CHAPTER 2
The Financial Environment:

Outlines


Financial Markets
Financial Institutions
4-1
The Capital Flow Process



In a well-functioning economy, capital flows
efficiently from those who supply capital to
those who demand it.
Suppliers of capital – individuals and
institutions with “excess funds.” These
groups are saving money and looking for a
rate of return on their investment.
Demanders or users of capital – individuals
and institutions who need to raise funds to
finance their investment opportunities.
These groups are willing to pay a rate of
return(interest) on the capital they borrow.
4-2
2-2
Three ways capital flow from savers to
borrowers?


Direct transfer
Investment Bank


Securities pass through the investment
bank
Financial intermediary

Intermediary create new securities for
savers.
4-3
What is a market


Market: A place/venue where goods
and services are exchanged
FM: A place where funds/financial
assets are traded.



lender: those with surplus of funds
(individual, firms, Gov.)
borrower: those need funds ( individual,
households, firms)
Who are lender/borrower: stock M, bond4-4M
Types of financial markets




Money vs. Capital
Primary vs. Secondary
Spot vs. Futures
Public vs. Private
4-5
FM











F Asset /F instruments: contracts specifying borrowing/lending terms,
claims on real assets
i.
Money M (borrowed for less than 1 Y) and Capital M (1 Y or
longer)
ii.
Primary M and secondary M
1.
PM: New issues are sold to the public
2.
SM: outstanding issues traded among investors
iii.
Private M vs. Public
1.
Private: transactions between two parties
2.
Public: standardized contracts traded on exchanges.
iv. Spot M vs. Future M
1. SM: transaction “on-the-spot”
2. FM: Contract specifying terms of future trading
4-6
Types of Financial Institutions

Banks

Commercial banks


Investment banks


Middleman between savers and borrowers
An organization that helps to sell new investment
securities (bonds, stocks).
Financial services corporations


A firm that offers a wide range of financial
services, including investment banking,
commercial banking, brokerage and insurances.
Citi, B of A, JPM
4-7
2-7
Types of Financial Institutions

Funds-pool money to invest





Mutual funds
Pension funds-retirement plans
Hedge funds
Exchange traded funds-ETF
Other financial institutions

Life Insurance companies: Collect premiums and
invest

Private equity:
company
borrows money to invest/mange the whole
4-8
2-8
The stock market

Types of stock market transactions


The secondary market
The primary market:



IPO market: Initial Public Offering
additional new shares
Basics of stock market and stock
investing
4-9