Financial Markets and Institutions

The Capital Allocation Process

 Surplus Units  Deficit Units
1. Direct Transfers
2. Indirect Transfers through Investment Bankers
3. Indirect Transfers through a Financial
Intermediary

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The Capital Allocation Process, contd.

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Types of Markets
 Physical Assets vs. Financial Assets
 Spot vs. Futures
 Money vs. Capital
 Primary vs. Secondary
 Private vs. Public

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Types of Markets contd.
 Physical asset markets: for products such as
wheat, autos, real estate, …
 Financial asset markets: for stocks, bonds,
derivative securities, …

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Types of Markets contd.
 Spot markets: Assets are bought and sold for
“on-the-spot” delivery.
 Futures markets: participants agree today to buy
or sell an asset at future date.

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Types of Markets contd.
 Money markets: Funds are borrowed or loaned
for short periods.
 Capital markets: Stocks and intermediate or
long-term debt are traded.

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Types of Markets contd.
 Primary markets: Corporation raise capital by
issuing new securities.
 Secondary markets: Securities and other
financial assets are traded after they had been
issued by corporations.

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Types of Markets contd.
 Private markets: Transactions are worked out
directly between two parties.
 Public markets: Standardized contracts are
traded on organized exchanges.

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Recent Trends
 Technological advances in computers and
telecommunications
 Globalization of banking and commerce 
 Deregulation and more competition along the
world
 More efficient, internationally linked markets,
more complex.
 Problems for policy makers.
 Increased use of derivatives.
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Financial
Institutions

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Financial Institutions, contd.
 Investment Bank: Underwrites and distributes
new investment securities and helps businesses
obtain financing.
 Commercial Bank: Traditional department store
of finance serving a variety of savers and
borrowers.

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Financial Institutions, contd.
 Financial Services Corporation: Offers a wide
range of financial services, including investment
banking, brokerage operations, insurance, and
commercial banking.
 Mutual Funds: Pool investor funds to purchase
financial instruments and thus reduce risks
through diversification.

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The Stock Market

1. Physical Location Exchanges: NYSE, AMEX

2. OTC and the NASDAQ (National Association of
Securities Dealers Automated Quotations) stock
markets
3. ECNs (Electronic Communications Networks)

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The Stock Market, contd.
 Physical Location Stock Exchanges: Formal
organizations having tangible physical locations
that conduct auction markets in listed securities.
 ECNs: online trading systems that bypass the
traditional exchanges. These systems, which are
known as electronic communications networks
(ECNs), use electronic technology to bring buyers
and sellers together and accelerated the move
toward 24-hour trading.

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The Stock Market, contd.
The dealer market system consists of:
(1) the relatively few dealers who hold inventories
of these securities and who are said to “make a
market” in these securities,
(2) the thousands of brokers who act as agents in
bringing the dealers together with investors,
(3) the computers, terminals, and electronic
networks that provide a communication link
between dealers and brokers

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The Market for Common Stock
 Closely Held Corporation: Owned by a few
individuals who are typically associated with the
firm’s management.
 Publicly Owned Corporation: Owned by a
relatively large number of individuals who are
not actively involved in the firm’s management.

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The Market for Common Stock, contd.

Types of Stock Market Transactions

 Outstanding shares of publicly owned companies
that are traded.
 Additional shares sold by publicly owned
companies: the primary market.
 Initial public offerings: the IPO market. Going
Public.

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Stock Markets and Returns
• Reporting: Real-time quotes throughout the day from a variety
of Internet sources. Yahoo!
• Stock Market Returns:

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Stock Market and Returns

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Stock Market Efficiency
 Market price: The current price of a stock.
 Intrinsic value: The price at which the stock
would sell if all investors had all knowable
information about a stock.
 Equilibrium price: The price that balances buy
and sell orders at any given time.
 Efficient Market: A market in which prices are
close to intrinsic values and stocks seem to be in
equilibrium.
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Stock Market Efficiency, contd.

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Stock Market Efficiency, contd.
 The market for entire companies: buying
company or a controlling stake in it.
 Companies which stocks are trading in an
efficient market while the company as a whole is
not efficiently priced.

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