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Master Financial Markets & Institutions
Dive into the world of finance with our easy-to-understand lessons on financial markets and institutions. Learn how money flows, how businesses access capital, and make smarter financial decisions.

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Now Playing:Financial markets and institutions – Example 0a
Intros
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  1. Finance & Money, Wealth & Savings
    • Finance: Providing funds for expenditures on capital
    • Money: Commodity or Token for Goods & Services
    • Wealth: The Value of all Things One Owns
    • Saving: Leftover Income
  2. Finance Capital Market
    • Bond Markets
    • Loan Markets
    • Stock Markets
Financial markets & institutions
Jump to:NotesConceptFAQsPrerequisites
Notes

Finance & Money, Wealth & Saving

To understand financial markets and financial institutions, we first need to understand the difference between the following,
  1. Finance & Money
  2. Wealth & Saving
  3. Physical & Financial Capital


Finance: the act of finding and providing funds which help pay for expenditures on capital.

When we study finance, want to see how households and firms obtain these funds, and how they deal with risks when they are financing.

Money: is any commodity or token that is acceptable as payment for goods and services. It is what we use to make financial transactions.

Finance and money are closely related, but they are not the same. Money is what you use to finance a project.

Note: In this chapter, we will mostly be focusing on finance.

Wealth: is the value of all items and money that a person owns. This is different from income, since that’s the money you earn during a time period.

Saving: the income that is not used on consumptions goods and services and tax.

Note: The more you save, the higher your wealth is.

Financial Capital Markets

We use savings as a source of the funds to finance investments. These funds are then supplied and demanded to three markets:
  1. Bond Markets
  2. Loan Markets
  3. Stock Markets


Bond Markets: When firms expand its business and open new stores, it is going to need money to do so. They get the money by selling bonds.

A bond is a fixed income investment that represents a loan made by an investor to a borrower. The investor gives a loan to a borrower, and the borrower pays a specific amount at a specific time period until the final payment is done.

Example: Person A loans firm $100. Firm pays person A $5 every year until 2050, where the firm pays the last $5 and also the loan amount ($100).

Firms use to this to get their money first, and then pay back later including interest.

Loan Market: Firms get money to expand their business by loaning from a bank.

For example, bank loans the firm $100 with an interest rate of 5%. The firm must pay back $100 including an additional $5 next year (total $105).

Households can also get financing for new homes by getting a mortgage from banks.

Stock Market: Firms can get money to expand their business by issuing stocks. A stock is a legal ownership which allows you to claim a certain percentage of the firm’s profits.

Example: If a firm has 100 stocks and you own 1 of them, then you are entitled to get 1% of the firm’s profits.

Financial Institutions

A financial institution is firm that conducts financial transactions like investments, loans and deposits. They operate on both sides of the market. In other words, they can be a borrower in one market, and a lender in another.

The 4 following financial institutions are:
  1. Insurance Companies: these companies allow households to deal with risks like theft, fire, death, and accidents. They receive premiums from clients and pay claims. They use statistical analysis to find out their actual losses for a given class, and by that they can calculate what the premiums should cost. This gives them a steady flow of funds.

  2. Commercial Banks: they accept deposits, give payment services to other institutions, and make loans to households and firms. You will learn more about how they manage their money later.

  3. Pension funds: uses pension contributions from workers and firms to buy bonds and stocks. There are pension funds that are extremely high, so they have a lot of power to what stock they want to hold.

  4. Government-sponsored mortgage lenders: In simple terms, they are large financial institutions that buy mortgages from banks, make them into mortgage-backed securities, and sell them.


Financial Assets & Interest Rates

Loans, bonds, and stocks are all known as financial assets.

The interest rate of a financial asset is the interest received from the percentage of the price of the asset.

Essentially:
  1. If price of asset  ↑ \, \uparrow \, , then interest rate  ↓ \, \downarrow \, .
  2. If price of asset  ↓ \, \downarrow \, , then interest rate  ↑ \, \uparrow \, .


Suppose the price of the asset (bond) is $100, and the interest received is $5 per year. So,

Interest Rate = 5100 ×100\frac{5} {100} \, \times 100 = 5%

  1. If the price of asset is now $110, then

    Interest Rate = 5110 ×100=4.54‾\frac{5} {110} \, \times 100 = 4.\overline{54}%
  2. If the price of asset is now $90, then

    Interest Rate = 590 ×100=5.55‾\frac{5} {90} \, \times 100 = 5.\overline{55}%

Note: If interest rate increases, then price of asset decreases, which makes it hard for firms to pay their debts.
Concept

Introduction to Financial Markets and Institutions

Welcome to the fascinating world of financial markets and institutions! These are the backbone of our modern economy, playing a crucial role in how money flows and how businesses and individuals access capital. Financial markets are where buyers and sellers trade various financial instruments, like stocks and bonds. On the other hand, financial institutions are the organizations that facilitate these transactions and provide financial services. Think of banks, insurance companies, and investment firms. Our introduction video is a great starting point to grasp these concepts. It breaks down complex ideas into easy-to-understand explanations, perfect for beginners. As we dive deeper into this topic, you'll see how these markets and institutions impact our daily lives, from saving for retirement to taking out a mortgage. Understanding these fundamentals is key to making informed financial decisions and navigating the economic landscape. So, let's get started on this exciting journey into the world of finance!

FAQs

  1. What are the main types of financial markets?

    The main types of financial markets include stock markets (for trading company shares), bond markets (for debt securities), money markets (for short-term debt instruments), foreign exchange markets (for currency trading), and derivatives markets (for contracts based on underlying assets).

  2. How do interest rates affect financial markets?

    Interest rates significantly impact financial markets by influencing borrowing costs, investment decisions, and asset valuations. Higher rates typically lead to lower bond prices, potentially slower economic growth, and can affect stock market performance. Lower rates often stimulate borrowing and investment but may lead to asset bubbles if maintained for too long.

  3. What role do commercial banks play in the financial system?

    Commercial banks are crucial intermediaries in the financial system. They accept deposits, provide loans, facilitate payment systems, and offer various financial services. Banks create money through the fractional reserve system and play a vital role in implementing monetary policy and maintaining economic stability.

  4. How do pension funds contribute to financial markets?

    Pension funds are significant institutional investors that manage retirement savings for employees. They contribute to financial markets by investing in various assets like stocks, bonds, and real estate. Their large-scale investments can influence market trends and provide capital for businesses and governments.

  5. What is the difference between stocks and bonds?

    Stocks represent ownership in a company, while bonds are debt instruments. Stockholders potentially benefit from company growth and may receive dividends, but face higher risk. Bondholders receive fixed interest payments and have priority in case of bankruptcy, but typically have limited upside potential compared to stocks.

Prerequisites

Understanding financial markets and institutions is a complex subject that requires a solid foundation in various economic and financial concepts. While there are no specific prerequisite topics provided for this subject, it's important to recognize that a broad understanding of economics, finance, and business principles can greatly enhance your comprehension of financial markets and institutions.

Financial markets and institutions play a crucial role in the global economy, facilitating the flow of funds between savers and borrowers, and providing essential services for individuals, businesses, and governments. To fully grasp the intricacies of this field, students should have a strong grasp of basic economic principles, such as supply and demand, market equilibrium, and the role of government in the economy.

Additionally, a fundamental understanding of financial concepts is vital. This includes knowledge of financial instruments, such as stocks, bonds, and derivatives, as well as an understanding of risk and return. Familiarity with accounting principles can also be beneficial, as it helps in interpreting financial statements and assessing the health of financial institutions.

Mathematics, particularly statistics and probability, forms another important foundation for studying financial markets and institutions. These skills are essential for analyzing market trends, assessing risk, and making informed financial decisions. Proficiency in these areas can significantly enhance a student's ability to understand complex financial models and theories.

Moreover, an awareness of current events and global economic trends is crucial. Financial markets are heavily influenced by geopolitical events, economic policies, and technological advancements. Staying informed about these factors can provide valuable context for understanding market behaviors and institutional decisions.

While specific prerequisite topics may not be listed, developing a broad knowledge base in economics, finance, mathematics, and current affairs can significantly enhance your understanding of financial markets and institutions. This multidisciplinary approach allows students to connect various concepts and see the bigger picture of how financial systems operate in the real world.

As you delve into the study of financial markets and institutions, you'll find that your knowledge in these foundational areas will be continuously applied and expanded. The interconnected nature of financial systems means that understanding one aspect often requires knowledge of several others. Therefore, maintaining a curious and open mindset, and being willing to explore related topics as they arise, is key to success in this field.

In conclusion, while there may not be a strict list of prerequisites, approaching the study of financial markets and institutions with a well-rounded background in economics, finance, mathematics, and current affairs will provide you with the tools necessary to navigate this complex and dynamic field effectively.