Introduction and Overview of Financial System

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INTRODUCTION ANDOVERVIEW OF THE

FINANCIAL SYSTEM

Financial Markets andBanking

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Motivating Questions

Recently there was mention in The EconomicTimes about a meeting between the RBIGovernor D. Subbarao and Finance Minister

Pranab Mukherjee where they discussed aboutthe interest rate stance of the RBI and liquidity incredit markets.

What does all this mean? Do I care about

interest rates? What is the RBI? Will thisimpact my firms ability to get a bank loan?


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These are good questions. Of course, theanswer to these questions can be found inthis course. In fact, this course touches

on a variety of topics, including the RBI,stock market, bond market, and banks.We will begin to appreciate many excitingissues related to these topics during thecourse of this term


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To start, we preview subjects of interest toanyone who is a part of a productive society. Wemotivate how financial markets and institutions

have significant impact on important questionsabout our financial well-being. Topics include:

Why Study Financial Markets?

Why Study Financial Institutions?

Applied Managerial Perspective

How Will We Study Financial Markets and Institutions


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Financial markets, such as bond and stockmarkets, are crucial in our economy.

1. These markets channel funds from saversto investors, thereby promoting economicefficiency.

2. Market activity affects personal wealth, thebehavior of business firms, and economyas a whole


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Well functioning financial markets, such asthe bond market, stock market, and foreignexchange market, are key factors inproducing high economic growth.

We will briefly examine each of these

markets, key statistics, and how we willexamine them throughout this course.


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Why Study Financial Markets?Debt Markets & Interest Rates

Debt markets, or bond markets, allowgovernments, corporations, and individualsto borrow to finance activities.

In this market, borrowers issue a security,called a bond, that promises the timelypayment of interest and principal over

some specific time horizon.

The interest rate is the cost of borrowing.


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There are many different types of marketinterest rates, including mortgage rates, carloan rates, credit card rates, etc.

The level of these rates are important. Forexample, mortgage rates today is around

12% compared to 8% a couple of yearsearlier. Financing a house is quiteexpensive at this time.


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Because interest rates are important toindividuals and business, understanding thehistory of interest rates is beneficial.

The next few slides show current interest rates invarious sectors of the bond market: Long-TermGOI Bond rates, Short-Term Treasury Bill rates,and corporate rates.

We will study these further in later sessions,examining the types and characteristics of bonds,as well as theories on how rates are determined.


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Bond Market and Interest Rates


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Why Study Financial Markets?The Stock Market

The stock market is the market where commonstock (or just stock), representing ownership in acompany, are traded.

Companies initially sell stock (in the primarymarket) to raise money. But after that, the stockis traded among investors (secondary market).

Of all the active markets, the stock market

receives the most attention from the media,probably because it is the place where people getrich (and poor) quickly.


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The next few slides show the level of theSenses and Nifty over the few years. Notehow volatile stock prices have been.

In future lectures, we will examine the roleof the stock market, as well as how prices

react to information in the marketplace.


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Stock Market


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Stock Market


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Companies, not just individuals, also watchthe market. Although corporations dont

typically invest in the market, they often

seek additional funding in equity marketsafter going public. The success of thesefuture-public offerings (FPOs) is very

dependent on the current price of thecompanys stock.


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Why Study Financial Markets?The Foreign Exchange Market

The foreign exchange market is whereinternational currencies trade andexchange rates are set.

Although most people know little about thismarket, it has a daily volume around

$1 trillion!


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The next slide shows how the INR has fluctuatedin price against a basket of foreign currencies.

These fluctuations matter!

In recent years, consumers have found thatvacationing in Europe and US are expensive, due to aweakening INR relative to the Euro and Dollar.

When the ruppee strengthens, foreign purchase ofdomestic goods falls, and Indian manufacturersexperience a decreased demand for their goods andvice-versa.


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Foreign Exchange Market


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In future lectures, we will examine howexchange rates are determined in both theshort- and long-run.


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We will also spend considerable time discussingfinancial institutionsthe corporations, organizations,and networks that operate the so-called marketplaces.These institutions play a crucial role in improving theefficiency of the economy. We will look at:

1. Central Banks and the Conduct ofMonetary Policy

The role of the RBI and foreign counterparts

2. Structure of the Financial System

Helps get funds from savers to investors


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3. Banks and Other Financial Institutions

Includes the role of insurance companies, mutualfunds, pension funds, etc.

4. Managing Risk in Financial Institutions

Focusing on risk management in thefinancial institution.


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Chapter Summary

Why Study Financial Markets?: the threeprimary markets (bond, stock, and foreignexchange) were briefly introduced.

Why Study Financial Institutions?: themarket, institutions, and key changes

affecting these were outlined.

Documents

Introduction and Overview of Financial System