Introduction to Financial Markets

• Financial markets and institutions are crucial for understanding the economy, personal wealth, and political events.
• The study of these markets and institutions provides valuable insights into various economic issues.

Why Study Financial Markets?

• Financial markets transfer funds from those with excess to those with a shortage.
• They promote economic efficiency by channeling funds to productive uses.
• Well-functioning markets are a key factor in high economic growth
• Poorly performing markets lead to poverty.
• Markets directly impact personal wealth, business behavior, consumer behavior, and economic cycles.

Debt Markets and Interest Rates

• A security (financial instrument) represents a claim on the issuer's future income or assets.
• Bonds are debt securities with periodic payments over a specified time.
• The bond market enables corporations and governments to borrow which facilitates economic activity.
• Interest rates are the cost of borrowing funds, expressed as a percentage.
• Interest rates can influence personal decisions like buying a house or saving money.
• Interest rates impact the economy overall by affecting spending, saving, and investment decisions.
• Interest rate fluctuations have been substantial over the past 35 years (1981-2022).
• Economists often refer to "the" interest rate because different rates tend to move in unison.

The Stock Market

• Common stock signifies ownership in a corporation and is a claim on its earnings and assets.
• Issuing stock is a method for corporations to raise funds.
• The stock market trades shares of stock and is widely followed in most countries.
• Stock market swings are major news because people can quickly gain or lose wealth.
• Stock prices are volatile, as indicated by the Dow Jones Industrial Average (DJIA) from 1950–2022.
• The market influences business investment decisions because share prices affect the funds raised by selling stock.

The Foreign Exchange Market

• This market converts funds from one currency to another, enabling international transactions.
• The foreign exchange rate is the price of one currency in terms of another.
• Fluctuations in exchange rates affect the cost of imports and exports

Why Study Financial Institutions?

• Financial institutions facilitate the flow of funds in financial markets, improving economic efficiency.

Structure of the Financial System

• The system is complex and includes banks, insurance companies, mutual funds, finance companies, and investment banks.
• These are heavily regulated by the government.
• Financial intermediaries, like banks and credit unions, channel funds between savers and borrowers.

Financial Crises

• Financial crises involve disruptions in financial markets, asset price declines, and firm failures.
• They often lead to business cycle downturns.
• The U.S. experienced a major crisis from 2007 to 2009, triggered by subprime mortgage defaults.

Central Banks and the Conduct of Monetary Policy

• A central bank is responsible for monetary policy, managing interest rates and the money supply.
• The Federal Reserve System (the Fed) is the central bank in the U.S.
• Monetary policy affects interest rates, inflation, and business cycles.

Are Bitcoin or Other Cryptocurrencies Money?

• Cryptocurrencies use cryptography for secure transactions and operate in a decentralized manner.
• Bitcoin is the most prominent cryptocurrency.
• Cryptocurrencies function well as a medium of exchange with low transaction fees and anonymity.
• Cryptocurrencies are poor measures of value due to large fluctuations
• Cryptocurrencies have high volatility which also means that they do not function as a store of value
• Bitcoin and other cryptocurrencies do not satisfy two of the three key functions of money.
• Governments may restrict the use of cryptocurrencies in the future

The International Financial System

• Increased capital flows have a growing impact on domestic economies.
• Exchange rate policies and capital controls affect financial systems and economic performance. International financial institutions play a role.

Banks and Other Financial Institutions

• Banks accept deposits and make loans and include commercial banks, savings and loan associations, mutual savings banks, and credit unions.
• Banks are the most common financial intermediaries.
• Other institutions like insurance companies and mutual funds have been growing.

Financial Innovation

• The development of new financial products and services is important for efficiency.
• Financial innovation can have a dark side.
• Improvements in information technology have led to e-finance.

Managing Risk in Financial Institutions

• Financial institutions face increasing risk, including interest rate fluctuations and market crashes.
• Institutions must manage this risk to avoid profitability swings and failures using risk management techniques.

Applied Managerial Perspective

• Financial institutions are large employers with competitive salaries.
• Knowing how these institutions are managed can help individuals and businesses get better deals.

How We Will Study Financial Markets and Institutions

• A unifying framework is emphasized, focusing on basic concepts like equilibrium, supply and demand, profit-seeking, transaction costs, and asymmetric information.