The Financial Market Environment

Financial Institutions and Markets

• An intermediary that channels the savings of individuals,
businesses, and governments into loans or investments.

• For financial institutions, the key suppliers of funds and the key
demanders of funds are individuals, businesses, and governments. The
savings that individual consumers place in financial institutions provide
these institutions with a large portion of their funds. Individuals not only
supply funds to financial institutions but also demand funds from them in
the form of loans. However, individuals as a group are the net suppliers
for financial institutions: They save more money than they borrow.
• Business firms also deposit some of their funds in financial institutions,
primarily in checking accounts with various commercial banks. Like
individuals, firms borrow funds from these institutions, but firms are net
demanders of funds: They borrow more money than they save.
• Governments maintain deposits of temporarily idle funds, certain tax
payments, and Social Security payments in commercial banks. They do
not borrow funds directly from financial institutions, although by selling
their debt securities to various institutions, governments indirectly
borrow from them. The government, like business firms, is typically a
net demander of funds: It typically borrows more than it saves. We’ve all
heard about the federal budget deficit.
FINANCIAL MARKETS
• Forums in which suppliers of funds and demanders of fundscan transact
business directly.
• Primary Market vs Secondary Market
• Primary market is financial market in which securities are initially issued;
the only market in which the issuer is directly involved in the transaction.
Secondary market is financial market in which preowned securities (those
that are not new issues) are traded.
Transfer of Funds on
Financial Market
Function of Financial Intermediaries
• Provide customers with liquidity service
• Help to repackage the risk
• Willing to create and sell assets with lesser risk to one party in order to buy
assets with greater risk form another party
• This process is referred to as asset transformation
Money Market vs Capital Market
• Money market is a financial relationship created between suppliers and
demanders of short-term funds.
• Marketable securities short-term debt instruments, such as treasury bills,
commercial paper, and negotiable certificates of deposit issued by government
, business, and financial institutions, respectively.
• Capital market is a market that enables suppliers and demanders of long-term
funds to make transaction.
• Key Securities Traded: Bonds and Stocks
Securities Traded in Money Markets
• Treasury Bills.
• Certificate of Deposit (CDs).
• Commercial Papers.
• Eurodollar Deposits.
• Banker’s Acceptance.
• Federal Funds.
• Repurchase Agreements.
Securities Traded in Financial Markets
(cont’d)
• Capital Market Securities:
• Capital market securities are those with a maturity of more than one year
• Bonds and mortgages
• Stocks
• Capital market securities have a higher expected return and more risk than
money market securities.
• Bond is a long-term debt instrument used by business and government to
raise large sums of money, generally from a diverse group of lenders.

• Preferred stock is a special form of ownership having a fixed periodic

dividend that must be paid prior to payment of any dividends to common
stockholders.
Types of Financial Markets (cont’d)
• Organized versus over-the-counter markets:
• A visible marketplace for secondary market transactions is an organized
exchange
• Some transactions occur in the over-the-counter (OTC) market (a
telecommunications network)
• Knowledge of financial markets is power:
• Decide which markets to use to achieve our investment goals or financing
needs
• Decide which markets to use as part of your job
• Avoid common mistakes in investing and borrowing
Broker Markets and Dealer Markets
• Broker market is the securities exchanges on which the two sides of a
transaction, the buyer and seller, are brought together to trade securities.
Securities exchanges are the organizations that provide the marketplace
in which firms can raise funds through the sale of new securities and
purchasers can resell securities.
• Dealer market is the market in which the buyer and seller are not brought
together directly but instead have their orders executed by securities
dealers that “make markets” in the given security.
• Market makers are securities dealers who “make markets” by offering to
buy or sell certain securities at stated prices.
Major Financial Institutions
• The major financial institutions in the economy are commercial banks,
savings and loans, credit unions, savings banks, insurance companies,
mutual funds, and pension funds.
COMMERCIAL BANKS, INVESTMENT BANKS, AND
THESHADOW BANKING SYSTEM
• Commercial banks are Institutions that provide savers with a secure place to
invest their funds and that offer loansto individual and business borrowers.
• Investment banks are Institutions that assist companies in raising capital,
advise firms on major transactions such as mergers or financial restructurings,
and engage in trading and market making activities.
• Shadow banking system is a group of institutions that engage in lending
activities, much like traditional banks, butdo not accept deposits and therefore
are not subject to the same regulations as traditional banks.
Role of Financial Institutions in Financial
Markets
• Role of depository institutions:
• Depository institutions accept deposits from surplus units
and provide credit to deficit units
• Depository institutions are popular because:
• Deposits are liquid
• They customize loans
• They accept the risk of loans
• They have expertise in evaluating
creditworthiness
• They diversify their loans
Role of Financial Institutions in Financial
Markets (cont’d)
• Commercial Banks:
• Are the most dominant depository institution
• Offer a wide variety of deposit accounts
• Transfer deposited funds by providing direct loans or purchasing debt
securities
• Serve both the public and the private sector
Role of Financial Institutions in Financial
Markets (cont’d)
• Savings Institutions:
• Include savings and loan associations (S&Ls) and savings banks
• Are mostly owned by depositors (mutual)
• Concentrate on residential mortgage loans
• Credit Unions:
• Are nonprofit organizations
• Restrict their business to credit union members
• Tend to be much smaller than other depository institutions
Role of Financial Institutions in Financial
Markets (cont’d)
• Role of Nondepository Financial Institutions:
• Nondepository institutions generate funds from sources other than deposits
• Finance companies
• Obtain funds by issuing securities
• Lend funds to individuals and small businesses
Role of Financial Institutions in Financial
Markets (cont’d)
• Mutual Funds:
• Sell shares to surplus units
• Use funds to purchase a portfolio of securities
• Some focus on capital market securities (e.g., stocks or bonds)
• Money market mutual funds concentrate on money market securities
Role of Financial Institutions in Financial
Markets (cont’d)
• Securities firms:
• Broker function
• Execute securities transactions between two parties
• Charge a fee in the form of a bid-ask spread
• Investment banking function
• Underwrite newly issued securities
• Dealer function
• Securities firms make a market in specific securities by adjusting their inventory
Role of Financial Institutions in Financial
Markets (cont’d)
• Insurance Companies:
• Provide insurance policies to individuals and firms for death, illness, and
damage to property
• Charge premiums
• Invest in stocks or bonds issued by corporations
Role of Financial Institutions in Financial
Markets (cont’d)
• Pension Funds:
• Offered by most corporations and government agencies
• Manage funds until they are withdrawn from the retirement account
• Invest in stocks or bonds issued by corporations or in bonds issued by the
government
The Securities Issuing Process (IPO)
• Before IPO, companies go for key aspects of early-stage equity financing.
• Private Equity:
External equity financing that is raised via a private placement, typically by
private early-stage firms with attractive growth prospects. It is done in two
ways-
1. Angel Financing: Private Equity financing provided to a young firm by a
wealthy individual investing his or her own money.
2. Venture Capital: Equity financing provided by a firm that specializes in
financing young, rapidly growing firms. Venture capital firms raise pols of
money from outside investors with which they then use to purchase equity
stakes in small private companies.
Going Public
• IPO : The first public sale of a firm’s stock.
• IPOs are typically made by small, rapidly growing companies that either
require additional capital to continue growing or have met a milestone for
going public that was established in an earlier agreement to obtain VC
funding.

• Prospectus: A portion of a security registration statement that describes

the key aspects of the issue, the issuer and its management and financial
position
The Investment Bank’s Role
• Investment Bank: Financial intermediary that specializes in selling new
security issues and advising firms with regard to major financial transactions.
• Underwriting: The role of the investment bank in bearing the risk of reselling,
at a profit, the securities purchased from an issuing corporation at an agreed-
on price.
• IPO Offer Price: The price at which the issuing firm sells its securities.
• Selling Group: A large number of brokerage firms that join the originating
investment bank, each accepts responsibility for selling a certain portion of a
new security issue on a commission basis.
 Assignment Topic
• Direct Listing Criteria of DSE
• Types or Methods of IPO used in DSE
 Overview of the Financial System of Bangladesh

• Formal Sector
• Semi-Formal Sector
• Informal Sector

• Elaboration- Class Work