AN OVERVIEW

OF THE
FINANCIAL
Chapter 2

SYSTEM
 1. Debt Markets 2. Equity Markets
• Short-term (maturity < 1 • Common stocks
year) Money Market
• Long-term (maturity > 1

STRUCTU year) Capital Market

RE OF 1. Primary Market 2. Secondary

Market
FINANCIA
• New security issues sold to
initial buyers • Securities previously issued
are bought and sold

L
MARKETS 1. Exchanges
• Trades conducted in central
2. Over-the-Counter
Markets
locations (e.g., Toronto • Dealers at different
Stock Exchange and New locations buy and sell
York Stock Exchange)
FINANCIA Money market instruments
L
MARKET
INSTRUM Capital market instruments
ENTS
MONEY MARKET
INSTRUMENTS
CAPITAL MARKET
INSTRUMENTS
 INTERNATIONALIZATION OF
FINANCIAL MARKETS
International bond
Market, Eurobonds, and World stock markets
Eurocurrencies
Foreign bonds
Eurobond
Eurocurrencies,
Eurodollars
FUNCTION Financial Intermediaries

S OF 1. Engage in process of indirect finance

2. More important source of finance than securities
FINANCIA markets

L 3. Needed because of transactions costs and

asymmetric information
INTERMED Transactions Costs
IARIES: 1. Financial intermediaries make profits by reducing
INDIRECT transactions costs
2. Reduce transactions costs by developing expertise
FINANCE and taking advantage of economies of scale
FUNCTIONS OF FINANCIAL
INTERMEDIARIES: RISK
SHARING
1. Create and sell assets with low risk
characteristics and then use the funds to buy assets
with more risk (also called asset transformation).
2. Also, lower risk by helping people to diversify
portfolios
FUNCTIONS OF FINANCIAL
INTERMEDIARIES: ASYMMETRIC
INFORMATION
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
TYPES OF FINANCIAL
INTERMEDIARIES
 Finance companies

INVESTM
ENT Mutual funds
INTEMEDI
ARIES
Money market mutual funds
 Increasing information
available to investors

Ensuring the soundness of

REGULATI financial intermediaries

ON OF •
•
Restrictions on entry
Disclosure
FINANCIA • Restrictions on assets and activities

L SYSTEM •
•
Deposit insurance
Limits on competition

Financial regulation abroad