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Unformatted text preview: Chapter 2: Overview of the Financial System Function of the Financial Markets o Perform the essential economic function of channeling funds through households, firms, and govts that have saved surpless by spending less thant their income to those who have a shortage of funds b/c they wish to spend more than their income o Function in Figure 1 on page 18 o The principal lender-savers are the households Sometimes govts and corporations have excess money to lend though o Most important borrower savers are the govt and the businesses Households and foreigners also borrow to finance purchase of cars, furnitureetc o In Direct Finance borrowers borrow funds directly from lenders in financial markets by selling them as securities , which are claims on the borrowers future income or assets o Securities are assets for the person who buys them but liabilities ( IOUs or debt) for the individual or firm that sells them. o essential to promoting economic efficiency o The existence of financial markets is also beneficial even if someone borrows for a purpose other than increasing production in a business Financial markets have people that can lend you money to buy house, and you pay them off later. That way you can enjoy house now instead of when you have money when you are old o Financial markets allow funds to move from people who lack productive investment opportunities to people who have such opportunities o Critical for producing an efficient allocation of capital, which contributes to higher production and efficiency for the overall economy o Directly improve well-being of consumers by allowing them to time their purchases better. o Provide funds to young people to buy what they need and can eventually afford w/o forcing them to wait until they have saved up the entire purchase price o Imporve economice welfare of everyone in the society Structure of the Financial Markets o Debt and Equity Markets Can obtain funds in FM in two ways Most common in debt instrument o Bond, mortgage (contractual agreement by borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until maturity Maturity of debt is the number of years until the expiration date Can be short term (less than a year) or long term (ten years or longer. In between a year or ten years in a intermediate term) o Other method is issuing equities like common stock, which are claims to share in the net income and assets of a business Equities often make periodic payments to their holders Means you have voting rights Main disadvantage of owining equity is that an equity holder is a residual claimant , the corporation must pay all its debt hodlers before its equity holders Advantage is that equity holders benefit directly from any increases in the corporations profitability of asset value o Primary and Secondary Markets Primary market New issues of security are sold to initial buyers Not well known to public because often takes place behind closed...
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This note was uploaded on 07/14/2008 for the course FNCE 4030 taught by Professor Madigan,ge during the Fall '07 term at Colorado.
- Fall '07
- Financial Markets