Introduction to Financial Markets Overview

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.