transferred from lenders to borrowers • Indirect finance – financial intermediaries receive funds from savers and lend them to borrowers Securities are assets for the holder and liabilities for the issuer
Debt instruments – contractual obligation to pay the holder fixed payments at specified dates (e.g., mortgages, bonds, car loans, student loans) Short-term debt instruments have a maturity of less than one year Intermediate-term debt instruments have a maturity between 1 and 10 years Long-term debt instruments have a maturity of ten or more years Equity – sale of ownership share (owners are residual claimants). Owners of stock may receive dividends
Primary market = financial market in which newly issued securities are sold. Secondary market = financial market in which previously owned securities are sold. Investment Banks underwrite securities in primary markets Brokers and dealers work in secondary markets • Broker – match buyers and sellers • Dealers – buy and sell securities
US treasury bills: 1-, 3-, 6-month maturities, discounted; no default risk Negotiable bank certificates of deposit (NCD): transferable in the secondary markets, large denominations Commercial paper (CP): issued by large banks or well-known corporations, growing fast, direct finance; largest instrument Banker’s Acceptances: can be resold in the secondary markets, use abroad in international trade Repurchase Agreements (repos): treasury bills are used to serve as collateral, <2 weeks Federal (Fed) funds: overnight loan b/w banks of their deposits at Fed
Stocks: largest instruments, hold by individuals (1/2), pensions, mutual funds, and insurance companies Mortgages: 3 government agencies, FNMA (Fannie Mae), GNMA (Ginnie Mae), FHLMC (Freddie Mac) Corporate bonds: convertible or non-convertible US government securities: issued by US Treasury, most liquid security US government agency securities: issued by other US gov’t agencies, e.g., FNMA, GNMA… State and local government bonds: also called municipal bonds, interest-exemption Consumer and bank commercial loans
• Foreign Bonds—sold in a foreign country and denominated
in that country’s currency • Foreign bonds may be used to avoid exchange-rate risk • Eurobond—bond denominated in a currency other than that of the country in which it is sold • Eurocurrencies—foreign currencies deposited in banks outside the home country Eurodollars—U.S. dollars deposited in foreign banks
outside the U.S. or in foreign branches of U.S. banks
• World Stock Markets London, Tokyo and other foreign stock exchanges have
Two Main Reasons for Regulation (Financial sector is one
of the most heavily regulated sectors of the economy) • To increase the information available to investors: Reduce adverse selection and moral hazard problems SEC forces corporations to disclose information to reduce insider trading • To ensure the soundness of financial intermediaries: Restrictions on entry Disclosure Laws (SEC) Restrictions on Assets and Activities Deposit Insurance Limits on Competition Restrictions on Interest Rates (no longer in effect)