Financial Markets and Institutions – BA 543 Tuesday Bexell :00 noon to 2:50 p.m. 6:00 p.m. to 8:50 p.m.

Chapter 1 – Financial Markets Types of Markets – Allocation of Economic Resources through Prices Product Markets Goods and Services Generally thought of as a consumption market Factor Markets Factors of production Generally thought of as labor and capital Financial Markets – One Part of Factor Market Market for financial assets (capital markets) Our focus for this course

Chapter 1 – Financial Assets Define an asset… Possession that has value in exchange Tangible asset – value determined by its physical characteristics  Diamond – 4 Cs  Car – physical properties Intangible asset – value determined by its legal claim to future benefits  Financial asset – aka financial instrument or security  Financial asset – claim to future cash flow Examples of Financial Assets on Page 2 Both tangible and Intangible can share one concept – expected to generate future cash flow

Chapter 1 – Financial Assets Valuing (Pricing) a Financial Asset -- Timing and Amount of Future Cash Flow Known (both timing and amount) Known (only timing and amount uncertain) Known (only amount and timing uncertain) Unknown amount and timing Risk of a Financial Asset Inflation risk or purchasing power risk Credit risk or default risk Foreign-exchange risk

Chapter 1 – Financial Assets Functions of Financial Assets Invest (postpone consumption) We demand a reward for postponing consumption Borrow (accelerate consumption) We pay for moving up consumption Transfer Risk Others can handle risk better (cheaper) than we can Rate of Return encompasses these functions Price of a financial asset…model for discounted cash flow includes the timing and amount of the cash flow and the discount rate covers inflation, real return, and risk premiums

Chapter 1 – Financial Markets Where Buyers and Sellers Meet In every transaction there is a buyer and a seller Both exchange the asset for a mutually agreed upon price Function of Financial Markets Buy or Sell financial assets Provide price discovery Provide liquidity Reduce transaction costs (search costs and information costs) Efficient Market place – operational and price

Chapter 1 – Financial Markets Classification of Financial Markets See Table 1-1 on page 7 Claim Maturity Seasoning Delivery Structure Location Limitations of Participants Members Only Qualifications

Chapter 1 – Global Financial Markets Access increasing due to technology Classification by Issuer and Issue Place Domestic – issuer domiciled in country where security is issued Foreign – issuer domiciled in foreign country but security issued in another country Examples…Yankee market (foreign issuers sell securities in the U.S.), Samurai market (foreign issuers sell in Japan), Matador market (foreign issuers sell in Spain)…etc. International (or off-shore or external or Euro- market) Simultaneous selling in multiple countries and issued outside the jurisdiction of any one country

Chapter 1 – Financial Assets Derivatives Forward and Futures Contracts Two parties agree to transact at a future date with the details of the transaction agreed upon today Large percentage of transactions are forward contracts Options Contracts – Calls and Puts Call is the right but not the obligation to buy in the future (at a pre-set price) Put is the right but not the obligation to sell in the future One function is to transfer risk

Chapter 1 – Regulations of Markets Why regulate? Goal of a market…”competitive market” Efficiency Low-cost Regulate when (reach or maintain equilibrium) Markets cannot on their own attain competitive status Markets are too slow at reaching competitive status Markets cannot maintain competitive status Types of Regulation Disclosure - information available to all participants Allowed activity – for example, insider trading Institutions activity – Sub-Prime Housing Market Foreign participation – limitation on individuals or countries

Chapter 1 – Financial Innovation Three Types of Innovation Market Broadening Instruments Increased liquidity (new borrowers or lenders) Risk Instruments Transfer of risk Arbitrage Instruments Reduce differences across markets Motivation Many reasons but the two strongest seems to be increase efficiency and risk sharing (hedging and speculating)