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CHAPTER 2The Financial Environment:

Outlines Financial Markets Financial Institutions

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The Capital Flow Process In a well-functioning economy, capital

flows efficiently from those who supply capital to those who demand it.

Suppliers of capital – individuals and institutions with “excess funds.” These groups are saving money and looking for a rate of return on their investment.

Demanders or users of capital – individuals and institutions who need to raise funds to finance their investment opportunities. These groups are willing to pay a rate of return(interest) on the capital they borrow. 2-2

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Three ways capital flow from savers to borrowers?

Direct transfer Investment Bank

Securities pass through the investment bank

Financial intermediary Intermediary create new securities

for savers.

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What is a market Market: A place/venue where goods

and services are exchanged FM: A place where funds/financial

assets are traded. lender: those with surplus of funds

(individual, firms, Gov.) borrower: those need funds ( individual,

households, firms) Who are lender/borrower: stock M, bond M

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Types of financial markets Money vs. Capital Primary vs. Secondary Spot vs. Futures Public vs. Private

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FM F Asset /F instruments: contracts specifying

borrowing/lending terms, claims on real assets i.      Money M (borrowed for less than 1 Y) and Capital M (1 Y

or longer) ii.      Primary M and secondary M 1.      PM: New issues are sold to the public 2.      SM: outstanding issues traded among investors iii.      Private M vs. Public 1.      Private: transactions between two parties 2.      Public: standardized contracts traded on exchanges. iv.      Spot M vs. Future M 1.     SM: transaction “on-the-spot” 2. FM: Contract specifying terms of future trading

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Types of Financial Institutions

Banks Commercial banks

Middleman between savers and borrowers Investment banks

An organization that helps to sell new investment securities (bonds, stocks).

Financial services corporations A firm that offers a wide range of financial

services, including investment banking, commercial banking, brokerage and insurances.

Citi, B of A, JPM 2-7

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Types of Financial Institutions

Funds-pool money to invest Mutual funds Pension funds-retirement plans Hedge funds Exchange traded funds-ETF

Other financial institutions Life Insurance companies: Collect

premiums and invest Private equity: borrows money to invest/mange

the whole company2-8

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The stock market Types of stock market transactions

The secondary market The primary market:

IPO market: Initial Public Offering additional new shares

Basics of stock market and stock investing