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Financial Markets Information asymmetry is when a stakeholder to a transaction

holds superior information than the other which causes
inefficient allocation of financial resources as one party may be
CH1: Financial Systems and The Financial in a better negotiating position because of the lacking
Market information of the other party.

Finance came from the French word finer means “to end and ELEMENTS OF A FINANCIAL SYSTEM
settle debt” is a (a) key player in ensuring the continuity of 1. Lenders and borrowers (who are the players?)
operations, (b) life-blood of the company and its continuous  are both fund providers and fund demanders were
flow is maximize. Hence, a process to (c) ensure that profit and the most essential stakeholders and the
wealth is maximize. foundation of a transaction.
 An application of economic principles to decision-
making that involves allocation of money under 2. Financial intermediaries (how will the exchange occur?)
conditions of uncertainty.  a third party to facilitate the borrowing activity and
got their funds from lenders and redistribute it to
SOURCES OF WEALTH borrowers through an investment vehicle like
1. Labor – through hard work they earn salary or wage loans.
(earned on a daily/weekly basis more than that is called a
salary) 3. Financial instruments(what will be used?)
2. Land – used in business or leased by someone which will  medium of exchange and IFRS defined these as a
generate wealth in the form of rent. contract where a party recognizes it as an
3. Capital – a venture is realizing good returns and will earn asset/liability.
interest.
4. Entrepreneurship – entrepreneurial skills by managing 4. Financial markets (where will it be traded?)
commercial affairs to ensure the company continuously  It is where suppliers and buyers of financial
grow and generate more profit. instruments meet.
 cash financial instrument in money market
Finance Financial System derivative financial instrument in capital market
Provides a framework for Provides a platform by which
making decisions as to how funds are transferred from those
5. Regulatory environment (how it is controlled?)
funds should be obtained and who have funds to invest to
invested. those that needs it to invest.
 Governance body to ensure the financial market
and institution stability, transparency and fairness

Financial system is a set of arrangements embracing the lending 6. Money creation (what is the value it creates?)
and borrowing of funds by non-financial economic units with the  Money is either be reinvested or earned which can
intermediation of financial intermediaries to facilitate the be converted into another form due to the
transfer of funds, to create additional money when required and exchange that occurred in the system.
markets in debt and equity instruments so that the price and
allocation of funds are determined efficiently. 7. Price discovery (How much is created?)
 provides the means to collect money from the people Process of determining/valuing the financial
who have it and distribute it to those who can use it instrument in the market
best. Hence, the efficient allocation of economic
resources is achieved by this system that allocates 8. Financial services (what are they offer?)
money to those people and for those purposes that will  offered by financial institutions such banking,
yield the greatest return. insurance policies, loans, and mortgages, pensions.
 Fund providers can also be a fund demander.
 Businesses – support to grow and expansion Financial market refers to channels/places where funds and
projects. financial instruments are exchanged or make transactions
 Government – finance infrastructure and directly. Participants include:
other community welfare projects  Public financial market – institutions, individuals and
 Households – borrow money to buy their cars local government
and houses.  Corporate financial market – large corps

Funds flow from lender-savers to borrower-spenders into two Three major economic functions of financial market:
routes:  Price discovery
 liquidity
Direct Financing Indirect Financing  Reduction in transaction cost
 deals directly through  borrowing activity between
selling financial both parties happens
TYPES OF FINANCIAL MARKETS
instruments which indirectly through 1. Primary Markets in which corporations raise funds through
represent claims on future intervention of a fanatical new issues of securities.
income/assets. intermediary.  private placement/ initial public offerings/
 borrowers recognized these additional securities of publicly traded firms
as liabilities while lenders
recognize this as an asset 2. Secondary Markets trade financial instruments once they
Ex. buying stocks directly are issued.
from a company  offer buyers and sellers liquidity—the ability to
turn an asset into cash quickly
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 as well as information about the prices or the value ▪ firms planning to issue new stocks or
of their investments bonds - register their securities with the SEC and to fully
 Increased liquidity = more desirable and easier sale describe the issue, and any risks associated with the issue, in a
of security legal document called a prospectus
▪ monitors trading on the major
3. Money Markets —markets that trade debt securities or exchanges
instruments with maturities of less than 1 year. ▪ not intended to protect investors against poor
 fluctuations in their prices in the secondary investment choices, but rather to ensure that investors have full
markets in which they trade are usually quite small and accurate information
 over-the-counter (OTC) markets

4. Capital Markets —markets that trade debt and equity

instruments with maturities of more than 1 year
▪ corporations and governments - major
suppliers of capital market securities (or users of funds)
▪ wider price fluctuations in the
secondary markets in which they trade than do money market
instruments
CAPITAL MARKET INSTRUMENTS
▪ Corporate stock —ownership claim in a public
corporation.
▪ Mortgages —loans to individuals or
businesses to purchase a home, land, or other real property
▪ Corporate bonds —long-term bonds
issued by corporations
▪ Treasury bonds —long-term bonds issued by the govt
▪ State and local government bonds —
long-term bonds issued by state and local governments
▪ Bank and consumer loans —loans to
commercial banks and individuals.

❖ Foreign Exchange Markets - trading one currency for

another

▪ Foreign exchange risk - sensitivity of the value of cash

flows on foreign investments to changes in the foreign
currency’s price in terms of dollars
▪ Spot FX - the immediate exchange of
currencies at current exchange rates.
▪ Forward FX - the exchange of currencies in the future
on a specific date and at a pre-specified exchange rate.

❖ Derivative Security (Markets)

▪ a financial security (such as a futures contract, option
contract, swap contract, or mortgage-backed security) whose
payoff is linked to another, previously issued security such as a
security traded in the capital or foreign exchange markets
▪ agreement between two parties to
exchange a standard quantity of an asset or cash flow at a
predetermined price and at a specified date in the future
▪ value of the underlying security to be
exchanged changes, the value of the derivative security changes
▪ the newest of the financial security
markets
▪ potentially the riskiest of the financial securities
▪ main purpose of the derivatives markets
is to transfer risk between market participants

Financial Market Regulation

❖ The Securities Act of 1933 - Full and fair disclosure and
securities registration.
❖ The Securities Exchange Act of 1934 -
Securities and Exchange Commission (SEC) is the main regulator
of securities markets

▪ full and fair disclosure of information on securities

issues to actual and potential investors