

New York Stock
Exchange
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OTC

Wired Network of
Dealers

No Central, Physical
Location

All Securities Traded
off the Exchanges
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Securities Traded in Financial
Markets
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Money Market Securities
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Capital market securities
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
Debt securities Only
Debt and equity securities
Derivative Securities

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Financial contracts whose value is derived from the values of
underlying assets
Used for hedging (risk reduction) and speculation (risk
seeking)
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Financial Markets
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
Video Clip – Types Financial Markets
Vidoe Clip - Derivatives
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Debt vs. Equity Securities
Debt Securities: Contractual obligations (IOU) of Debtor
(borrower) to Creditor (lender)

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Investor receives interest
Capital gain/loss when sold
Maturity date
Equity Securities: Claim with ownership rights
and responsibilities

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
Investor receives dividends if declared
Capital gain/loss when sold
No maturity date—need market to sell
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Valuation of Securities
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Value a function of:
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Future cash flows
When cash flows are received
Risk of cash flows
Present value of cash flows discounted at the
market required rate of return
Value determined by market demand/supply
Value changes with new information
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Financial Market Efficiency

Security prices reflect available information

New information is quickly included in
security prices

Investors balance liquidity, risk, and return
needs
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Financial Market Regulation
Why Government Regulation?

To Promote Efficiency

High level of competition

Efficient payments mechanism
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Low cost risk management contracts
Financial Market Regulation
Why Government Regulation?
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To Maintain Financial Market Stability
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Prevent market crashes
 Circuit breakers
 Federal Reserve discount window

Prevent Inflation--Monetary policy
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Prevent Excessive Risk Taking by Financial Institutions
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Financial Market Regulation
Why Government Regulation?

To Provide Consumer Protection
 Provide
adequate disclosure
 Set rules for business conduct

To Pursue Social Policies
 Transfer
income and wealth
 Allocate saving to socially desirable areas
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
Housing
Student loans
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Financial Market Globalization
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Increased international funds flow
Increased disclosure of information
 Reduced transaction costs
 Reduced foreign regulation on capital flows
 Increased privatization
Results: Increased financial integration--capital
flows to highest expected risk-adjusted return
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Role of Financial Institutions in
Financial Markets
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Information processing
Serve special needs of lenders (liabilities) and
borrowers (assets)
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By denomination and term
By risk and return
Lower transaction cost
Serve to resolve problems of market
imperfection
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Role of Financial Institutions in
Financial Markets
Types of Depository Financial Institutions
Commercial
Banks
$5 Trillion
Total Assets
Savings
Institutions
$1.3 Trillion
Total Assets
Credit Unions
$.5 Trillion
Total Assets
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Types of Non-depository Financial
Institutions
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Finance companies
Mutual funds
Securities companies
Insurance companies
Pension funds
Security pools
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Role of Non-depository Financial
Institutions
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Focused on capital market
Longer-term, higher risk intermediation
Less focus on liquidity
Less regulation
Greater focus on equity investments
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Trends in Financial Institutions
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Increased competition between financial Institutions
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In the 60’s & 70’s, heavy regulation prevented
competition
In the late 70’s & 80’s, the development of mutual funds
and deregulation led to increased flexibility and
competition. This continued through to the 90’s and into
today.
Increased consolidation of financial institutions via
mergers has resulted in the growth of financial
conglomerates e.g. Cayman National Corporation
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Cayman Financial Corporation
CNC
CNB
CNP
CNT
CNS
Caymanx
CNI
CNIB
CGI
CNIM
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Cayman National Corporation Holding Company
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CNB – Cayman National Bank – Banking
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CNP – Cayman National Property Holding – Property Holding
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CNT – Cayman National Trust - Company & Trust Management
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CNS – Cayman National Securities - Securities Brokerage
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Caymanx – Caymanx Trust Company Limited – Banking, company and trust management
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CNI – Cayman National Investments – Investment in a merchant bank
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CNIB – Cayman National Insurance Brokers – Insurance brokerage
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CGI – Cayman General Insurance – General (property & casualty) and heath insurance
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CNIM – Cayman National Insurance Management - General (property & casualty) and heath
insurance
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Global Expansion by Financial
Institutions
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International expansion through mergers and
emerging markets
The single European currency – Euro, €, helped
to eliminate concerns about foreign exchange
risks
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