FIN 4140
Financial Markets & Institutions
Lecture 1-2
Overview of Financial Markets
Financial markets transfer funds from those who
have excess funds to those who need funds.
Households and businesses that supply funds to
financial markets earn a return on their investment;
the return is necessary to ensure that funds are
supplied to the financial markets.
The main participants in financial markets can be
classified as households, businesses, and govt.
agencies.
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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Surplus units: those participants who provide funds
to the financial markets are called surplus units.
Household are the main type of surplus units.
Deficit units: Participants who use financial markets
to obtain funds are called deficit units.
Many deficit units issue (sell) securities to surplus
units in order to obtain funds. A security is a certificate
that represents a claim on the issuer. Securities are a
form of debt. They specify a maturity date when the
issuer will repay the surplus units.
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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Types of Financial Markets
 There are many different types of financial markets
and each market can be distinguished by the maturity
structure and trading structure of its securities.
Money markets vs Capital markets: The financial
market that facilitate the transfer of debt securities are
commonly classified by the maturity of the securities.
Those financial markets that facilitate the flow of short
term funds ( with maturity less than one year) are
known as money markets, while those that facilitate
the flow of long term funds are known as capital
markets.
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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Primary markets vs Secondary markets:
Primary markets facilitate the issuance of new
securities, while secondary markets facilitate the trading
of existing securities.
Primary market transactions provide funds to the initial
issuer of securities while secondary market transactions
do not.
The issuance of new corporate stock or new treasury
securities is a primary market transaction, while the sale
of existing corporate stock or treasury security holdings
by any business or individual is a secondary market
transaction.
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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An important characteristic of securities that are traded
in the secondary markets is liquidity, which is the degree
to which securities can easily be liquidated or sold
without a loss of value.
Some securities have active secondary market meaning
that there are many willing buyers and sellers of the
security at a given point in time. Investors prefer liquid
securities so that they can easily sell the securities
whenever they want (without a loss in value). If a
security is illiquid, investors may not be able to find a
willing buyer for it in the secondary market and may have
to sell the security at a large discount just to attract a
buyer.
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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Organized markets vs Over-the-Counter markets:
Some secondary stock market transactions occur
at an organized exchange, or a visible marketplace
for secondary market transactions. E.g. Dhaka
Stock Exchange, New York Stock Exchange, etc.
Over the counter market is a virtual market where
the transactions are done using telecommunications
network (telephone, internet)
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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Securities Traded in Financial Markets
Securities can be classified as:
Money Market Securities
Capital Market Securities
Derivative Securities
 Money market securities are debt securities that
have a maturity of one year or less. They generally
have a relatively high degree of liquidity. Money
market securities tend to have a low expected
return but also a low degree of risk.
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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Table: Money Market Securities
Money Market
Securities
Issued by
Common Investors
Common
Maturities
Sec. Mkt
Activity
Treasury Bills
Govt
HH, Firms, FI
13/26 wks, 1
yr
High
Retail Certificates of
Deposit
Banks, savings
inst.
HH
7days-5yrs or
longer
None
Negotiable Certificate
of Deposit
Large banks and
savings inst.
Firms
2wks-1yr
Moderate
Commercial Paper
Banks, finance
companies
Firms
1day-270day
Low
Eurodollar Deposit
Banks located
outside US
Firms, Govt
1day-1yr
None
Banker’s Acceptance
Banks
Firms
30-270 days
High
Federal Funds
Depository Inst
Depository Inst
1-7 days
None
Repurchase
Agreements
Firms & Fin. Inst.
Firms, FI
1-15 days
None
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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 Capital Market Securities: Securities with a maturity more than one year are
called capital market securities. Three common type of capital market securities
are bonds, mortgages, and stocks.
Bonds & Mortgages:

Bonds are long term debt obligations issued by corporations and govt to support
their operations.

Mortgages are long term debt obligations created to finance the purchase of real
estate.

Bonds provide a return to investors in the form of interest income (coupon
payments) every six months

Bonds and mortgages specify the amount and timing of interest and principal
payments to investors who purchase them.

At maturity investors holding the debt securities are paid principal. Debt securities
can be sold in the secondary market if investors do not want to hold them until
maturity.

Long term debt securities tend to have a higher expected return than money
market securities but they have more risk as well.
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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Table: Capital Market Securities
Capital Market
Securities
Issued by
Common
Investors
Common
Maturities
Sec. Mkt
Activity
Treasury notes &
Bonds
Fed Govt
HH, Firms, FI
3-30 yrs
High
Municipal Bonds
State/local
govt
HH, Firms
10-30 yrs
Moderate
Corporate Bonds
Firms
HH, Firms
10-30 yrs
Moderate
Mortgages
Individuals,
Firms
FI
15-30 yrs
Moderate
Equity Securities
Firms
HH, Firms
None
High
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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Stocks:
 Stocks (also referred to as equity securities) are certificates
representing partial ownership in the corporations that issued them.
 Stocks are classified as capital market securities because they have no
maturity and therefore serve as a long term source of funds.
 Some corporations provide income to their stockholders by
distributing a portion of their quarterly or yearly income in the form of
dividends while others retain and reinvest all of their earnings, which
allows them more potential for growth.
 Investors can earn a return from stocks in the form of periodic
dividends and a capital gain when they sell the stock.
 Equity securities have a higher expected return than most long term
debt securities but also exhibit a higher degree of risk.
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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Derivative Securities:
 Derivative securities are financial contracts whose values are derived
from the values of underlying assets (such as debt securities or equity
securities). Many derivative securities enable investors to engage in
speculation and risk management.
Mohammad Kamrul Arefin, MSc. in Quantitative Finance, University of Glasgow
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