Financial Markets and

Institutions

Course Teacher
S.M. Zahidur Rahman
Professor
Business Administration Discipline
Khulna University
 Reference Book

Money and Capital Markets

Peter S. Rose
Irwin McGraw Hill Publishers
 Chapter 1

The Role of the Financial

System in the Global
Economy
What is Financial System?
 Financialsystem is the collection of
markets, institutions, laws,
regulations, and techniques through
which bonds, stocks and other
securities are traded, interest rate is
determined, and financial services
are produced and delivered around
the world.
 Importance of Financial
System
 Financial system is one of the most
important inventions of modern society.
Its primary task is to move scarce loan-
able funds from those who save to
those who borrow to buy goods and
services and to make investments in
new equipment and facilities so that the
global economy can grow and increase
the standard of living enjoyed by its
citizens.
 The financial system determines
both the cost of credit and how
much credit will be available to
pay for different goods and
services we purchase daily.
 What happens in this system has a
powerful impact on the health of global
economy.
 When credit becomes more costly and
less available, total spending for goods
and services falls.
 As such, unemployment rises and
economy’s growth slows down as
business cut back their production &
layoff workers.
 In contrast, when the cost of credit
declines and loan able funds
become more readily available,
total spending in economy
increases, more jobs are created,
and economic growth accelerates.
 We can conclude that, financial
system is an integral part of
economic system.
The Flows within Economic
System
 The basic function of any economy is to
allocate scarce resources- land, labor,
management skill and capital – to
produce the goods and services needed
by the society
 The high standard of living depends on
the ability of the global economy to turn
out each day an enormous volume of
food, shelter and other essentials of
modern living.
The Flows within Economic
System
 This is a very complex task indeed.
 The economy generates a flow of
production in return for a flow of
payments.
 Flows of payments and production
within the economic system works as a
circular flow between producing units
(mainly businesses and Govt.) and
consuming units (mainly households).
Flows within Economic System
 In modern economies, household
provides labor, management, and
natural resources to business firms and
governments in return for income in the
form of wages and other payments.
 Income received by the households is
spent to purchase goods and services
from businesses and governments.
Flows within Economic System
 The result of this spending is a flow of
funds back to producing units as
income.
 Income stimulates them to produce
more goods and services in the future.
 The circular flow of production and
income is interdependent and never
ending.
Flows within the Global Economic
System

Land and
other natural Flow of production
resources
Labor and Goods and
managerial services sold
skills to the public
Capital
equipment Flow of payments
Flows within the Global Economic
System

Producing units
(mainly business firms Consuming units
and governments) (mainly households)
The Role of Market in the
Economic System
 What is Market?
–It is an institution set up by the
society to allocate resources that
are scarce relative to the demand
for them. Markets are the
channels through which buyers
and sellers meet to exchange
goods, services and resources.
–It answers the economic
problems.
 Types of Markets

Factor Market
Product Market
Financial Market
 Factor Market
– FM are the markets where the
consuming unit sells their labor and
other resources to those producing
units offering the highest prices. The
factor markets allocate factors of
production- land, labor and capital-
and distribute income-wages, rental
payments and so on to the owners of
productive resources.
 Product Market
 In product market different
products for consumption are sold.
Consuming units use most of their
income from factor markets to
purchase goods and services in
product markets.
 Financial Market
 In Financial market transaction of
different types of financial instruments
are made.
 It performs a vital function within the
economic system. The financial markets
channel savings to those individuals and
institutions needing more funds for
spending than are provided by their
current incomes.
 Financial Markets

–The financial markets are the

hearts of financial system
attracting and allocating
savings and setting interest
rates and security prices.
Functions of Financial System
Savings Function
 Wealth Function
 Liquidity Function
 Credit Function
 Payment Function
 Risk Function
 Policy Function
 Savings Function
 Bonds, stocks, and other financial
claims sold in the money and capital
market provides a potentially
profitable, low risk outlet for public
savings. This savings flow through
the financial markets into investments
so that more goods and services can
be produced to increase society’s
standard of living.
 Wealth Function
 The financial instruments sold in the
money and capital markets provide an
excellent way to store wealth until
funds are needed for spending.
 Unlike normal wealth like car, (which is
subject to depreciation) bonds, stocks
and other financial instruments do not
wear out overtime and usually generate
income.
 Liquidity function:

 Financial system provides a means of

raising funds by converting securities
and other financial assets into cash
balances. Thus the financial markets
provide liquidity for savers who hold
financial instruments but are in need of
money.
 Credit Function

 The financial markets provide credit

to finance consumption and
investment spending in the
economy.
 Credit consists of a loan of funds
in return for a promise of future
payment.
 This can be consumer credit or
business credit
 Payment Function

 The financial system provides a

mechanism for making
payments to purchase goods
and services.
 Debit card, credit card, ATM
card etc. are unique
mechanism for payment.
 Risk function

 The financial markets offer

businesses, consumers and
Govts protection against life,
health, property and income
risks.
 These functions are performed
by sale of insurance policies like
general insurance, property
insurance etc
 Policy Function

Itprovides a channel for

Govt. policy to achieve
society’s goals of high
employment, low inflation
and sustainable economic
growth.
 By manipulating interest rates
and the availability of credit,
Govt can affect the borrowing &
spending plans of the public,
which, in turn influence the
growth of jobs, production and
prices
Financial Services supplied
by the Money and Capital
Markets

 Payment
 Thrift
 Insurance
 Credit
 Hedging
 Agency
 Payment services

 It provides payments
accounts against which the
customer can write checks or
wire funds to pay for
purchases of goods &
services.
 Thrift services

It provides attractive financial

instruments with adequate
safety and yield to encourage
people, businesses and Govt.
to save for their future
financial needs.
 Insurance services:

It provides protection from

loss of income or property
in the event of death,
disability, negligence, or
other adverse
developments.
 Credit services

It provides loanable funds

to supplement current
income in order to sustain
current living standard.
 Hedging services

It provides protection against loss

due to unfavorable movements in
the market prices or interest
rates through such devices as
futures, options, and other
hedging instruments
 Agency services

It Provides services by acting

as agent for a customer in
managing retirement funds
or other property
Types of Financial Market

 Money Market vs Capital

Market
 Open Vs Negotiated Market
 Primary Vs Secondary
Markets
 Spot Vs Futures, Forward,
and Option Markets
 Money Market
 The money market is designed
for making of short-term loans.
 It is the institution through
which individuals and firms with
temporary surpluses of funds
meets the needs of the
borrowers who have temporary
funds shortages.
 Money Market
 A security or loan maturing one
year or less is considered to be a
money market instrument.
 One of the principal functions of
money market is to finance the
working capital needs of
corporations and to provide
Govt. with short-term fund.
 Capital Market
–The capital market is designed to
finance long term investments
(maturing more than one year) by
business, Governments and households.
–Trading of funds in the capital market
makes possible the construction of
factories, highways, schools etc.
 Open Market

 In an open market, financial

instruments are bought and
sold at large without any
restrictions.
 For example, some corporate
bonds are sold in the open
market to the highest bidder
 Negotiated Market

–In a negotiated market,

financial instruments like
corporate stocks, bonds etc.
are sold to one or few buyers
under private contract.
 The Primary Market

–The Primary market is for the

trading of new securities issued
for the 1st time.
– Its principal function is raising
capital to support new
investment in different
projects/ventures.
–e.g. IPO.
The Secondary Market

–The secondary market deals

in securities previously
issued.
–Its chief function is to
provide liquidity to security
investors.
–Example includes trading in
CSE, DSE.
 Spot Market

A Spot Market is one in

which securities or
financial services are
traded for immediate
delivery(usually within one
or two business
days).
 A Spot Market

For example, you instruct your

broker to purchase 1000 share
of BATA Shoe Comp shares at
today’s price. You expect to
acquire ownership of those
shares within few hours/minutes.
A Future or Forward
Market
– These are designed to trade
contracts calling for the future
delivery of financial instruments.
– The purpose of such contract is to
reduce risk by agreeing on a price
today rather than later when price
of security may rise.
– Example: Fex Dealings in advance.
 Options Markets
 It offers investors an opportunity to
reduce risk. These markets make
possible the trading of options on
selected stocks and bonds which are
agreements that give an investor the
right to either buy or sell designated
securities to the writer of the option at
a guaranteed price at any time during
the life of the contract.
 Factors that tie all
Financial Markets together

Credit
Speculation
Arbitrage
Perfect and Efficient
Market.
Factors Tying All Financial Markets
Together

 Credit, the Common Commodity. The

shifting of borrowers among markets
helps to weld the parts of the global
financial system together and to bring
the credit costs in the different markets
into balance with one another.
 Speculation and Arbitrage. Speculators
who watch for profitable arbitrage
opportunities help to maintain
consistent prices among the markets.
Factors Tying All Financial Markets
Together

 Perfect and Efficient Markets. There is

some research evidence suggesting that
financial markets are closely tied to one
another due to their near perfection
and efficiency.
 In the real world however, market
imperfection and information
asymmetry exist.