Chapter 1: Why Study Financial Markets?

Financial markets are crucial in our economy.

1. Channel funds from savers to investors, promoting economic efficiency.

2. Market activity affects: personal wealth, business firms, and economy

• Financial markets and institutions involve the movement of huge quantities of money and affect the profits of businesses.

• Financial market activities affect

– personal wealth.

– spending decisions by individuals and business firms.

– the economy’s location in the business cycle.

Segments of Financial Markets

1. Direct Finance

– Borrowers borrow directly from lenders in financial markets by selling financial instruments which are claims on the borrower’s future income or assets

2. Indirect Finance

– Borrowers borrow indirectly from lenders via financial intermediaries (established to source both loanable funds and loan opportunities) by issuing financial instruments which are claims on the borrower’s future income or assets

Present Value Applications

There are four basic types of credit instruments which incorporate present value concepts:

1. Simple Loan: requires the borrower to repay the principal at the maturity date along with an interest payment.

2. Fixed Payment Loan: periodic payments until maturity date

3. Coupon Bond: The owner of a coupon bond receives a fixed interest payment every year until the maturity date, when the face or par value is repaid.

4.Discount Bond: bought at a price below its face value, and the face value is repaid at the maturity date.