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Unformatted text preview: Topic 1: Overview of the Financial System Mishkin et al, Chapter 1: Overview of the Financial System Function of Financial Markets • channel funds from people with a surplus to those who have a shortage • lender-savers : households , businesses, government (prov., local), foreigners • borrowers-spenders : businesses , government (fed.) , households, foreigners • direct fnance : B borrow directly from L in ¡nancial markets by selling them securities • securities : claims on borrower’s future income (asset to lender, liability to borrower) 1. people who save money (households) don’t always have pro¡table investment opportunities (available to entrepreneurs) so they transfer through ¡nancial markets • promote higher production and ef¡ciency in the economy 2. people (newlyweds) may not have enough resources currently to buy what they want (house), but have the ability to pay for it in the future so they borrow money through ¡nancial institutions and pay it back later with interest (buy without having full sum ready) • functional and ef¡cient ¡nancial markets improve the economic welfare of the society Structure of Financial Markets • debt and equity markets : get money by accumulating debt or increasing equity 1. issue debt instruments (bonds, mortgages, trade payables...) • borrower pays instrument holder ¡xed amount at regular intervals until maturity date • short term (<1 yr.), intermediate term (1-10 yrs.), long term (>10 yrs.) 2. issue equities (common stock, preferred stock) • stockholders have claims to net income and assets of a ¡rm (their % of total shares) • usually get periodic payments ( dividends ), stockholders typically have voting rights • considered long-term securities since there’s no maturity date • residual claim on assets only, but value of stock goes up if business does well • primary and secondary markets : • primary market : new issues of security sold to initial buyers by gov./bus. borrowing it • investment banks underwrite securities (guarantee a price for it, then sell to public) • secondary market : previously issued securities (secondhand) can be resold • brokers (work for investors) match buyers/sellers; dealers buy/sell at stated price • TSX, bond markets, foreign exchange markets, futures markets, options markets... 1. easier to sell instruments for cash; high liquidity, high demand in primary market 2. determine price of security that issuing ¡rm sells in the primary market • exchanges and over-the-counter markets : • exchanges : buyers/sellers of securities (or agents/brokers) meet in central location • OTC market : dealers everywhere have a bunch of securities; ready to buy/sell to anyone who comes and is willing to accept their price • dealers communicate via computer, know prices; stiff competition (like exchange) • CS traded OTC, though big companies have their stocks on TSX • Canadian gov. bond market set up as OTC market • money and capital markets...
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- Winter '11
- Financial Markets, Stock exchange