The Financial Market Environment
References:
- Gitman & Zutter: Chapter -2
- Class Notes
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Learning Outcomes
Understand the role that financial institutions play in
managerial finance
Contrast the functions of financial institutions and
financial markets
Describe the differences between the capital markets
and the money markets
Describe the differences between other types of markets
Know various financial instruments
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FINANCIAL Institutions
An intermediary that channels the savings of
individuals, businesses, and governments into
loans or investments.
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Key Customers of Financial Institutions
The key suppliers of funds and the key demanders of
funds are individuals, businesses, and
governments
Individuals as a group are the net suppliers for
financial institutions: They save more money than they
borrow
Business firms also deposit some of their funds in
financial institutions, primarily in checking accounts
with various commercial banks. Like individuals, firms
borrow funds from these institutions, but firms are net
demanders of funds: They borrow more money than
they save.
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Key Customers of Financial Institutions
Governments maintain deposits of temporarily
idle funds, certain tax payments, and Social
Security payments in commercial banks.
The government, like business firms, is typically
a net demander of funds: It typically borrows
more than it saves. We’ve all heard about the
budget deficit.
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Financial Markets
Financial Market refers to a conceptual
mechanism by which surplus units and deficit
units get together.
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Financial Market
Forums in which suppliers of funds and
demanders of funds can transact business
directly.
A Financial Market is a market in which
financial assets (securities) such as stocks
and bonds are traded (purchased or sold)
through the interaction of the buyers
(Investors) and the sellers (Issuers).
Financial Markets facilitate the flow of funds
from surplus units to deficit units. 8
Importance of Financial Markets
Financial Markets help bring together
borrowers and savers (lenders) by
facilitating the flow of funds.
The more efficient the process of funds
flow, the more productive the economy,
both in terms of manufacturing and
financing.
The mechanisms of financial markets
allow us to consume more than our
current income.
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Types of Financial Markets
1. Nature of 2. Maturity of [Link] [Link] [Link] 6. Location
Claim Claim of Claim Structure Requirement • Domestic Market
• Debt Market • Money Market • Primary Market • Organized • Spot Market • International
• Equity Market • Capital Market • Secondary Market • Future/Forward Market
Market • OTC Market Market
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Debt Vs Equity Markets:
The market where loans are traded is debt market, on the
other hand the market in which stocks of a corporations
are traded are called equity market.
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Money Vs Capital Markets:
Those financial markets that facilitate the flow of
short-term funds (with maturities of less than
one year) are known as money market.
Whereas Financial markets that facilitate the
flow of long-term funds like stock and long-term
debt are called Capital Market (generally longer
than one year).
Private placement: The sale of a new security
directly to an investor or group of investors.
Public offering: The sale of either bonds or
stocks to the general public
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THE MONEY MARKET:
A financial relationship created between
suppliers and demanders of short-term funds.
The money market exists because some
individuals, businesses, governments, and
financial institutions have temporarily idle funds
that they wish to invest in a relatively safer,
temporary interest-bearing asset.
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The MONEY MARKET:
Most money market transactions are made in
marketable securities, which are short-term
debt instruments such as U.S. Treasury bills,
commercial paper, and negotiable certificates of
deposit issued by government, business, and
financial institutions, respectively.
The international equivalent of the domestic
money market is called the Eurocurrency
market. This market for short-term bank
deposits is denominated in U.S. dollars or other
major currencies
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The MONEY MARKET:
Eurocurrency deposits arise when a corporation
or individual makes a bank deposit in a currency
other than the local currency of the country
where the bank is located.
For example, if a multinational corporation were
to deposit U.S. dollars in a London bank, this
action would create a Eurodollar deposit (a
dollar deposit at a bank in Europe)
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Financial Instruments/ Assets of money market
Money Market Securities:
◦ Treasury Bills: When the govt. needs to borrow
funds, they frequently issue short-term securities
known as treasury Bills (T-Bills).
◦ Commercial Paper: Commercial Paper are short-
term, transferable, debt instruments issued only by
well-known, creditworthy firms and is typically
unsecured.
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Financial Instruments/ Assets of money
market
◦ Certificates of Deposit: These are issued by large
commercial banks and other depository institutions as
a short-term source of funds.
◦ Repurchase Agreement: With a repurchase
agreement (repo), one party sells securities to another
with an agreement to repurchase the securities at a
specified date and price.
◦ Banker’s Acceptance: It indicates that a bank
accepts responsibility for a future payment. Banker’s
acceptance are commonly used for international trade
transactions.
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The CAPITAL MARKET
A market that enables suppliers and demanders
of long-term funds to make transactions.
Key Securities Traded: Bonds and Stocks
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The CAPITAL MARKET
Bond: Long-term debt instrument used by business and
government to raise large sums of money, generally from
a diverse group of lenders.
Lakeview Industries, a major microprocessor
manufacturer, has issued a 9% coupon interest rate, 20-
year bond with a $1,000 par value that pays interest
semiannually. Investors who buy this bond receive the
contractual right to $90 annual interest (9% coupon
interest rate * $1,000 par value) distributed as $45 at the
end of each 6 months (1>2 * $90) for 20 years, plus the
$1,000 par value at the end of year 20.
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The CAPITAL MARKET
Treasury Bonds: Govt. issues this type of securities to meet
up its long-term financing requirements or expenditures.
Municipal Bonds: Like the govt., sometimes the state and
local govt. spend more than the revenues they receive. To
finance this difference, they issue the Municipal Bond.
Corporate Bonds: When a corporation needs to borrow , it
issues corporate bonds which usually promises a fixed interest
on the bond value.
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The CAPITAL MARKET
Stock: shares of common stock are units of
ownership, or equity, in a corporation. Common
stockholders earn a return by receiving
dividends— periodic distributions of cash—or by
realizing increases in share price
Preferred stock: A special form of ownership
having a fixed periodic dividend that must be
paid prior to payment of any dividends to
common stockholders.
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Primary Vs Secondary Markets:
Primary Market facilitates the issuance and sale of new
securities. Primary Market transactions provide funds to
the initial issuer of the securities.
Secondary Market facilitates the trading in the existing
securities. Transaction in this market does not provide
anything to the issuing firm.
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Broker Markets and dealer Markets
Broker Market: The securities exchanges on
which the two sides of a transaction, the buyer
and seller, are brought together to trade
securities
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Broker Markets and dealer Markets
Dealer Market: The buyer and the seller are
never brought together directly. Instead, market
makers execute the buy/sell orders. Market
makers are securities dealers who “make markets”
by offering to buy or sell certain securities at
stated prices.
Example: Party A sells his or her securities (Dell)
to a dealer, and Party B buys his or her securities
(in Dell) from another, or possibly even the same,
dealer. Thus, there is always a dealer (market
maker) on one side of a dealer–market
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Dealer Market
Dealer Markets One of the key features of the
dealer market is that it has no centralized trading
floors. Instead, it is made up of a large number
of market makers who are linked together via a
mass-telecommunications network.
bid price: The highest price offered to purchase
a security
ask price The lowest price at which a security is
offered for sale
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The Role of Capital Markets
From a firm’s perspective, the role of a capital
market is to be a liquid market where firms can
interact with investors to obtain valuable external
financing resources.
From investors’ perspectives, the role of a
capital market is to be an efficient market that
establishes correct prices for the securities that
firms sell and allocates funds to their most
productive uses
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The Role of Capital Markets
If the market is efficient, at any given time, a
stock’s price reflects all the information that is
known about the stock.
Changes in the price reflect new information that
investors learn about and act on.
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The Role of Capital Markets
For example, suppose that a certain stock
currently trades at $40 per share.
If this company announces that sales of a new
product have been higher than expected, and if
investors have not already anticipated that
announcement, investors will raise their estimate
of what the stock is truly worth.
So, there will temporarily be more buyers than
sellers wanting to trade the stock, and its price
will have to rise to restore equilibrium in the
market.
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The Role of Capital Markets
The more efficient the market is, the more
rapidly this whole process works.
In theory, even information known only to
insiders may become incorporated in stock
prices
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Securities Exchanges
Organizations that provide the marketplace in
which firms can raise funds through the sale of
new securities and purchasers can resell
securities.
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Securities Exchanges in BD
Bangladesh Security Exchange & Commission:
The Bangladesh Securities and Exchange
Commission is the regulator of the capital
market of Bangladesh, comprising Dhaka Stock
Exchange and Chittagong Stock Exchange.
Dhaka Stock Exchange (DSE)
Chittagong Stock Exchange (CSE)
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Assignment
Listthe top 10 stock exchanges around the
world.
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Types of Financial Markets
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Organized Vs OTC market
Organized OTC market
• Centralized • Decentralized
• Standardized • Direct trading
• Example: NYSE, CSE, DSE • Non-standardized/
Customized
Example: NASDAQ
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Edition, Copyright © John C. Hull 2008
Types of Financial Markets
Spot Vs Future Markets:
The markets where assets are bought or sold for on the spot delivery
(immediately or within a few days) are called spot markets.
The markets for delivery of assets at some later date is called future
market.
Domestic Vs International Market:
Markets inside any particular country is known as domestic/ internal
market.
Global market is known as international market where trading is done
between or among countries.
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