Financial markets and

Institutions
 FINANCIAL MARKETS
 FINANCIAL INSTITUTIONS
 FINANCIAL REGULATIONS
AN OVERVIEW OF FINANCIAL MARKETS
What is Financial Markets?
Structure of Financial markets?
 Instruments traded in Financial markets?
 Functions of Financial markets
What is Financial system?
Financial system (FS) – a framework for describing set
of markets, organisations, and individuals that engage
in the transaction of financial instruments (securities),
as well as regulatory institutions. - the basic role of FS
is essentially channelling of funds within the different
units of the economy – from surplus units to deficit
units for productive purposes.
What is Financial Markets?
Financial markets perform the essential function of
channeling funds from economic players that have saved
surplus funds to those that have a shortage of funds
At any point in time in an economy, there are individuals or
organizations with excess amounts of funds, and others with
a lack of funds they need for example to consume or to invest.
Exchange between these two groups of agents is settled in
financial markets
 The first group is commonly referred to as lenders, the
second group is commonly referred to as the borrowers of
funds.
What is Financial Markets?
There exist two different forms of exchange in financial markets. The
first one is direct finance, in which lenders and borrowers meet
directly to exchange securities.

Securities are claims on the borrower’s future income or assets.

Common examples are stock, bonds or foreign exchange

 The second type of financial trade occurs with the help of financial
intermediaries and is known as indirect finance. In this scenario
borrowers and lenders never meet directly, but lenders provide funds
to a financial intermediary such as a bank and those intermediaries
independently pass these funds on to borrowers.
Structure of Financial Markets
Financial markets can be categorized as follows:
Debt vs Equity markets
 Primary vs Secondary markets
Exchange vs Over the Counter (OTC)
 Money vs Capital Markets
 Debt vs Equity
Financial markets are split into debt and equity markets.

Debt titles are the most commonly traded security. In these arrangements,
the issuer of the title (borrower) earns some initial amount of money
(such as the price of a bond) and the holder (lender) subsequently
receives a fixed amount of payments over a specified period of time,
known as the maturity of a debt title.

 Debt titles can be issued on short term (maturity < 1 yr.), long term
(maturity >10 yrs.) and intermediate terms (1 yr. < maturity < 10 yrs.).

 The holder of a debt title does not achieve ownership of the borrower’s
enterprise.
 Common debt titles are bonds or mortgages.
 Debt vs Equity
Equity titles are somewhat different from bonds. The most common
equity title is (common) stock.

First and foremost, an equity instruments makes its buyer (lender) an

owner of the borrower’s enterprise.

 Formally this entitles the holder of an equity instrument to earn a share

of the borrower’s enterprise’s income, but only some firms actually pay
(more or less) periodic payments to their equity holders known as
dividends. Often these titles, thus, are held primarily to be sold and
resold.

 Equity titles do not expire and their maturity is, thus, infinite. Hence
they are considered long term securities
PRIMARY MARKETS Vs SECONDERY
MARKETS
Markets are divided into primary and secondary markets
Primary markets are markets in which financial
instruments are newly issued by borrowers.
Secondary markets are markets in which financial
instruments already in existence are traded among
lenders.
Secondary markets can be organized as exchanges, in
which titles are traded in a central location, such as a
stock exchange, or alternatively as over-the-counter
markets in which titles are sold in several locations.
MONEY MARKETS VS CAPITAL MARKETS
Money markets are markets in which only short term
debt titles are traded.
Capital markets are markets in which longer term
debt and equity instruments are traded.
Exchange and OTC Market
Exchange refers to the formally established stock
exchange wherein securities are traded and they have a
defined set of rules for the participants.
When the trading is performed through the exchange, it is
under the supervision of the exchange and so it ensures
that all the rules and regulations are duly complied with

Over the Counter, shortly known as OTC is a dealer

oriented market of securities, which is a decentralized and
unorganized market where trading happens by way of
phone, emails, etc.
INSTRUMENTS TRADED IN THE
FINANCIAL MARKETS
Most commonly you will encounter:
Corporate stocks are privately issued equity instruments,
which have a maturity of infinity by definition and, thus,
are classified as capital market instruments
Corporate bonds are private debt instruments which
have a certain specified maturity. They tend to be long-run
instruments and are, hence, capital market instruments
The short-run equivalent to corporate bonds are
commercial papers which are issued to satisfy short-run
cash needs of private enterprises.
INSTRUMENTS TRADED IN THE
FINANCIAL MARKETS
Most commonly you will encounter:
On the government side, the most commonly used
long-run debt instruments are Treasury Bonds or T-
Bonds. Their maturity exceeds ten years.

Short-run liquidity needs are satisfied by the issuance

of Treasury Bills or T-Bills, which are short-run debt
titles with a maturity of less than one year.
Functions of Financial markets
Borrowing and Lending
Financial markets channel funds from households,
firms, governments and foreigners that have saved
surplus funds to those who encounter a shortage of
funds (for purposes of consumption and investment)
Price Determination
 Financial markets determine the prices of financial
assets. The secondary market here plays an important
role in determining the prices for newly issued assets
Functions of Financial markets
Coordination and Provision of Information
The exchange of funds is characterized by a high
amount of incomplete and asymmetric information.
Financial markets collect and provide much
information to facilitate this exchange.
Risk Sharing
 Trade in financial markets is partly motivated by the
transfer of risk from borrowers to lenders who use the
obtained funds to invest
Functions of Financial markets
Liquidity
 The existence of financial markets enables the owners
of assets to buy and resell these assets. Generally this
leads to an increase in the liquidity of these financial
instruments.
 Efficiency
The facilitation of financial transactions through
financial markets lead to a decrease in informational
cost and transaction costs, which from an economic
point of view leads to an increase in efficiency.
What are Financial Institutions ?
A financial institution (FI) is a company engaged in
the business of dealing with financial and monetary
transactions such as deposits, loans, investments, and
currency exchange.
Financial institutions encompass a broad range of
business operations within the financial services sector
including banks, trust companies, insurance
companies, brokerage firms, and investment dealers.
Financial institutions can vary by size, scope, and
geography.
The term financial institution is a broad phrase
referring to organizations which act as agents, brokers,
and intermediaries in financial transactions. Agents
and brokers contract on behalf of others;
intermediaries sell for their own account. Financial
intermediaries purchase securities for their own
account and sell their own liabilities and common
stock
Brokers are agents who match buyers with sellers for
a desired transaction.
A broker does not take position in the assets she/he
trades (i.e. does not maintain inventories of those
assets)
 Brokers charge commissions on buyers and/or sellers
using their services
 Examples: Real estate brokers, stock brokers
Like brokers, dealers match sellers and buyers of
financial assets.
Dealers, however, take position in their assets, their
trading.
 As opposed to charging commission, dealers obtain
their profits from buying assets at low prices and selling
them at high prices.
 A dealer’s profit margin, the so-called bid-ask spread is
the difference between the price at which a dealer offers
to sell an asset (the asked price) and the price at which a
dealer offers to buy an asset (the bid price)
 Examples: Dealers in U.S. government bonds, Nasdaq
stock dealers
Types of Financial Institutions

Central Banks
Central banks are the financial institutions responsible
for the oversight and management of all other banks. In
the United States, the central bank is the
Federal Reserve Bank (Fed), which is responsible for
conducting monetary policy and supervision and
regulation of financial institutions.4
Individual consumers do not have direct contact with a
central bank; instead, large financial institutions work
directly with the Fed to provide products and services to
the general public.
Types of Financial Institutions

Commercial Banks
A commercial bank is a type of financial institution
that accepts deposits, offers checking account services,
makes business, personal, and mortgage loans, and
offers basic financial products like certificates of
deposit (CDs) and savings accounts to individuals and
small businesses. A commercial bank is where most
people do their banking, as opposed to an investment
bank. 
 Types of Financial Institutions
Investment Banks
Investment Banks
Investment banks are financial institutions that provide services and
act as an intermediary in complex transactions—for instance, when
a startup is preparing for an initial public offering (IPO), or in
mergers. They can also act as a broker or financial advisor for large
institutional clients such as pension funds.

Investment banks do not take deposits; instead, they help

individuals, businesses, and governments raise capital through the
issuance of securities. Investment companies, traditionally known as
mutual fund companies, pool funds from individuals and
institutional investors to provide them access to the broader
securities market.
Types of Financial Institutions
Insurance Companies
Among the most familiar 
non-bank financial institutions are insurance
companies. Providing insurance, whether for
individuals or corporations, is one of the oldest
financial services. Protection of assets and protection
against financial risk, secured through insurance
products, is an essential service that facilitates
individual and corporate investments that fuel
economic growth.
Types of Financial Institutions
Brokerage Firms
Brokerage firms assist individuals and institutions in
buying and selling securities among available
investors. Customers of brokerage firms can place
trades of stocks, bonds, mutual funds,
exchange-traded funds (ETFs), and some alternative
investments.
FINANCIAL REGULATION
Why regulate financial markets?
Financial markets are among the most regulated
markets in modern economies.
The first reason for this extensive regulation is to
increase the information available to investors (and,
thus, to protect them).
 The second reason is to ensure the soundness of the
financial system.
. Increasing information available to
investors
asymmetric information can cause severe problems in
financial markets (Risk behavior, insider trades,....)
Certain regulations are supposed to prohibit agents with
superior information from exploiting less informed
agents.
In the U.S. the stock-market crash of 1929 led to the
establishment of the Securities and Exchange
Commission (SEC), which requires companies involved in
the issuance of securities to disclose certain information
relevant to their stockholders. The SEC further prohibits
insider trades
 Ensuring the soundness of financial
intermediaries
Even more devastating consequences from asymmetric
information manifest themselves in collapses of the entire
financial system – so called financial panics.
 Financial panics occur if providers of funds on a large scale
withdraw their funds in a brief period of time from the
financial system leading to a collapse of the system. These
panics can produce enormous damage to an economy.
 Examples of some recent panics are the crises in the Asian
Tiger states, Argentina or Russia. The United States, while
spared for most of the second half of 20th century, has a long
tradition of financial crises throughout the 19th century up to
the Great Depression.
What is financial regulation?

Financial regulation refers to the rules and laws firms

operating in the financial industry, such as banks,
credit unions, insurance companies, financial brokers
and asset managers must follow.
 However financial regulation is more than just having
rules in place - it's also about the ongoing oversight
and enforcement of these rules.
Why is financial regulation important?
All of us depend on the financial system in one way or
another.
For example, savers rely on banks to have their money
available when they need it.
 Businesses need to be able to borrow to maintain and
develop their business.
Consumers taking out a mortgage or insurance may need
to get advice on the best product for them.
In the case of insurance companies, policyholders rely on
getting claims paid when something goes wrong.
How does financial regulation work?

Ensuring firms have the funding to trade safely, have the

appropriate risk controls in place and are appropriately
governed is known as "prudential regulation".
Ensuring firms treat customers fairly from the sales
process to how complaints are managed, is known as
"consumer protection".
An important part of prudential regulation is
authorisation. We call this our "gatekeeper role" and
means we only allow firms to operate in the financial
system once they have fulfilled a number of criteria,
including governance and risk control.
Consumer protection rules are also in place. These
spell out how firms must treat their customers when
selling them financial products. So for example, a
regulated firm must ensure that it "acts honestly, fairly
and professionally in the best interests of its customers
and the integrity of the market".