Course Title: Financial Market &

Institutions
Financial Market & Institutions

Course Teacher:
Dr. S. M. Soharb Uddin
Professor
Department of Finance & Banking
University of Chittagong
Financial Market & Institutions Chapter: 1

Asset: An asset is any possession that has value

in an exchange. Assets are two types –

I. Tangible assets: The assets which value

depend on some particular physical properties
and these assets have physical existence, such
as, plants, machinery, land etc.
Financial Market & Institutions Chapter: 1

⚫ Tangible assets are again two types—

– Reproducible Assets: The assets which have ability to change
the physical feature of any goods and services, such as
machinery.
– Non-reproducible Assets: The assets which do not have any
ability to change the physical features of any goods and
services, such as, mine, a work of art etc.
II. Intangible Assets: Intangible assets are those which have legal
claim to some future benefits. Their value bears no relation to
the form, physical or otherwise, in which the claims are
recorded. Financial assets, financial instruments or securities
are intangible assets.
Financial Market & Institutions Chapter: 1

⚫ Financial Assets:
⚫ Financial asset is a claim against the income or wealth of
a business firm, household or unit of government, usually
represented by a certificate, receipt or other legal
documents. Familiar examples include stocks, bonds,
insurance policies, future contract and deposits held in a
bank or credit union. Financial assets do not provide
continuing stream of services to their owners as a home,
an automobile or a washing machine would do. These
assets promise future returns to their owners and serve
as a store of value which is commonly known as
“purchasing power”.
Financial Market & Institutions Chapter: 1

Characteristics of Financial Assets:

⚫ Financial Asset represents a claim against the income or wealth of
a business firm, household or unit of government.
⚫ Financial Assets promise future returns to their owners.
⚫ These assets can not be depreciated because they do not wear out
like physical assets.
⚫ The physical condition or form of the financial assets is not relevant
in determining its market value (price).
⚫ Financial Assets are represented by a piece of paper or by
information stored in a computer and as a result of this their cost of
transportation and storage is low.
⚫ Financial Assets can easily be changed in form and substituted for
other assets.
Financial Market & Institutions Chapter: 1

⚫ Different Kinds of Financial Assets:

⚫ Although there are thousands of different
financial assets, they generally fall into four
categories:
Money, equities, debt securities and
derivatives.
Financial Market & Institutions Chapter: 1

⚫ Money: Money is a financial asset that serves as a

medium of exchange and standard of value for
purchase of goods and services. Checking accounts
and currency are financial assets serving as
payment media and, therefore, are forms of money.
It is the most important and the oldest financial
assets in the economy. All financial assets are
valued in terms of money and flows of funds
between lenders and borrowers occur through the
medium of money.
Financial Market & Institutions Chapter: 1

Functions of Money:
Money performs a wide variety of important services. The
following are some of them:
⚫ It serves as a standard of value or unit of account for all
the goods and services we might wish to trade.
⚫ It serves as a medium of exchange. It is usually the
only financial asset that virtually every business,
household and unit of government will accept in
payment for goods and services.
⚫ It serves as a store of value- a reserve of future
purchasing power. Purchasing power can be stored in
currency, in a checking account or in a computer file
until the time is right to buy.
Financial Market & Institutions Chapter: 1

• Money functions as the only perfectly liquid

asset in the financial system. An asset is
liquid if it can be converted into cash quickly
with little or no loss in value. A liquid asset
possesses three essential characteristics:
price stability, ready marketability and
reversibility. An asset must be considered
liquid if its price tends to be reasonably
stable over time.
Financial Market & Institutions Chapter: 1

⚫ Equities:
Equities, more commonly known as stock,
represent ownership shares in a business firm
and as such, are claim against the firm’s profits
and against proceeds from the sale of its assets.
We usually subdivide equities into common stock
and preferred stock.
Financial Market & Institutions Chapter: 1

⚫ Debt securities:
Debt securities represent claims against the assets of a business
firm, individual or unit of government represented by bond and other
contracts evidencing a loan of money. Debt securities include such
familiar instruments as bonds, notes, accounts payable and saving
deposits. Legally, these financial assets entitle their holders to a
priority claim over the holders of equities to the assets and income of
an individual, business firm or unit of government. Financial analysts
usually divide debt securities into two broad classes: a) negotiable,
which can be easily transferred from holder to holder as a
marketable security, and b) non-negotiable, which can not legally
be transferred to another party.
Financial Market & Institutions Chapter: 1

⚫ Derivatives:
Financial instruments, such as forward,
future, option, swap, which value depend
upon an underlying financial instrument (e.g.,
stocks, bond, debenture etc.). Derivatives are
the newest kinds of financial assets. These
types of financial assets usually provide
hedging or risk management services.
Financial Market & Institutions Chapter: 1

⚫ Issuers and Investors of a Financial

Instrument:
⚫ Issuer: The entity that has agreed to make
future cash payments is called issuer of financial
instrument.
⚫ Investor: The persons or institutions that have
surplus money to invest and purchase financial
instruments are called investor. In other wards,
the owners of financial instrument are called
investor.
Financial Market & Institutions Chapter: 1

⚫ Identify the issuer and investor from the

following financial transactions:
⚫ A bond issued by the treasury Department of
Bangladesh Government.
⚫ A bond issued by Square Limited.
⚫ A bond issued by the Federal Reserve
Systems.
⚫ An automobile loan.
⚫ Common stock issued by NCC Bank Limited.
Financial Market & Institutions Chapter: 1

The Value of a Financial Asset:

⚫ Valuation is the process of determining the fair
value of a financial asset. The fundamental
principle of valuation is that the value of any
financial asset is the present value of the cash
flow expected. This principle applies regardless
of the financial asset. Consequently, it applies
equally to common stock, a bond, a loan and real
estate.
Financial Market & Institutions Chapter: 1

Process of Valuation:
Step 1: Estimating Cash Flows:
⚫ The first problem encountered in valuing a
financial asset is interpreting what is meant by
“cash flow”. Accounted has a set answer: it is the
net income after taxes plus non cash outlays
such as depreciation. This is a nice definition but
useless for our purposes. Cash flow is simply the
cash that is expected to be received each period
from investing in a particular financial asset.
Financial Market & Institutions Chapter: 1

Factors influencing the Cash Flow:

⚫ Types of financial assets—Debt Vs Equity
⚫ Characteristics of issuers—Government Vs Private.
⚫ Degree of certainty of cash flow of private debt
instrument:
– The issuer may default.
– Right to change the series of payments by the issuer and/ or
investors.
– Interest rate may be changed over time if the borrowed funds
are outstanding.
Financial Market & Institutions Chapter: 1

Degree of certainty of cash flow of

Government debt instrument:
⚫ Government can not be defaulted.
⚫ Cash flows of the securities issued by the government
are certain.
Degree of certainty of cash flows of Equity
instrument:
⚫ Payment of dividend is uncertain (in amount of
dividend)
⚫ Uncertainty in timing of dividend.
Financial Market & Institutions Chapter: 1

Step 2: Determining the appropriate discount rate:

⚫ For determining the expected discount rate we have to
depend on the following factors:
– Minimum interest rate.
– Risk premium expected by the investor for perceiving risk.
⚫ Risk associated with cash flows:
Credit risk/ Default risk: Default in obligation by
borrowers or investors.
Purchasing power risk/ inflation risk: Increasing the
average price level of goods and services in an
economy.
Exchange rate risk:
Valuation of Securities in Financial Market
Estimate the cash flow
(Cash flow= Interest, Principal
repayment, dividends, expected
sale price of Stock)

Determine the appropriate interest

rate for discounting the cash flow:
-Minimum interest rate
-Plus premium required for
perceived risk

Value of Financial Asset = PV of

expected cash flow
 Use of Information to make Investment
Decision

Information
on
Economic
Condition Firms’ Valuation Decide
expected of Security whether to
Information take a
Cash
on Industry flow position in
Condition Security

Firm
Specific
Information
Globalization of Financial Markets

Globalization means the integration of

financial markets throughout the world into
an international financial market. Because of
the globalization of financial markets, entities
in any country seeking to raise funds need
not to be limited to their domestic financial
market.
Globalization of Financial Markets

The factors that have lead to the integration of

financial markets are:
⚫ Deregulation or liberalization of financial markets and
the activities of market participants in key financial
centers.
⚫ Technological advances for monitoring the world
markets, executing orders and analyzing financial
opportunities.

⚫ Increased institutionalization of financial markets.

 Classification of Global Financial
Markets

Internal Market External Market

(also called national (also called international
market) market, offshore market,
and Euromarket)

Domestic Market Foreign Market

Globalization of Financial Markets

The Domestic Market is where issuers domiciled in the

country issue securities and where those securities are
subsequently traded.
The Foreign Market of a country is where the securities of
issuers not domiciled in the country are sold and traded.
The rules governing the issuance of foreign securities are
those imposed by regulatory authorities where the
security is issued. Nicknames have been used to
describe the various foreign markets. For example, the
foreign market in the U.S. is called the “Yankee market”.
The foreign market in Japan is nicknamed the “Samurai
Market,” in the U.K. the “Bulldog market,” in the
Netherlands the “Rembrandt market,” and in Spain the
“Matador market.”
Globalization of Financial Markets

The External Market, also called the

international market, includes securities with
the following distinguishing features:
At issuance the securities are offered
simultaneously to investors in a number of
countries, and the securities are issued
outside the jurisdiction of any single country.
The external market is commonly referred to
as the offshore market, or more popularly,
the Euromarket.
Financial Market & Institutions Chapter: 1

Economic Functions/Role of Financial Assets:

Financial assets have two economic functions:
⚫ Transfer funds from those who have surplus
fund to invest to those who need to invest in
tangible assets.
⚫ Transfer funds in such a way as to redistribute
the unavoidable/ systematic risk associated
with cash flows generated by tangible assets
among those seeking and those providing the
funds.
Financial Market & Institutions Chapter: 1

Properties of financial assets/ Factors that determine or influence

on the attractiveness of financial assets:
⚫ Moneyness;
⚫ Divisibility and Denomination;
⚫ Reversibility;
⚫ Term to maturity;
⚫ Liquidity;
⚫ Convertibility;
⚫ Currency;
⚫ Cash flow and return predictability;
⚫ Complexity and
⚫ Tax status.
Financial Market & Institutions Chapter: 1

⚫ Moneyness:
Some financial assets are used as medium of
exchange or in settlement of transactions. These
assets are called money. In Bangladesh, they
consist of currency and all forms of deposits that
permit check writing. Other financial assets, although
not money, are very close to money in that they can
be transformed into money at little cost, delay or risk.
They are referred o as near money. These include
time and saving deposit and Treasury bill.
Moneyness is clearly a desirable property for
investors.
Financial Market & Institutions Chapter: 1

⚫ Divisibility and Denomination:

Divisibility relates to the minimum size at which a
financial asset can be liquidated and exchange for
money. The smaller the size, the more the financial
asset is divisible. A financial asset such as a deposit
at a bank is typically infinitely divisible. On the other
hand, denomination refers to the per unit value of a
financial asset that will pay at maturity. Many bonds
come in $1000 denomination while some debt
instruments come in $1 million denominations. In
general, divisibility is desirable for investors.
Financial Market & Institutions Chapter: 1

⚫ Reversibility:
Reversibility refers to the cost in investing in a financial asset and then
getting out of it and back into cash again. Consequently, reversibility is
also referred to as round-trip cost.
Financial asset such as a deposit at a bank is obviously highly
reversible because usually there is no charge for adding to or
withdrawing from it. For financial assets traded in the organized
exchange or with ‘market makers’ the most relevant component of
round-trip cost is the so called bid-ask spread. The bid-ask spread is
the difference between a market maker is willing to sell a financial asset
for (i.e., the price it is asking) and the price that a market maker is
willing to buy the financial asset for (i.e., the price it is bidding).
Bid-ask spread charged by a market maker depend on the two factors:
-- Variability of price
-- Thickness of the market.
Financial Market & Institutions Chapter: 1

⚫ Term to maturity:
The term to maturity is the length of the interval
until the date when the instrument is scheduled
to make its final payment or the owner is entitle
to demand liquidation.
Instruments for which the creditors can ask for
repayment at any time, such as checking
accounts and many saving accounts are called
demand instruments. Maturity is an important
characteristic of financial assets such as debt
instruments.
Financial Market & Institutions Chapter: 1

⚫ Liquidity:
Convertibility of financial asset into cash with
minimum time, cost and risk is referred to as
liquidity. In other word, how much the sellers
stand to lose if they wish to sell immediately
as against engaging in a costly and time-
consuming search.
Financial Market & Institutions Chapter: 1

Liquidity depends on the three factors:

⚫ Contractual agreement: Ordinary deposits at bank,
for example, are perfectly liquid because the bank
has a contractual obligation to convert them at par
on demand. In contrast, financial contracts
representing a claim on a private pension fund may
be regarded as totally illiquid, because these can
be cashed only at retirement.
⚫ Quantity of financial assets one wish to buy or sale:
Liquidity may depend not only on the financial
asset but also on the quantity one wishes to sell (or
buy); while a small quantity may be quite liquid, a
large lot may run into illiquidity problems.
⚫ The thickness of the market:
Financial Market & Institutions Chapter: 1

⚫ Convertibility:
An important property of some financial assets is
that they are convertible to other bond. For
example a bond can be converted into another
bond. A corporate convertible bond can be
exchanged into equity shares. The timing, costs
and condition for conversion are clearly spelled
out in the legal descriptions of the convertible
security at the time it is issued.
Financial Market & Institutions Chapter: 1

⚫ Currency:
Most financial assets are denominated in one currency.
Some issuers responding to the investors wishes to
reduce foreign exchange risk, have issued dual-currency
securities.
⚫ Cash flow and return predictability:
Cash flow is the expected cash to be received each
period. The predictability if expected return depends on
the predictability of cash flow. Return predictability is a
basic property of financial assets, in that it is a major
determinant of their value.
Financial Market & Institutions Chapter: 1

⚫ Complexity:
Some financial asset is complex in the sense that they
are actually combinations of two or more simple assets.
To find out the true value of such assets, one must
‘decompose’ it into its component parts and price each
component separately.
⚫ Tax status:
An important feature of any financial asset is its tax
status. The owner or holder of financial assets should
pay tax on their income. Tax status differ from year to
year, country to country, financial asset to financial asset
Financial Market & Institutions Chapter: 1

⚫ Financial Transactions:
Financial transaction refers to transferring funds from
those who save and lend (surplus-budget unit) to those
who wish to borrow and invest (deficit-budget unit).
Deficit-budget unit means an individual, business firm or
unit of government whose current expenditures exceeds
its current receipts of income, forcing it to become a net
borrower of funds in the financial market. On the other
hand, surplus-budget unit means an individual, business
firm or unit of government whose current receipts of
income exceeds its current expenditures, allowing it to
become a net lender of funds in the financial market.
Financial Market & Institutions Chapter: 1

⚫ The transfer of funds from savers to

borrowers can be accomplished in at least
three different ways. We label these methods
of fund transfer:
– Direct Finance
– Semi-direct finance and
– Indirect Finance.
Financial Market & Institutions Chapter: 1

1. Direct Finance:
With the direct financing technique, borrower and
lender meet each other and exchange funds in
return for financial assets without the help of a
third party to bring them together. When you
borrow money from one of your friend and give
him or her the borrowed amount, or when you
purchase stock or bond directly from the
company issuing them then those are direct
finance.
 Flow of Funds in a World without FIs: Direct
Transfer

Financial Claims
(Equity and debt
Users of Funds instruments) Suppliers of
(Deficit unit) Funds
Cash (Surplus unit)

Example: A firm sells shares directly to investors without going

through a financial institution
Financial Market & Institutions Chapter: 1

Advantage:
⚫ It is the simplest method of carrying out financial
transaction.
Disadvantages/Limitation:
⚫ Both the borrower and lender must be willing to
exchange the same amount of funds at the same time,
i.e., there must be coincidence of wants between
surplus and deficit budget units in terms of amount and
form of a loan.
⚫ Both the lender and borrower must frequently incur
substantial information costs simply to find each other.
Financial Market & Institutions Chapter: 1

2. Semi-direct Finance:
⚫ In semi-direct finance, some individual and
business firms become securities brokers
and dealers whose essential function is to
bring surplus-budget units (SBUs) and
deficit-budget units(DBUs) together, thereby
reducing information cost.
Semi-Direct financial flow markets

Copyright © 2003 McGraw-Hill Australia Pty Ltd PPTs t/a

Financial Accounting by Willis
Slides prepared by Kaye Watson
Financial Market & Institutions Chapter: 1

Advantages:
⚫ It lower the search cost for participants in the
financial market.
⚫ A dealer will split up a large issue of primary
securities into smaller units so that even
smaller saver can purchase them.
Disadvantages:
⚫ There still must be a fundamental coincidence
of wants and needs between surplus and deficit
budget units.
Financial Market & Institutions Chapter: 1

3. Indirect Finance:
⚫ Indirect finance carried out with the help of financial
intermediaries. Financial intermediaries are the active
players in today’s financial market. Their fundamental
role in the financial system is to serve both ultimate
borrowers and lenders but in a much more complete way
than the brokers and dealers do. Financial intermediaries
issue securities of their own - often called secondary
securities – to the ultimate lenders and at the same time
accept primary securities from the borrowers.
Indirect (intermediated) financial flow
markets

Copyright © 2003 McGraw-Hill Australia Pty Ltd PPTs t/a

Financial Accounting by Willis
Slides prepared by Kaye Watson
 Types of Financial Institutions

⚫ Depository, Contractual, and Investment

Intermediaries.
⚫ Commercial banks
– Depository institutions whose major assets are loans
and major liabilities are deposits.
⚫ Thrifts
– Depository institutions in the form of savings and loans,
credit unions.
⚫ Insurance companies
– Financial institutions that protect individuals and
corporations from adverse events.
⚫ Securities firms and investment banks
– Financial institutions that underwrite securities and
engage in securities brokerage and trading.
⚫ Finance companies
– Financial institutions that make loans to individuals and
businesses.
⚫ Mutual Funds
– Financial institutions that pool financial resources and
invest in diversified portfolios.
⚫ Pension Funds
– Financial institutions that offer savings plans for
retirement.
Financial Market & Institutions Chapter: 1

⚫ What is Market?
⚫ A market is an institutional set up created by
the society to allocate resources that are
scarce relative to the demand for them.
⚫ Markets are the channel through which
buyers and seller meet to exchange goods
and services and productive resources.
Financial Market & Institutions Chapter: 1

The role of Market in the Global Financial System

The following roles are played by the markets in the
global financial system:
⚫ The market determines what goods and services will be
produced and in what quantity. This is accomplished
through the changes of goods and services offered in the
market. If the prices of an item rises, business firm
produce more goods and services. On the other hand, a
decline in the price leads to reduce production of goods
and services.
⚫ Markets also distribute income. In a pure market system,
the income of an individual is determined solely by the
contribution each makes to producing goods and
services demanded by consumers.
Financial Market & Institutions Chapter: 1

Types of markets:
There are three type of market in the within the
global financial system. They are:
⚫ Factor Markets
⚫ Product Markets, and
⚫ Financial Market.
Financial Market & Institutions Chapter: 1

⚫ Factor Markets: Factor markets are the markets which

allocate factors of production – land, labor, management
skill and capital – and distribute income – wages, rental
payments and so on – to the owner of the productive
resources.
⚫ Product Markets: Product Markets are the markets
where consuming units purchase goods and services and
make payments for them.
⚫ Financial Market: Financial Market is an institutional set
up created by society to channel savings and other
financial services to those individual and institution willing
to pay for them.
Financial Market & Institutions Chapter: 1

Financial markets and Financial System: Channel for

saving and investment
Nature of saving:
All factor income is not consumed. A substantial portion
of after tax income is earmarked for saving. “The
definition of saving differs depending on what type of
unit in the economy is doing the saving.” For
household, saving are what is left from current income
after consumption expenditure and tax payments are
made. In the business sector, saving include current
earnings retain inside business firm after payments of
taxes, stockholders dividends, and other cash expenses.
Government saving arise where there is a surplus of
current income over current expenditure.
Financial Market & Institutions Chapter: 1

Household Saving (SH):

SH= Y-C-t Where, Y= Income
C= Consumption
t= Tax payment
Business Saving (SB):
SB= Y-Exp-t-Div
Where, Y= income
t= tax payment
Exp=Expenditure
Div= Dividend
Government Saving (SG):
SG= Y-Exp
Financial Market & Institutions Chapter: 1

⚫ Nature of Investment:
Most of the saving flow through global financial
markets is used to support investment by
business firms, government, and households.
Investment generally refers to the acquisition of
capital goods (such as building and equipment)
and purchase of inventories of raw materials and
goods to sell.
Financial Market & Institutions Chapter: 1

⚫ Definition of investment:
⚫ Investment is the expenditure on capital goods or on
inventories of goods and raw materials that are used to
produce other goods and services, causing future
production and income to rise.
⚫ “The investment varies with the particular units
doing the investing.”
⚫ For business firm, expenditure on capital goods (fixed
assets such as building and equipment) and for
inventories (raw materials and goods offering for sale) is
investment expenditure.
⚫ Household invest (make expenditure on capital goods)
when they buy a new home or purchase furniture,
automobiles and other durable goods.
Financial Market & Institutions Chapter: 1

⚫ Government expending to build and maintain public facilities (such

as building monuments and highways) is another form of investing.
⚫ In modern economics, a huge amount of investment is required to
produce goods and services demanded by consumers. Investment
increases the productivity of labor and leads a high standard of
living. Investment often requires huge amount of fund far beyond the
resources available to a single firm or government. By selling
financial claim (stock, bond) in the financial market large amount of
fund can be raised quickly for investment. So, financial markets
operating within the financial system make the exchange of current
income for future income and the transfer of saving into investment
possible.
Financial Market & Institutions Chapter: 1

Functions of financial system & financial market:

The functions of financial system and financial market
can be divided into seven (7) broad categories.
They are:
⚫ Saving Function
⚫ Wealth Function
⚫ Liquidity Function
⚫ Credit Function
⚫ Payment Function
⚫ Risk Protection Function and
⚫ Policy Function.
Financial Market & Institutions Chapter: 1

⚫ Saving Function:
⚫ Financial Markets and institutions provide a channel
for public savings. Bonds, stocks and other financial
claims are sold in the money and capital markets
provide a profitable, relatively a low risk outlet for
public saving. Those public savings are used in
investment so that more goods and services can be
produced, increasing the world standard of living.
Financial Market & Institutions Chapter: 1

⚫ Wealth Function:
Financial instrument sold in the money and capital
markets provide an excellent way to store wealth
(store purchasing power) until funds are needed for
spending on goods and services.
⚫ Liquidity Function:
For wealth store in the financial instruments, the
financial market provides a means of converting
those instruments into cash with little risk of loss.
Financial markets provide liquidity (immediately
spendable cash) for saver who hold financial assets
but are need of money.
Financial Market & Institutions Chapter: 1

⚫ Credit Function:
Credit is a loan of funds in return for a
promise of future payment. Financial market
provides a supply of credit to support both
consumption and investment spending in the
global economy. Consumers need credit to
stock their shelves, construct new building,
meet payrolls, and grant dividend to their
stockholders.
Financial Market & Institutions Chapter: 1

⚫ Payment Function:
Financial system provides mechanism for making
payments for goods and services around the world.
Certain financial assets, including checking account,
negotiable order of withdrawal (NOW) account serve as
medium of exchange in making payment.
⚫ Risk Protection Function:
Financial market provides a means to protect business,
consumer and government against risk to property and
income by providing and selling risk-protection services
like insurance policies.
Financial Market & Institutions Chapter: 1

⚫ Policy Function:
Financial market provides a channel for government
policy to achieve society’s goals of full employment,
low inflation and sustainable economic growth. By
manipulating interest rate and availability of credit,
government can affect the borrowing and spending
plans of public, which, in turn, influence the growth of
jobs, production, and prices.
Financial Market & Institutions Chapter: 1

Classification of Financial Markets:

Financial markets can be classified by the following
ways:
⚫ Classification by Nature of Claim:
– Debt Market: Debt market is the market where debt
instruments (loans, bond, debenture etc.) are traded. It is
the market for trading those financial assets that represent
creditorship.
– Equity Market: Equity market is the market where stocks
of corporation are traded. It is the market for trading those
financial assets that represent ownership right.
Financial Market & Institutions Chapter: 1

⚫ Classification by Maturity of Claim:

– Money Market: Money market is the market where
short term (one year or less) financial assets are
traded. It is the institutional set up by society to
channel temporary surpluses of cash into temporary
loans of funds, one year or less.
– Capital Market: Capital market is the market where
long term (over one year) debt securities and stocks
of corporation are traded. It is the institutional set up
that provide a channel for borrowing and lending of
long term funds.
Financial Market & Institutions Chapter: 1

⚫ Classification by Seasoning of Claim:

– Primary Market: Primary market is the market
where newly issued loan and securities are
traded.
– Secondary Market: Secondary market is the
market where already issued (existing) loan and
securities are traded.
Financial Market & Institutions Chapter: 1

Classification by Participation in Trading :

– Open Market: Open market is the institutional
setup by society to make loan and trade
securities in which any individual or institution
can participate.
– Negotiated Market: Negotiated market is the
institutional setup by society to make loan and
trade securities in which the terms of trade are
set by direct bargaining between a lender and a
borrower.
Financial Market & Institutions Chapter: 1

⚫ Classification by Delivery Requirement:

– Spot market: A spot market is one in which
securities or financial services are traded for
immediate delivery (usually within 1/2 days).
– Future or Forward market: A future or forward
market is designed to trade contracts calling for
future delivery of financial instruments.
Financial Market & Institutions Chapter: 1

⚫ Factor tying all Financial Market together:

Each corner of global financial system represents a
market segment with its own special characteristics. Each
segment is insulated from the others to some degree by
investor preferences and by rules and regulations. Yet
when interest rates and security prices change in one
corner of financial system, all of the financial markets
likely will be affected eventually. This implies that, even
though the global financial system is split up into many
different markets, there must be forces at work to tie all
financial market together.
Financial Market & Institutions Chapter: 1

⚫ Credit, the Common Commodity:

One unifying factor is the fact that the basic
commodity being traded in most financial
markets is credit. Borrower can switch from
one market to another, seeking the most
favorable credit terms.
Financial Market & Institutions Chapter: 1

⚫ Speculation and Arbitrage:

Another unifying element is profit seeking by
demanders and suppliers of funds. Speculators in
securities are continually on the look out for
opportunities to profit from their forecast of future
market development. The speculator in the financial
marketplace gambles that security prices or interest
rates will move in a direction that will result in quick
gains due to his or her ability to outguess the
markets collective judgment. Speculators are risk
seekers, willing to gamble their funds even when the
probability of success is low. They buy those, they
believe are under priced and selling those thought to
be overpriced.
Financial Market & Institutions Chapter: 1

⚫ Still another unifying force in the financial

markets comes from investors who watch for
profitable opportunities to arbitrage funds.
Arbitrageurs help to maintain consistent
prices between markets, aiding other
security buyers in finding the best prices with
minimal effort.
Financial Market & Institutions Chapter: 1

⚫ Perfect and Efficient markets:

Because of the near perfection and efficiency, all
financial markets are closely tied one another.
Perfect market is a market in which all available
information affecting the value of financial
instrument is freely available to everyone. It is a
market where there is no transaction cost (cost is
zero or nearly), no searching cost, etc. all the
participants in the market is price takers not
price setters.
Financial Market & Institutions Chapter: 1

⚫ A competitive market in which the prices of

financial instruments traded there fully reflects all
the latest information available. In an efficient
market, no information that might affect
security prices or interest rates is wasted.
Thus, no buyer or seller can expect to reap
excess profits from collecting information that is
readily available in the marketplace and then
trading on the basis of that information.
Financial Market & Institutions Chapter: 1

⚫ Financial Market in the Real World: Imperfection and

Asymmetry
⚫ Unfortunately, as nearly perfect and efficient as many financial
markets are, there is still a great deal that is imperfect in our financial
system. Not all financial service markets are fully competitive, and
collusion to fix prices and interest rates does occur.
⚫ Moreover, we now realize that not all the information needed by
purchaser of financial services is readily or cheaply available all over
the world. Increasingly, we are coming to an awareness of the
importance of asymmetric information in our global financial
system—that is, different participants in the financial market often
operate with different set of information, some possessing special or
inside information that other do not possess.
Financial Market & Institutions Chapter: 1

⚫ Problems:
⚫ 1. Classify the following financial transactions as to whether they fit in
(a) Debt market or Equity market (b) Money market or Capital market
(c) Primary market or Secondary market (d) Open market or
Negotiated market (e) Spot market or Future / Forward market.
(Note: the transaction below may fit in more than one of the above
categories of markets. Be sure to include all of the appropriate types
of markets that each transaction fits.)
⚫ You visit a local bank today and secure a three- year loan to finance
the purchase of a new car and some furniture.
⚫ You purchase a new U.S. Treasury bill for $99,000 through Federal
Reserve Bank for delivery today.
⚫ Responding to a rise in the price of Beximco common stock, you
have just purchased 1000 shares of that company’s stock through a
phone call to your broker, who is linked to a major stock exchange.
Financial Market & Institutions Chapter: 1

⚫ Concerned about recent trends in the price of American Dollar, you

contact a large money center bank in the region and purchase
$3000 at today’s Tk./$ exchange rate for delivery in six months,
when you plan to fly to Florida.
⚫ Receiving an unexpected windfall, you contact a local bank and
purchase a $25000 four year CD bearing an interest rate on which
you and your bank officer have agreed.
⚫ The corporation you represent need to raise $50 million
immediately to purchase raw materials. You contact a securities
dealer who agrees to advertise the sale of $50 million in
commercial paper, maturing in 90 days, this afternoon. The dealer
expects to sell all the CP within 24 hours.
Financial Market & Institutions Chapter: 1

2. What functions of the financial system do the following transactions

illustrate or represent? (Note: Some transaction may involve more
than one function. Be sure to identify all of the financial system
functions involved in each transaction.)
⚫ Mr. X purchases health and accident insurance policies through the
company where he works.
⚫ Ms. Sharon uses her credit card to purchase wallpaper for a home
remodeling project.
⚫ Fearing a slowdown in the rate of economic growth and increasing
joblessness, Bangladesh Bank (BB) moves to lower interest rates.
⚫ Diamond Corporation places some of its current earnings in a bank
CD anticipating a need for funds in about a year to build a new
warehouse.
Financial Market & Institutions Chapter: 1

⚫ The Bangladesh government sells new bonds in the

open market to cover a large budget deficit.
⚫ Mr. Rahim and Mrs. Rahima hope to put their three
young children through college someday.
Accordingly, they begin buying Bangladesh
government saving bonds.
⚫ Needing immediate spending power, Diamond
Corporation sells its holding of CD through a security
broker.
⚫ The William family withdraws its bank deposit in order
to purchase new furniture for their home.
Financial Market & Institutions Chapter: 1

3. What concept, institution or instruments is described by each of the

phrases or sentences listed below:
– All market participants are price takers.
– No information that might affect financial asset prices or interest rates
is wasted.
– Different participants in the financial market often operate with different
set of information.
– Transferring funds from one market to another due to differences in
price.
– Risk seekers.
– Trading of loans and securities in which any individual or institution
can participate.
– Mechanism set up by society in which newly issued loan and securities
are traded.
– Immediately spendable cash.
– Expenditures on capital goods or raw materials.
Financial Market & Institutions Chapter: 1

– Current earnings retained in the business.

– Funds left over out of current income after deducting
current consumption expenditure.
– An institutional mechanism for trading goods and
services.
– Increases the productivity of labor and leads a high
standard of living.
– Help to maintain consistent prices between markets.
– An institutional mechanism for trading securities or
financial services for immediate delivery.
-- A market for trading those financial assets that
represent ownership right.