Introduction to Financial Markets Overview

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Questions and Answers

What has been a significant trend in the shares of total assets of financial institutions in the United States from 1948 to 2019?

A decline in the share of depository institutions (correct)

The dominance of credit unions over commercial banks

An increase in the share of investment banks

A significant increase in the share of insurance companies

Which of the following statements best describes the impact of regulation on financial institutions?

Regulation entirely removes the regulatory burden on private FI owners.

Regulation has no effect on social welfare benefits.

Regulation enhances social welfare while imposing private costs. (correct)

Regulation only imposes costs without any benefit.

What effect did World War II have on the distribution of total assets among financial institutions?

It had no significant impact on financial institutions.

It caused a shift towards more government-owned financial institutions.

It marked the beginning of a decline in the share of depository institutions. (correct)

It led to an increase in the share of depository institutions.

What can be inferred about the role of financial institutions based on their changing shares of total assets?

Alternative financial institutions are gaining a larger share of the market. Signup and view all the answers

What primarily characterizes the regulatory environment for financial institutions?

An increasing burden of compliance costs on financial institutions. Signup and view all the answers

Which type of risk arises when a financial institution holds assets subject to default?

Credit risk Signup and view all the answers

What risk is associated with mismatched maturities of balance sheet assets and liabilities?

Interest rate risk Signup and view all the answers

Which of the following describes the risk a financial institution faces from foreign exchange fluctuations?

Foreign exchange risk Signup and view all the answers

What type of risk is represented by off-balance-sheet assets and liabilities a financial institution holds?

Off-balance-sheet risk Signup and view all the answers

Which risk involves the financial institution's inability to meet withdrawal demands from liability holders?

Liquidity risk Signup and view all the answers

What does technology risk in financial institutions primarily refer to?

Risk associated with dependencies on technological systems Signup and view all the answers

What is the consequence of an insufficient capital reserve in a financial institution?

Insolvency risk Signup and view all the answers

Which financial service was established to support American agriculture with credit access?

Farm Credit System Signup and view all the answers

What is the primary consequence of a breakdown in the provision of financial services?

Costly impacts on suppliers and users of funds Signup and view all the answers

How can individual financial institution (FI) failures impact the overall financial system?

They can lead to doubts about the stability of the financial system. Signup and view all the answers

What was one measure taken by the FDIC during the financial crisis of 2008?

Increasing the deposit insurance cap to $250,000 Signup and view all the answers

What can be a result of panics caused by individual financial institution failures?

Withdrawal runs on sound financial institutions Signup and view all the answers

Why are financial institutions regulated?

To prevent market failures and protect the economy Signup and view all the answers

What risk is primarily associated with insurance company failures?

Exposure to catastrophic medical costs in old age Signup and view all the answers

What effect did the financial crisis have on the overall economy?

It resulted in a deep recession globally. Signup and view all the answers

What can be considered a measure of the effectiveness of financial regulations?

The prevention of financial crises Signup and view all the answers

Study Notes

Introduction and Overview of Financial Markets

Financial markets boomed in the 1990s, with the Dow Jones Industrial Average rising from 2,800 to over 11,000.
The early 2000s saw an economic downturn. The DJIA fell below 10,000 in early 2000s, then rose to over 14,000 in 2007.
A subprime mortgage crisis escalated to a full-blown financial crisis and recession in 2008. The DJIA fell to 6,547.
Recovery came to over 11,000 by 2010.
The DJIA surpassed its pre-crisis high of 14,164 in early 2013.
The DJIA reached over 27,000 by 2019.
Coronavirus pandemic caused a sharp fall to below 20,000 in early 2020.

Learning Goals

Differentiate between primary and secondary markets.
Differentiate between money and capital markets.
Understand foreign exchange markets.
Understand derivative security markets.
Distinguish between different types of financial institutions.
Know the services financial institutions perform.
Know the risks financial institutions face.
Appreciate why financial institutions are regulated.
Recognize that financial markets are becoming increasingly global.

Chapter Overview

Financial markets transfer funds from suppliers to users.
Primary markets sell newly issued securities.
Secondary markets trade previously issued securities.
Money markets trade short-term securities.
Capital markets trade long-term securities.
Foreign exchange markets trade currencies.
Derivative markets trade financial instruments based on other assets.
Financial institutions facilitate transactions.

Primary Markets vs. Secondary Markets

Primary markets create new financial instruments.
Secondary markets trade the previously issued instruments.
Examples of primary market instruments include IPOs (initial public offerings) of corporate bonds and equity.
Data from 2000 to 2019 shows fluctuations in primary market sales, with a significant drop during the 2008 crisis.

Money Markets vs. Capital Markets

Money markets trade securities with maturities less than one year.
Capital markets trade securities with maturities over one year.
OTC (over-the-counter) markets facilitate transactions not requiring a specific location, like phone calls or computer transactions.
Examples of money market instruments include Treasury bills, federal funds, repurchase agreements, commercial paper, and negotiable certificates of deposit.

Capital Markets

Trade securities such as stocks and bonds with maturities exceeding one year.
Offer price fluctuations greater than money markets.
Key capital market securities include corporate stock, mortgages, treasury securities, and corporate bonds.
Data demonstrates a huge increase in the value of capital market instruments outstanding between 1990 to 2019.

Foreign Exchange Markets

Foreign exchange markets facilitate currency trading, enabling companies operating globally to manage exchange risks.
Depreciation or appreciation of a foreign currency affects the dollar value of foreign investments.
Government intervention can impact foreign currency exchange rates.
Foreign exchange risk is the exposure to changes in exchange rates.

Derivative Security Markets

Derivative security markets trade financial instruments whose value is based on other assets.
. Derivatives include futures, options, and swaps.
These markets experienced significant growth, but also played a role in the 2008 financial crisis.
Their value is dependent on the value of the underlying assets.

Financial Institutions

Facilitate the flow of funds between users and suppliers.
Include banks, insurance companies, mutual funds.
They offer services like monitoring, liquidity and price risk reduction, and denomination creation.

Financial Market Regulation

Regulations ensure fair and transparent trading practices.
Regulations often aim to prevent market failures.
The Financial Stability Board (FSB) defines fintech as technology-enabled innovation in financial services.

Globalization of Financial Markets

Financial markets have become internationally interconnected.
The U.S. financial market has grown, alongside global emerging markets.
International debt and equity trading has increased significantly through technology advancements.

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Description

Explore the fundamentals of financial markets, including key historical trends and the structure of primary and secondary markets. This quiz will help you understand the various types of financial institutions, their services, and the risks they face. Prepare to delve into money and capital markets, as well as foreign exchange and derivative securities.