3
Chapter
Key Sources of Financial
Information
Money and Capital Markets
Financial Institutions and Instruments in a Global Marketplace
Eighth Edition
Peter S. Rose
McGraw Hill / Irwin
Slides by Yee-Tien (Ted) Fu
3-2
 Learning Objectives 
 To identify important sources of information
about the global financial system.
 To understand why the efficient distribution of
information within the financial system is
important.
 To learn how market participants keep track of
the prices of financial assets.
 To learn about the content and concepts behind
the main social accounting systems.
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Introduction
 Sound financial decisions require adequate and
accurate financial information.
 We may divide the sources of information
relied on by financial decision makers into:
 debt
security prices and yields,
 stock prices and dividend yields,
 information on security issuers,
 general economic and financial conditions, and
 social accounting data.
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Efficient Markets & Asymmetric Information
 The efficient markets hypothesis (EMH)
contends that information relevant to the
pricing (valuation) of loans, securities, and
other financial assets is readily available to all
borrowers and lenders at negligible cost.
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Efficient Markets & Asymmetric Information
 On the other hand, the concept of asymmetric
information argues that the financial
marketplace contains pockets of inefficiency in
the availability and use of information, such
that insiders can earn excess returns by
selectively trading assets based on the special
information they have been able to acquire.
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Efficient Markets & Asymmetric Information
 In an efficient marketplace, each individual
investor will rationally use all the relevant
information that is available to value stocks
and bonds.
 Hence, each financial asset will generate an
ordinary or normal rate of return
commensurate with its level of risk.
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Efficient Markets & Asymmetric Information
 According to the capital asset pricing model
(CAPM), the expected return on financial asset
(or portfolio of assets) i, E(Ri), is:
ERi   rF  β i ERM   rF 
 The CAPM indicates that E(Ri) depends on
 rF, the time value of money (risk-free interest rate)
 E(RM) – rF, the reward for bearing systematic risk
 i,
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asset i’s level of systematic risk
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Efficient Markets & Asymmetric Information
 The line or curve described by the CAPM
equation is usually called the security market
line (SML).
E(Ri)
RM
SML

market portfolio M
rF
0
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Efficient Markets & Asymmetric Information
 If the EMH holds, any temporary deviation of
actual returns from the SML should be quickly
eliminated as investors react to temporary
underpricing or overpricing of assets.
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Different Forms of the EMH
 The weak form of the EMH argues that the
current price of a financial asset already
reflects all its price and trading volume history.
 The semistrong form contends that the current
price of a financial asset already reflects all
publicly available and relevant information.
 The strong form argues that the current price
of a financial asset already captures all
relevant public and private information.
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Different Forms of the EMH
 Repeated research studies have essentially
confirmed the weak and semistrong forms of
the EMH.
 The strong form, however, has been the most
controversial, especially because of the
existence of insider trading activities and
because of the apparent asymmetrical
scattering of pockets of special information
throughout the financial system.
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Problems Informational Asymmetries Can Create
 Lemons and Plums. A loan officer (buyer)
cannot be sure without incurring substantial
costs whether his or her potential customer
(seller) is a lemon (sour) or plum (sweet).

Result: Plums may be driven away from the
market.
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Problems Informational Asymmetries Can Create
 Adverse Selection. A bank that sets one price
for all its checking account customers runs the
risk of being adversely selected against by its
high-balance, low-activity (and hence most
profitable) customers.

Solution: Enabling customer signaling via a price
schedule for different account plans.
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Problems Informational Asymmetries Can Create
 Moral Hazard. One party to a principal-agent
contract may decide to pursue its own selfinterest at the expense of the other party.

Solution: Contracts drawn with the appropriate
incentives and monitoring.
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Asymmetry, Efficiency, & Real-World Markets
 All real-world markets seem to have elements
of both efficiency and asymmetry.
 Perhaps, real-world markets can be split into
two segments:
 A highly
efficient segment in which well-informed
individuals and institutions trade.
 A market segment in which less-well-informed
small investors and small businesses trade.
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Possible Remedies for Informational Asymmetries
 Some laws and regulations are designed to
improve the flow of information between
buyers and sellers and to protect the public
against deception in valuing financial assets.
 Examples (U.S. ):
1934 Securities Exchange Act
 1940 Investment Company Act
 1970 Securities Investor Protection Act
 Regulation FD (Fair Disclosure), 2000

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Sources of Information
Debt Security Prices and Yields
 Data: bid & ask prices, yields-to-maturity
Sources: real-time computer networks (e.g.
Reuters, Bloomberg), televised reports (e.g.
CNN, CNBC), financial press (e.g. The Wall
Street Journal)
 Data: bond yield indexes
Sources: Moody’s Investor Service, The Daily
Bond Buyer, U.S. Treasury, Dow Jones
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Sources of Information
Stock Prices and Dividend Yields
 Data: prices (year-high, year-low, day-high,
day-low, closing), sales volume, most recent
dividend, dividend yield, P-E ratio, stock price
indexes (e.g. DJIA, S&P500), foreign stock
prices
Sources: computer networks (e.g. Internet),
financial press, television, radio, financial
institutions (e.g. S&P, Morningstar)
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Sources of Information
Security Issuers
 Data: firm history, principal products/services,
key officers, recent operation summary,
financial statements, credit ratings, industry
performance indicators
Sources: regulatory agencies (e.g. SEC), trade
associations, commercial institutions (e.g.
Moody’s, S&P, Dun & Bradstreet), directories
& databases, journals & magazines, credit
bureaus
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Sources of Information
General Economic and Financial Conditions
 Data: interest rates, money supply measures,
industrial output, international transactions,
unemployment rate, inflation, forecasts
Sources: central banks (e.g. the Federal
Reserve), statistical bureaus (e.g. Bureau of
Economic Analysis), financial press
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Social Accounting Data
 Social accounting refers to the system of
record keeping that reports transactions
between the principal sectors of the economy,
such as households, financial institutions,
corporations, and units of government.
 The two most closely followed social
accounting systems in the U.S. are the
National Income Accounts and the Flow of
Funds Accounts.
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National Income Accounts
 The National Income Accounts (NIA) present
data on the nation’s production of goods and
services, income flows, investment spending,
consumption, and savings.
 In particular, the level and growth of the
nation’s economic activity is summarized by
the gross national product (GNP) and gross
domestic product (GDP).
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Sample
Table from
the U.S.
National
Income and
Product
Accounts
(NIPA)
Source: http://www.bea.gov
National Income
Accounts
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Flow of Funds Accounts
 The Flow of Funds Accounts
 trace the flow of savings by businesses,
households, and governments into
purchases of financial assets,
 show how the various parts of the financial
system interact with each other, and
 highlight the interconnections between the
financial sector and the rest of the economy.
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Flow of Funds Accounts
 The construction of the Flow of Funds
Accounts requires four basic steps:
 Sector the economy.
 Construct sector balance sheets.
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Sample Balance Sheet
from the U.S. Flow of Funds Accounts
Flow of Funds Accounts
Source: http://www.federalreserve.gov
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Flow of Funds Accounts
 The construction of the Flow of Funds
Accounts requires four basic steps:
 Sector the economy.
 Construct sector balance sheets.
 Prepare a sources and uses of funds
statement for each sector.
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Sample Sources and Uses of Funds Statement
from the U.S. Flow of Funds Accounts
Flow of Funds Accounts
Source: http://www.federalreserve.gov
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Flow of Funds Accounts
 The construction of the Flow of Funds
Accounts requires four basic steps:
 Sector the economy.
 Construct sector balance sheets.
 Prepare a sources and uses of funds
statement for each sector.
 Construct a flow of funds matrix for the
economy as a whole.
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Sample U.S. Flow of Funds Matrix
Flow of Funds Accounts
Source: http://www.federalreserve.gov
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Money and Capital Markets in Cyberspace
 Most key institutions provide extensive online
information. Visit, for example, the Federal
Reserve at http://www.federalreserve.gov and the
Securities and Exchange Commission at
http://www.sec.gov. Or link to worldwide central
banks from http://www.bis.org/cbanks.htm.
 Many financial institutions have also made it
easier to track money and capital market
movements. Visit, for example, Money
Magazine’s http://money.cnn.com/.
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Chapter Review
 Introduction
 Efficient Markets and Asymmetric Information

The Efficient Markets Hypothesis (EMH)
• The Security Market Line (SML)
• Different Forms of the EMH
Insiders and Insider Trading
 The Concept of Asymmetric Information

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Chapter Review
 Efficient Markets and Asymmetric Information
… cont

Problems Informational Asymmetries Can Create
• Lemons and Plums
• Adverse Selection
• Moral Hazard
Asymmetry, Efficiency, and Real-World Markets
 Possible Remedies for Informational Asymmetries

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Chapter Review
 Sources of Information
Debt Security Prices and Yields
 Stock Prices and Dividend Yields
 Security Issuers
 General Economic and Financial Conditions

 Social Accounting Data
National Income Accounts
 Flow of Funds Accounts

McGraw Hill / Irwin
 2003 by The McGraw-Hill Companies, Inc. All rights reserved.