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The Economics of Money, Banking and Financial Markets- Fredcric S.Mishkin. ppt, ch02

The Economics of Money, Banking and Financial Markets- Fredcric S.Mishkin. ppt, ch02


chapter 2

An Overview of the Financial System

Function of Financial Markets
1. Allows transfers of funds from person or business without investment opportunities to one who has them 2. Improves economic efficiency

Copyright ? 2003 Addison Wesley

TM 2- 2

Classifications of Financial Markets
1. Debt Markets Short-term (maturity < 1 year) Money Market Long-term (maturity > 1 year) Capital Market 2. Equity Markets Common stocks 1. Primary Market New security issues sold to initial buyers 2. Secondary Market Securities previously issued are bought and sold 1. Exchanges Trades conducted in central locations (e.g., New York Stock Exchange) 2. Over-the-Counter Markets Dealers at different locations buy and sell
Copyright ? 2003 Addison Wesley TM 2- 3

Money Market Instruments

Copyright ? 2003 Addison Wesley

TM 2- 4

Capital Market Instruments

Copyright ? 2003 Addison Wesley

TM 2- 5

Internationalization of Financial Markets
International Bond Market 1. Foreign bonds 2. Eurobonds Now larger than U.S. corporate bond market

World Stock Markets U.S. stock markets are no longer always the largest: Japan sometimes larger

Copyright ? 2003 Addison Wesley

TM 2- 6

Function of Financial Intermediaries
Financial Intermediaries 1. Engage in process of indirect finance 2. More important source of finance than securities markets 3. Needed because of transactions costs and asymmetric information Transactions Costs 1. Financial intermediaries make profits by reducing transactions costs 2. Reduce transactions costs by developing expertise and taking advantage of economies of scale

Copyright ? 2003 Addison Wesley

TM 2- 7

Asymmetric Information: Adverse Selection,and Moral Hazard
Adverse Selection 1. Before transaction occurs 2. Potential borrowers most likely to produce adverse outcomes are ones most likely to seek loans and be selected

Moral Hazard 1. After transaction occurs 2. Hazard that borrower has incentives to engage in undesirable (immoral) activities making it more likely that won’t pay loan back
Financial intermediaries reduce adverse selection and moral hazard problems, enabling them to make profits
Copyright ? 2003 Addison Wesley TM 2- 8

Financial Intermediaries

Copyright ? 2003 Addison Wesley

TM 2- 9

Size of Financial Intermediaries

Copyright ? 2003 Addison Wesley

TM 2- 10

Regulatory Agencies

Copyright ? 2003 Addison Wesley

TM 2- 11

Regulation of Financial Markets
Three Main Reasons for Regulation 1. Increase information to investors A. Decreases adverse selection and moral hazard problems B. SEC forces corporations to disclose information 2. Ensuring the soundness of financial intermediaries A. Prevents financial panics B. Chartering, reporting requirements, restrictions on assets and activities, deposit insurance, and anti-competitive measures 3. Improving monetary control A. Reserve requirements B. Deposit insurance to prevent bank panics

Copyright ? 2003 Addison Wesley

TM 2- 12


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