© 2004 Pearson Addison-Wesley. All rights reserved 2-1 Function of Financial Markets 1. Allows transfers of funds from person or business without investment opportunities to one who has them 2.Improves economic efficiency 3.Transfer funds over life horizon

© 2004 Pearson Addison-Wesley. All rights reserved 2-2 Direct and Indirect Finance Direct finance: lenders hold direct claims on borrowers’ assets or future income. Indirect finance: Lenders hold claims on financial intermediary, which in turn hold claims on borrowers. (q)

© 2004 Pearson Addison-Wesley. All rights reserved 2-3 Classifications of Financial Markets I By Financial Instruments 1.Debt Markets Short-term (maturity < 1 year) Long-term (maturity > 10 year) 2.Equity Markets Common stocks (owner a residual claimant) Securities are assets for holders, but liabilities for issuers. (q) The value of debt instruments was $20 trillion in 2002 while the value of equity was $11 trillion.

© 2004 Pearson Addison-Wesley. All rights reserved 2-4 Classifications of Financial Markets II 1.Primary Market (often behind closed doors) New security issues sold to initial buyers 2.Secondary Market Securities previously issued are bought and sold Investment Bank. Role of Brokers and Dealers. (q) Liquidity and Valuation Provided by the Secondary Market.

© 2004 Pearson Addison-Wesley. All rights reserved 2-5 Classifications of Financial Markets III By Organization of Secondary Market 1.Exchanges Trades conducted in central locations (NYSE,ASE) 2.Over-the-Counter (OTC) Markets Dealers at different locations buy and sell U.S. Gov’t Bond Market Organized as an OTC market with 40 or so dealers.

© 2004 Pearson Addison-Wesley. All rights reserved 2-6 Classifications of Financial Markets IV By Maturity 1.Money Market (< 1 year debt instruments) 2.Capital Market (longer term debt and equity).