1. Financial Markets Chapter 31 McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

2. Financial Intermediaries
By reducing search and information costs, financial intermediaries facilitate raising funds
They reduce the cost to borrowers of locating loanable funds
They reduce the cost to savers of finding suitable lending or investment opportunities

3. The Supply of Loanable Funds
The supply of loanable funds comes from savings
Savings decisions are influenced by
Time preferences: In deciding to save, people effectively reallocate spending over time
Interest rates: Higher interest rates increase the quantity of available savings (loanable funds)

4. Risk Premiums
Lenders want to be compensated for any above-average risks they take
Risk premium: The difference in rates of return on risky (uncertain) and safe (certain) investments

5. Time Value of Money
Present discounted value (PDV): The value today of future payments, adjusted for interest accrual
where N refers to the number of years in the future a payment is to be made

6. Time Value of Money The PDV of a future payment declines with:
Higher interest rates
Longer delays in future payments (higher N)

7. Expected Value
Expected value: The probable value of a future payment, including the risk of nonpayment

8. The Demand for Loanable Funds
How much loanable funds are demanded depends on:
The expected rate of return
The cost of funds
The higher the expected return, or the lower the cost, the greater demand will be

9. Shared Ownership Corporate stock: Shares of ownership in a corporation
Each share of corporate stock represents partial ownership of the business
Shareholders select a board of directors to monitor corporate activity and protect their interests

10. Stock Returns
Dividend: Amount of corporate profits paid out for each share of stock
An increase in the value of a stock represents a capital gain for shareholders
Capital gain: An increase in the market value of an asset

11. Total Return There are two motivations for buying and holding stocks:
The expectation of dividends
The anticipation of capital gains
The higher the expected return, the greater the desire to buy and hold stocks

12. Worsening Expectations
Initial demand
for stock
Initial supply
of stock
New supply
of stock
Price A B
New demand for stock
Quantity of Stock (shares per day)

13. Bond Trading
Once a bond has been issued, the initial lenders can sell their bonds to someone else
Liquidity is an important consideration for prospective bondholders
Liquidity: The ability to convert an asset into cash

14. Financial Markets End of Chapter 31 McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.