FIN-322: Why Study Financial Markets?

• The course is Financial Markets and Institutions, course ID FIN-322, Level 3, with a major in Finance and Investment for the Spring 2025 semester.
• Ihab Raouf Petro, the Head of Finance Department (Acting), is the instructor.
• Mahitab Hisham Hosny, an MSc Researcher, serves as the course assistant.

Why Study Financial Markets

• Financial markets transfer funds from those with excess funds to those with a shortage, promoting economic efficiency.
• Well-functioning financial markets are key to high economic growth.
• Financial markets influence personal wealth, business behavior, and economic cycles.

Debt Markets and Interest Rates

• A security or financial instrument is a claim on the issuer's future income or assets.
• A bond is a debt security with periodic payments for a specified time.
• Debt markets, or bond markets, enable borrowing for corporations and governments, where interest rates are determined.
• Interest rate is the cost of borrowing funds, usually as a percentage per year.
• Interest rates affect personal decisions, consumer spending, business investments, and the overall economy.

The Stock Market

• Common stock represents ownership in a corporation.
• Corporations issue stock to raise funds.
• The stock market is widely followed and influences business investment decisions.
• Stock prices affect the funds raised for production.

The Foreign Exchange Market

• The foreign exchange market converts currencies between countries, enabling international fund transfers.
• It determines the foreign exchange rate, which is the price of one currency in terms of another.

Why Study Financial Institutions

• Financial institutions facilitate financial markets.
• They move funds from savers to borrowers for productive investment.
• They improve economic efficiency.
• The financial system includes banks, insurance companies, mutual funds, and investment banks, regulated by the government.
• Financial intermediaries, like commercial banks and credit unions, channel funds indirectly.

Financial Crises

• Financial crises involve sharp asset price declines and firm failures.
• They are associated with business cycle downturns.
• The financial crisis of 2007-2009 was triggered by defaults in subprime mortgages, leading to institution losses and failures.

Central Banks and Monetary Policy

• The central bank is the key financial institution that conducts monetary policy.
• In the U.S., it's the Federal Reserve System (the Fed).
• Monetary policy manages interest rates and the money supply.

The International Financial System

• Increased capital flow impacts domestic economies.
• A country's exchange rate policy and capital controls affect monetary policy and economic performance.

Banks and other Financial Institutions

• Banks accept deposits and make loans, including commercial banks, savings and loan associations, and credit unions.
• They are the most frequent financial intermediaries for individuals.
• Most Americans hold financial wealth in banks through checking accounts or savings accounts.

Overview of the Financial System

• A financial system allows the exchange of funds between lenders, investors, and borrowers.
• An efficient financial system contains financial markets, financial institutions, and financial instruments.

Function of Financial Markets

• Financial markets channel funds from households, firms, and governments with saved surplus funds to those with fund shortages.
• Those who have saved and lend funds are lender-savers.
• Those who borrow funds to finance their spending are borrower-spenders.
• Principal lender-savers are households, business enterprises, and the government.
• The most important borrower-spenders are businesses and the government.
• Funds flow from lender-savers to borrower-spenders via two routes: direct finance and indirect finance.
• In direct finance, borrowers borrow funds directly from lenders in financial markets by selling them securities or financial instruments, which are claims on the borrower's future income or assets.
• These securities are liabilities for the individual or firm that sells (issues) them, like IOUs or debts.
• Financial markets are essential to promoting economic efficiency.
• Financial markets improve the consumers' well-being by allowing them to spend time on their purchases better.

Structure of Financial Markets

• The financial system is an economic arrangement that allows funds and the exchange of financial instruments between borrowers, lenders, and investors.
• Funds transfer from the units of the surplus of funds to the units of shortage of funds via two routes.
• One route is to channel the funds directly from the surplus side to the shortage side by trading financial instruments in different financial markets.
• This direct way of finance is known as market-based finance.
• The second route is known as indirect finance and it involves a financial intermediation process through one of the financial institutions or financial intermediaries.

Debt and Equity Markets

• Firms get funds by issuing debt instruments like bonds or mortgages, which is a contractual agreement to pay the holder fixed dollar amounts at regular intervals (interest and principal payments) until the maturity date.
• The maturity of a debt instrument is the number of years until expiration.
• A debt instrument is short-term if its maturity is less than a year and long term if its maturity is 10 years or longer.
• A debt issuing maturity of between one and ten years is said to be intermediate term
• Firms raise funds by issuing equities, such as common stock and the assets of a business.
• Equities typically make periodic payments (dividends) and are long-term, with no maturity date.
• Owning stock means owning a portion of the firm with the right to vote on issues and elect directors.
• Equity holders are residual claimants, that only get paid after debt holders.
• Equity holders directly benefit from increases in profitability because equities confer ownership.

Primary and Secondary Markets

• A primary market is a financial market where new securities like bonds or stocks are sold to initial buyers.
• A secondary market is a financial market where previously issued securities are resold.
• Selling securities to initial buyers often takes place behind closed doors.
• An investment bank assists in the initial sale of securities by underwriting them by guaranteeing a price and then selling them to the public.
• The New York Stock Exchange and NASDAQ are secondary markets.
• Secondary markets serve two functions.
• They make it easier to sell financial instruments to raise cash, making them more liquid.
• They determine the price of the security that the issuing firm sells by setting the price in the secondary market.

Exchanges and Over-the-Counter Markets

• Secondary markets can be organized on exchanges, where buyers and sellers meet in a central location to trade.
• the New York and American Stock Exchanges for stocks and the Chicago Board are all organized exchanges.
• another method for organizing a secondary market is to have an over the counter (OTC) market.
• The US government bond market, is set up as an over-the-counter market.

Money and Capital Markets

• The money market trades short-term debt instruments, with original maturity of less than one year.
• The capital market trades longer-term debt, with original maturity of one year or greater, and equity instruments.
• Money market securities are more widely traded and liquid than long-term ones.
• Before the 1980s, U.S. financial markets were larger than those outside the U.S., but this has changed.
• Foreign financial markets have grown due to increased savings and deregulation.
• International markets include international bond markets, Eurobonds, and Eurocurrencies.

Financial Intermediaries: Indirect Finance

• Indirect finance, or financial intermediation, moves funds from lenders to borrowers.
• Financial intermediaries are primarily what corporations use for financing.

Types of Financial Intermediaries

• Financial intermediaries fall into three categories: depository institutions, contractual savings institutions, and investment intermediaries.

Depository institutions

• Depository institutions accept deposits to make loans.
• These institutions include commercial banks, savings and loan associations, mutual savings banks, and credit unions.
• Commercial banks raise funds via checkable deposits, savings deposits, and time deposits.
• They then make commercial, consumer, and mortgage loans and buy U.S. government securities and municipal bonds.
• Savings and Loan Associations obtain funds through savings deposits and time and checkable deposits.
• Credit unions are small cooperative lending institutions that acquire funds from deposits called shares and make consumer loans.

Contractual Savings Institutions

• Contractual savings institutions, like insurance companies and pension funds, acquire funds at steady intervals.
• They do not have to worry as much about losing funds quickly, and so the liquidity of assets is not a large consideration for them.
• These institutions invest primarily in long-term securities like corporate bonds, stocks, and mortgages.
• Life insurance companies insure people against the financial hazards of death and sell annuities.
• Their funding comes from insurance premiums.
• Life insurance companies then buy corporate bonds and mortgages, and stocks.
• Fire and Casualty Insurance Companies insure loss from theft, fire, and accidents.
• Fire and Casualty Insurance Companies have more liquid assets than fire insurance as they hold less stocks.
• Fire and Casualty Insurance Companies have the largest asset holding as municipal bonds.
• Pension Funds and Government Retirement Funds provide retirement income.
• Pensions funds has establishment actively encouraged by the federal government
• Pension Funds and Government Retirement Funds assets are corporate bonds and stocks.

Investment Intermediaries

• Investment Intermediaries includes finance companies, mutual funds, and money market mutual funds.
• Finance companies raise funds by selling commercial paper and issuing stocks and bonds.
• Companies then loan these to consumers and small businesses.
• Mutual Funds acquire funds by selling shares to individuals.
• They then use the money to purchase diversified portfolios.
• Mutual funds allow shareholders to take advantage of lower transaction costs when buying large blocks of securities.
• Investments in mutual funds can be risky.
• Money market mutual funds sell shares to acquire funds and buy safe, liquid money market instruments.
• Interests in these assets are paid to the shareholders.
• An investment bank does not take in deposits and lend them out.
• Instead, an investment bank helps a corporation issue securities by advising the corporation on which type of securities to issue by purchasing them from the corporation and reselling them in the market.
• Investment banks also participate with helping corporations acquire other companies with mergers or acquisitions.

Ensuring the Soundness of Financial Intermediaries

• Asymmetric information can lead to a financial panic, a collapse of financial intermediaries.
• Providers of funds to financial intermediaries pull out their funds if they have doubts about the overall health of financial intermediaries.
• To protect against financial panic, the government used restrictions and regulations.
• The government implemented six types of regulations, being; restrictions on entry, disclosure restrictions, restrictions on assets and activities, deposit insurance, limits on competitions, and Restrictions on Interest Rates.