Econ 2035 Notes

1/14/15

Chapter 2:

An Overview of the Financial System

Functions of the Financial Market

Financial Market: the place or channel for buying or selling stocks, bonds and other securities

Financial Institutions: insitutions through which savers

Financial instruments: the instruments that are used to transfer resources from savers to investors. Transfer risk to those who are best equipped to bear it

Direct Finance: borrows borrow funds directly rom lenders in financial markets by selling them securities

Indirect Finance: borrowers borrow form financial institutions

Function 1: Perform the essential functions of channeling funds from economic players that have saved surplus funds to those that have a shortage of funds.

* Who supplies funds? Savers

* Who demands funds? Investors

*

In the absence of financial markets, you cannot borrow.

No investments, no productions

Savers/Borrowers

* Households

* Firms

* Governments (Domestic and Foreign)

* Foreigners

Example: You have just graduated from college with a business degree and you want to start your own business.

How to finance your investment? The essential question

* Your own savings

* If you don’t have savings

* Borrow money from a bank, family, friend, etc.

* Get a business partner who is willing to do the initial investment

* 1 and 2 are someone else’s money! (The saver’s money. You are the investor)

Function 2: By bringing savers and borrowers together, financial markets promote economic efficiency (It allocates the capital efficiently)

Function 3: Financial markets directly improve the well-being of consumers by allowing them to “time their purchases” better.

Structure of Financial Markets

Debt and Equity Markets

There are two ways to obtain funds in a financial market

1. Issue a debt instrument (bond or mortage)

2. Issue equity (stock)

What is a debt instrument?

A contractual agreement by the borrower...