Chapter 2 Exam Notes

Chapter 2: Financial Markets &

Institutions

1. Methods of Fund Transfer (continued)

2. Indirect transfer through investment bankers - Process:

Company gives securities to investment bank → Investment bank sells
to investors → Company gets money. - Example: IPO.

Banks --Securities--> Investment --Securities--> Savers

Banks <--Dollars----- Banks <--Dollars------ Savers

3. Indirect transfer through a financial intermediary - Middleman

= bank, mutual fund, etc. - Process: You deposit money in bank → Bank
lends money to company.

Banks --Securities--> Financial --Intermediary's Securities--> Savers

Banks <--Dollars----- Intermediary <--Dollars------------------ Savers

2. Financial Markets

Financial Markets are places that bring together people who need
money with people who have money. - Helps smooth flow of funds. -
Match savers with users of capital.

Types of Financial Market

(Varies with customers, parts of country, maturity of securities being

traded & types of assets used to back the securities)

(1) Physical Asset Markets vs Financial Asset Markets - Physical

Asset Markets – deal with real, tangible goods (wheat, automobile,
real estate, machinery, etc.) - Financial Asset Markets – deal with
financial instruments (stocks, bonds, notes, mortgages). Also derivative
securities, whose value depends on other assets.

(2) Spot Market vs Futures Market - Spot Markets – assets are

bought & sold for immediate/near-immediate delivery (usually within a
few days). - Futures Markets – buy & sell assets in contract for future
dates.

(3) Money Market vs Capital Market - Money Market – market for

short-term, highly liquid debt securities. - Maturity generally less than
1 year. - Examples: Treasury bills, commercial paper. - Major money
markets: New York, London & Tokyo. - Capital Market – deals in
intermediate & long-term debt & equity securities. - Time: 1–10 years
(intermediate); more than 10 years (long-term). - Example: New York
Stock Exchange [Bonds, common stocks].

(4) Primary Market vs Secondary Market - Primary Markets –

markets where new securities are issued; used by corporations to raise
new capital. - Secondary Markets – market where existing securities
are traded among investors; no new capital raised.

(5) Private Market vs Public Market - Private Markets –

transactions negotiated directly between two parties; customized
contracts [Bank loans, private debt placements]. - Public Markets –
standardized contracts traded on organized exchanges; securities held
by large numbers of investors [Corporate bonds, common stocks].

3. Financial Institutions

Financial Institutions act as intermediaries between savers and

borrowers & help in smooth functioning of financial markets.

Types of Financial Institutions

1. Investment Banks
Underwrite & distribute new investment securities.
Help corporations raise capital.
Main functions: design securities attractive to investors;
purchase securities from issuing firms; resell securities to
savers.
Since they guarantee capital raising, they are called
underwriters.
2. Commercial Banks
Known as traditional “departmental stores of finance.”
Serve a wide range of savers & borrowers.
Main functions: accept deposits; provide loans; maintain
checking accounts.
Play a key role in money supply control through the central
bank.
3. Financial Service Corporations
Large financial conglomerates offering multiple financial
services.
Combine different financial institutions under one corporate
structure.
Example services: commercial banking, investment, insurance,
leasing.
4. Credit Unions
Co-operative, non-profit financial institutions.
Members share a common bond.
Savings are loaned only to members.
Common loans: auto loans, home improvement loans,
mortgages.
Cheapest source of funds available to individual borrowers.
5. Pension Funds
Retirement saving plans that help workers save money for when
they retire.
Employers/govt pay money into these funds for employees to
use in retirement.
Invest this money in stocks, bonds, mortgages, real estate.
Administered primarily by the trust departments of commercial
banks or by life insurance companies.
6. Life Insurance Companies
Collect savings in the form of premiums that protect families
after a loved one passes away.
Also offer tax-deferred retirement savings plans.
Invest funds in: stocks, bonds, real estate, mortgages.
7. Mutual Funds
Corporations that accept money from savers & then use these
funds to buy stocks, long-term bonds/short-term debt
instruments issued by businesses or government units.
Advantages:
Risk reduction through diversification.
Achieve economies of scale in analyzing securities,
managing portfolios, and buying & selling securities.
Different funds meet different investor objectives.
8. Exchange Traded Funds (ETFs)
An investment fund that holds multiple underlying assets & can
be bought & sold on an exchange, much like an individual stock.
Similar to mutual funds but traded throughout the day on
exchanges.
Holds a basket of underlying assets. Can track: stock indices,
commodities, industries, countries.

4. The Stock Market

The stock market is where already issued shares & securities of

companies are bought & sold. This is done in what is called the
secondary market. Helps in determining the prices of companies &
allows investors to buy or sell shares. - Stock markets in Bangladesh:
DSE, CSE.

Types of Stock Market

(1) Physical Location Stock Exchanges - Have a physical trading

floor. - Only authorized (limited) members are allowed to trade. -
Operated under an elected board of governors. - Examples: New York
Stock Exchange (NYSE), American Stock Exchange (AMEX), Regional
exchanges. - Membership: Earlier, members owned “seats.” Now,
seats are replaced by annual trading licenses. - Large investment
banks: operate brokerage departments, purchase trading licenses,
appoint officers as exchange members.

(2) Electronic Dealer-Based Markets - No trading floor. - Trading is

done electronically. - Examples: NASDAQ, Over the Counter Market,
Electronic Communication Networks (ECNs).

Over the Counter Market (OTC) is a large collection of brokers and

dealers connected electronically by telephone & computers, that
provides trading in unlisted securities. Most small & medium
companies trade here; large companies trade on NYSE.

The Market for Common Stock

Privately/Closely Held Corporations Publicly Owned Corporations

Owned by a small number of investors, Owned by thousands of investors
usually managers
Stocks aren’t actively traded Separate management & ownership
Known as closely held stock Actively traded stocks
Known as publicly held stocks

Types of Stock Market Transactions

1. Secondary Market Transactions – involves trading of existing

outstanding shares of established publicly owned companies;
company receives no new funds.
2. Primary Market Transactions – occurs when an established
publicly owned company issues new shares; used to raise new
 equity capital.
3. Initial Public Offering (IPO) Market – occurs when a privately
held company sells shares to the public for the first time.
This process is called going public.
The market for stock that is just being offered to the public is
called the IPO market.
Helps raise capital & expand ownership.

Stock market plays a crucial role in price discovery, capital

formation & wealth creation. It links investors with firms &
supports economic growth.

5. The Foreign Exchange Market

A foreign exchange market is a market in which currencies are

bought and sold. It is distinguished from a financial market, where
currencies are borrowed & lent. The purpose is to permit transfers of
purchasing power denominated in one currency to another (to trade
one currency for another currency).

Need for Foreign Exchange Market

International trade & investment require currency exchange.

Exporters & importers usually want payment in their own domestic
currency.
It is impractical for buyers & sellers to find each other individually.
F.E.M. works as an intermediary.

Nature

Not a physical market. Rather, electronically linked network of

banks, foreign exchange brokers & dealers whose function is to
bring together buyers & sellers of foreign exchange.
Market operates across major financial centers such as: London,
New York, Tokyo, Paris, Zurich, Hong Kong, Frankfurt, Milan & other
cities.

Trading Mechanism

Traditionally through: telephone, telex, The SWIFT System.

SWIFT (Society for Worldwide Interbank Financial

Telecommunications) - An international electronic communications
network for banks that links all brokers & traders. - Connects over 7000
banks, brokers/dealers in 192 countries. - Processes more than 5
million transactions a day, representing about $5 trillion in payments.

Major Participants in the Foreign Exchange Market

Large commercial banks.

Foreign exchange brokers in the interbank market.
Commercial customers — mainly multinational corporations.
Central banks, which intervene to: reduce exchange rate
fluctuations; maintain target exchange rates.

Functions of Foreign Exchange Market

Facilitate currency conversion.

Provide instruments to manage foreign exchange risks (such as
forward exchange).
Allow investors to speculate in the market for profit.
6. International Financial Institutions

International Monetary Fund (IMF)

Background: IMF was created in 1944 during the Bretton Woods

Conference to ensure global monetary stability after the Great
Depression & World War II. It officially began operations in 1945 with
29 member countries. Today it has 190+ member nations &
headquarters in Washington D.C.

What it is: An international financial organization that provides policy

advice, financial assistance & technical support to countries facing
economic instability or balance-of-payment problems.

Mission: To promote global monetary cooperation, secure financial

stability, and facilitate balanced international trade & sustainable
economic growth.

Vision: A stable, prosperous global economy where countries

experience low inflation, sustainable growth & financial stability.

Objectives: - Ensure stability of international monetary system. -

Provide temporary financial assistance to countries in crisis. - Promote
exchange rate stability & balanced international trade. - Conduct global
economic surveillance. - Support poverty reduction & economic
reforms in developing nations.

Note: IMF doesn’t finance development projects.

Functions: - Surveillance – monitoring global & national economic

trends. - Financial Assistance – loans to countries to deal with
currency crises, inflation/financial instability. - Technical Assistance
& Training – support in tax policy, budgeting, financial regulation &
statistics. - Policy Advice – guidance on monetary & fiscal policies.

Investment Corporation of Bangladesh (ICB)

Background: Established in 1976 under ICB ordinance with the

purpose of accelerating industrialization & developing the capital
market of Bangladesh. At the time of its creation, Bangladesh’s
financial market was underdeveloped, with limited long-term financing
options for industries. ICB was introduced as a specialized financial
institution to mobilize savings & channel them into productive
investments.

What it is: ICB is a state-owned investment & financial service

provider that engages in underwriting, mutual funds, portfolio
management activities. Major role in project financing & market
stabilization activities & developing securities market in Bangladesh.

Mission: To mobilize savings, encourage investment & contribute to

economic development through efficient financial services & capital
market operations.

Vision: To become a leading institution supporting a strong, stable &

transparent capital market in Bangladesh.

Objectives: - Develop capital market. - Provide long-term financing. -

Promote investment culture. - Reduce dependence on bank loans. -
Support privatization & economic growth.
Functions: - Underwriting shares & debentures. - Managing mutual
funds. - Portfolio management services. - Margin lending. - Corporate
advisory services. - Market stabilization.

International Commercial Banks

(One other form of ICB) - Operate in more than one country. - Provide
banking services for international trade & investment.

Main Functions: - Accept deposits in different currencies. - Provide

short-term & long-term loans. - Finance international trade (trade
finance, LC). - Foreign exchange transactions. - Help multinational
corporations manage global cash flows.

Example: HSBC, Citibank, Standard Chartered.

Asian Development Bank (ADB)

Background: ADB was founded in 1966 & is headquartered in Manila,

Philippines, to promote development in Asia & the Pacific.

What it is: A regional development bank providing loans, grants &

technical support for development projects.

Mission: To promote a prosperous, inclusive & sustainable Asia &

reduce poverty.

Vision: A poverty-free Asia with strong infrastructure & sustainable

development.

Objectives: - Reduce poverty. - Promote economic growth. - Develop

infrastructure. - Support regional cooperation.

Functions: - Providing loans, grants & technical assistance. - Reducing

poverty. - Supporting sustainable development. - Financing
infrastructure projects. - Research & policy support. - Supporting
private sector development.

Inter-American Development Bank (IDB)

Established in 1959.
Headquartered in Washington D.C.

Objective: Promote economic & social development in Latin America

and the Caribbean.

Main Functions: - Provide long-term loans & technical assistance. -

Support poverty reduction. - Encourage private sector development. -
Improve education, health & infrastructure. - Focuses on regional
development like ADB for America.

World Bank (WB)

Background: Established in 1944 at the Bretton Woods Conference to

support reconstruction & development after World War II.

What it is: A global financial institution providing loans & technical

assistance to developing countries.

Mission: To end extreme poverty & promote shared prosperity.

Vision: A world free from poverty with sustainable & inclusive

economic growth.
Objectives: - Reduce global poverty. - Support development projects
(education, health, agriculture, infrastructure). - Improve living
standards. - Promote sustainable growth. - Strengthen institutions in
developing countries.

Functions: - Providing long-term development loans. - Funding

infrastructure projects. - Supporting education & health. - Policy advice
& research. - Technical assistance.

Quick Recap (Exam Cheat-Sheet)

Fund transfer methods: Direct, via investment bankers, via

financial intermediary.
Financial market types: Physical vs Financial; Spot vs Futures;
Money vs Capital; Primary vs Secondary; Private vs Public.
Financial institutions: Investment banks, commercial banks,
financial service corporations, credit unions, pension funds, life
insurance companies, mutual funds, ETFs.
Stock markets: Physical location exchanges (NYSE, AMEX) vs
Electronic dealer-based markets (NASDAQ, OTC). Transactions:
secondary, primary, IPO.
Forex market: No physical location; trades currencies; SWIFT
system; participants = commercial banks, brokers, MNCs, central
banks.
International institutions: IMF (monetary stability, est. 1944),
World Bank (poverty reduction, est. 1944), ADB (Asia, est. 1966),
IDB (Latin America, est. 1959), ICB (Bangladesh capital market, est.
1976).