Money and Banking

1. Money and Banking Lecture 6

2. Review of the Previous Lecture • Financial Intermediaries • Financial Instruments • Uses • Characteristics • Value

3. Topics under Discussion • Financial Instruments • Examples • Financial Markets • Roles • Structure • Financial Institutions

4. Examples of Financial Instruments Primarily Stores of Value • Bank Loans • a borrower obtains resources from a lender immediately in exchange for a promised set of payments in the future • Bonds • a form of a loan, whereby in exchange for obtaining funds today a government or corporation promises to make payments in the future

5. Examples of Financial Instruments Primarily Stores of Value • Home Mortgages • A loan that is used to purchase real estate. • The real estate is collateral for the loan, • it is a specific asset pledged by the borrower in order to protect the interests of the lender in the event of nonpayment. • If payment is not made the lender can foreclose on the property. • Stocks • an owner of a share owns a piece of the firm and is entitled to part of its profits.

6. Examples of Financial Instruments Primarily to transfer risk • Insurance Contracts • the primary purpose is to assure that payments will be made under particular (and often rare) circumstances • Futures Contracts • an agreement to exchange a fixed quantity of a commodity, such as wheat or corn, or an asset, such as a bond, at a fixed price on a set future date. • It is a derivative instrument since its value is based on the price of some other asset. • It is used to transfer the risk of price fluctuations from one party to another

7. Examples of Financial Instruments Primarily to transfer risk • Options • Derivative instruments whose prices are based on the value of some underlying asset; • They give the holder the right (but not the obligation) to purchase a fixed quantity of the underlying asset at a predetermined price at any time during a specified period.

8. Financial Markets • Financial Markets are the places where financial instruments are bought and sold. • Enable both firms and individuals to find financing for their activities. • Promote economic efficiency by ensuring that resources are placed at the disposal of those who can put them to best use. • When they fail to function properly, resources are no longer channeled to their best possible use and the society suffers at large

9. Structure of Financial Markets • Primary vs. Secondary Markets • In a primary market a borrower obtains funds from a lender by selling newly issued securities. • Most companies use an investment bank, which will determine a price and then purchase the company’s securities in preparation for resale to clients; this is called underwriting. • In the secondary markets people can buy and sell existing securities

10. Structure of Financial Markets • Centralized Exchanges vs. Over-the- counter Markets. • In the centralized exchange the trading is done “on the floor” • Over-the-counter (or OTC) market are electronic networks of dealers who trade with one another from wherever they are located

11. Structure of Financial Markets • Debt and Equity vs. Derivative Markets • Equity markets are the markets for stocks, which are usually traded in the countries where the companies are based. • Debt instruments can be categorized as • money market (maturity of less than one year) or • bond markets (maturity of more than one year

12. Financial Markets Characteristics of a well-run financial market • Low transaction costs. • Information communicated must be accurate and widely available • If not, the prices will not be correct • prices are the link between the financial markets and the real economy • Investors must be protected. • A lack of proper safeguards dampens people’s willingness to invest

13. Market Size and Investor Protection

14. Summary • Financial Instruments • Examples • Financial Markets • Roles • Structure

15. Upcoming Topics • Financial Institutions • Time Value of Money • Future value, • Compound Interest • Present Value • Interest Rates