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CHAPTER 1

Why Study Financial Markets and Institutions?

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Chapter Preview

The evening news features a segment about interest rates, the Fed Chairman Ben Bernanke, and liquidity in credit markets.

What does all this mean? Do I care about interest rates? What is “the Fed?” Will this impact my firm’s ability to get a bank loan?

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Chapter Preview

These are good questions.

And this course will help you answer these questions by addressing a variety of topics ranging from the functioning of the bond and sock markets to the behavior of the Fed and banks.

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Why Study Financial Markets?

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

1.These markets channel funds from savers to investors, thereby promoting economic efficiency.

2.Market activity affects personal wealth, the behavior of business firms, and economy as a whole

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Why Study Financial Markets?

Well functioning financial markets, such as the bond market, stock market, and foreign exchange market, are key factors in producing high economic growth.

We will briefly examine each of these markets, key statistics, and how we will examine them throughout this course.

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Why Study Financial Markets? Debt Markets & Interest Rates

Debt markets, or bond markets, allow governments, corporations, and individuals to borrow to finance activities.

In this market, borrowers issue a security, called a bond, that promises the timely payment of interest and principal over some specific time horizon.

The interest rate is the cost of borrowing.

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Why Study Financial Markets? Debt Markets & Interest Rates

There are many different types of market interest rates, including mortgage rates, car loan rates, credit card rates, etc.

The level of these rates are important. For example, mortgage rates in the early part of 1983 exceeded 13% vs near 4.5% over the past several years.

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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 common stock (or just stock), representing ownership in a company, are traded.

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

Of all the active markets, the stock market receives the most attention from the media. Why?

Stock Market

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Why Study Financial Markets? The Foreign Exchange Market

The foreign exchange market is where international currencies trade and exchange rates are set.

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

$1 trillion!

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Foreign Exchange Market

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Why Study Financial Institutions?

We will also spend considerable time discussing financial institutions—the corporations, organizations, and networks that operate the so-called “marketplaces.”

1. Structure of the Financial System─ Helps get funds from savers to investors

2. Financial Crises─ The financial crises of 2007–2009 was the worst

financial crisis since the Great Depression. Why did it happen?

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Why Study Financial Institutions?

3. Banks and Other Financial Institutions─ Includes the role of insurance companies, mutual

funds, pension funds, etc.

4. Financial Innovation─ Focusing on the improvements in technology and

its impact on how financial products are delivered

5. Managing Risk in Financial Institutions─ Focusing on risk management in the

financial institution.

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Applied Managerial Perspective

Financial institutions are among the largest employers in the U.S. and often pay high salaries.

Knowing how financial institutions are managed may help you better deal with them.

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How We Study Financial Markets and Institutions

Basic Analytic Framework

1.Simplified approach to demand for assets.

2. Basic supply & demand approach to understanding behavior in financial markets.

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How We Study Financial Markets and Institutions

Basic Analytic Framework

3. Equilibrium forces & profit seeking behavior

4.Transactions cost & asymmetric information approach to financial structure

Learning Objectives

You should be familiar with and able to explain key elements of financial markets and how they function, including

─ the basic theory of asset demand and determination of asset prices,

─ the role of arbitrage and profit motive in financial markets,

─ the role of information in financial markets, ─ and the causes and consequences of

financial crises.

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Learning Objectives

You should be able to use appropriate models to analyze the issues listed above, and to draw appropriate conclusions about the effects of economic developments and policy interventions.

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Exploring the Web

Web ExerciseThe next three slides (starting on page 10 in the text) show you how to (1) find historical interest rates from the Fed and save the information, (2) how to import the data into Excel, and (3) how to examine the information.

Exploring the Web

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Exploring the Web

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Exploring the Web

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