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LODescribe the role of the financial system in the economy and the two basic ways in which money fl ows through the system.
Discuss direct financing and the important role that investment banks play in this process.
Describe the primary, secondary, and money markets, explaining the special importance of secondary and money markets to business organizations.
Explain what an efficient market is and why market effi ciency is important to financial managers.
Explain how financial institutions serve the needs of consumers, small businesses, and corporations.
Compute the nominal and the real rates of interest, differentiating between them.
2.1 THE FINANCIAL SYSTEM
financial assets
assets that are claims on the cash flows from other assets; business loans, stocks, and bonds are financial assets
real assets
nonfinancial assets such as plant and equipment; productive assets are real assets; many financial assets are claims on cash flows from real assets
The Financial System at Work
How Funds Flow through the Financial System
DIRECT- FINANCIAL MARKETS INDIRECT - FINANCIAL INSTITUTIONS
2.2 DIRECT FINANCING
A Direct Market Transaction
Investment Banks and Direct Financing
investment banks
firms that underwrite new security issues
money center banks
large commercial banks that provide both traditional and investment banking services throughout the world
Origination
Underwriting
Distribution
2.3 TYPES OF FINANCIAL MARKETS
Primary and Secondary Markets
primary market
a financial market in which new security issues are sold by companies directly to investors
secondary market
a financial market in which the owners of outstanding securities can sell them to other investors
Marketability versus Liquidity
marketability
the ease with which a security can be sold and converted into cash
liquidity
the ability to convert an asset into cash quickly without loss of value
Brokers versus Dealers
brokers
market specialists who bring buyers and sellers together, usually for a commission
dealers
market specialists who “make markets” for securities by buying and selling from their own inventories
Exchanges and Over-the-Counter Markets
Money and Capital Markets
money markets
markets where short-term financial instruments are traded
Public and Private Markets
public markets
financial markets where securities registered with the SEC are sold
private placement
the sale of an unregistered security directly to an investor, such as an insurance company or a wealthy individual
Futures and Options Markets - derivative securities
Futures markets- two famous- the New York Board of Trade and the Chicago Board of Trade
options- The Chicago Board Options
2.4 MARKET EFFICIENCY
true (intrinsic) value
for a security, the value of the cash flows an investor who owns that security can expect to receive in the future
efficient market
market where prices reflect the knowledge and expectations of all investors
market operational efficiency
the degree to which the transaction costs of bringing buyers and sellers together are minimized
market informational efficiency
the degree to which current market prices reflect relevant information and, therefore, the true value of the security
Efficient Market Hypotheses
efficient market hypothesis
a theory concerning the extent to which information is refl ected in security prices and how information is incorporated into
security prices
strong-form of theefficient market hypothesis
the theory that security prices reflect all information
private information
information that is not available to all investors
semistrong-form of the efficient market hypothesis
the theory that security prices reflect all public information but not all private information
public information
information that is available to all investors
weak-form of the efficient market hypothesis
the theory that security prices reflect all information in past prices but do not reflect all private or all public information
2.5 FINANCIAL INSTITUTIONS AND INDIRECT FINANCING
financial intermediation
conversion of securities with one set of characteristics into securities with another set of characteristics
Indirect Market Transactions
Financial Institutions and Their Services
Commercial Banks
Life and Casualty Insurance Companies
Pension Funds
Investment Funds
Business Finance Companies
Corporations and the Financial System
initial public offering (IPO) the first offering of a corporation’s stock to the public
2.6 THE DETERMINANTS OF INTEREST RATE LEVELS
The Real Rate of Interest
real rate of interest
the interest rate that would exist in the absence of inflation
nominal rate of interest
the rate of interest that is unadjusted for inflation
Determinants of the Real Rate of Interest
Returns on Investments
Time Preference for Consumption
Equilibrium Condition
Fluctuations in the Real Rate
Loan Contracts and Inflation
The Fisher Equation and Inflation
Cyclical and Long-Term Trends in Interest Rates
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