ch02 - Chapter 2 The Financial Environment and the Level of...

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Chapter 2 The Financial Environment and the Level of Interest Rates Learning Objectives 1. Describe the primary role of the financial system in the economy and the two basic ways in which money flows through the system. 2. Discuss direct financing and the important role that investment banks play in this process. 3. Describe the primary, secondary, and money markets, explaining the special importance of secondary and money markets to business organizations. 4. Explain what an efficient market is and why market efficiency is important to financial managers. 5. Explain how financial institutions serve the needs of consumers, small businesses, and corporations. 6. Compute the nominal and the real rates of interest, differentiating between them. I. Chapter Outline 2.1 The Financial System A. The Financial System at Work It is competitive. Money is aggregated in small amounts and loaned in large amounts. Directs money to the best investment opportunities in the economy. 1
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Banks earn much of their profits from borrowing at a low rate from depositors and lending at a higher rate. B. How Funds Flow through the Financial System The primary concern of the financial system is funneling money from lenders- savers to borrowers-spenders. Direct funds flow, or Indirect funds flow (intermediation) 2.2 Direct Financing Financial markets perform the important function of channeling funds from lenders- savers to borrowers-spenders. A . A Direct Market Transaction Direct Financial Markets— wholesale markets in which the borrower raises capital from the market rather than borrowing from another institution. Investment Banks —firms that specialize in helping companies sell new debt or equity issues in the public or private security markets. Money Center Banks —large commercial banks located in major U.S. financial centers that transact in both the national and international money markets. Origination is the process of preparing a security issue for sale. Underwriting—a basic investment banking service is to assist firms in the sale of debt or equity in the primary market. To underwrite a new security 2
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issue, the investment banker buys the entire issue at a guaranteed price from the issuing firm and resells the securities to institutional investors and the public. Distribution is the process of marketing and reselling the securities to investors. 2.3 Types of Financial Markets A. Primary Market any financial market in which new security issues are sold for the first time. B. Secondary Market —any financial market in which the owners of outstading securities can resell them to other investors. Investors are willing to pay higher prices for securities in primary markets if the securities have active secondary markets. The ease with which a security can be sold and converted into cash is called
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This note was uploaded on 04/01/2012 for the course BUSINESS 100 taught by Professor Bens during the Spring '12 term at FIU.

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ch02 - Chapter 2 The Financial Environment and the Level of...

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