An overview of the financial system

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An overview of the financial system

• Mishkin, Chap 2

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• Chap 2 (a chapter of definitions mostly)
• I. the financial system and its components
  (financial markets, financial intermediaries,
  regulators)
• II. the structure of the financial markets
  types of markets, instruments
• III. role of financial intermediation in general
• IV. types of intermediaries
• V. role of regulation in general

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• I. The financial system and its components
• The financial system of a modern economy usually
  consists of
• the most important function that a financial
  system performs is to
• savers/lenders
• dis-savers/borrowers
• How does the financial system basically perform
  its function?
• financial asset?

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• Two types of financing
• direct finance
• example US govt. issues new 10-year notes worth
  10 m. Mary buys 100 of them from a dealer
• indirect finance
• example US govt. issues new 10-year notes worth
  10 m. Marys bank Wells Fargo buys 5 m worth of
  them from a dealer
• What are financial intermediaries?
• How would you describe the dealer in the second
  example?

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• II. Financial markets can be classified as
• primary markets
• secondary markets
• Examples of the two
• Suppose you sell off 100 Microsoft shares that
  you have to a dealer, on NASDAQ. Does Microsoft
  benefit from the transaction, revenue wise?
• Which of the two experiences a (much) higher
  volume of trading?
• Which of the two is more closely watched by
  company CEOs?
• By ordinary households?
• Why?

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• Exchanges
• Over the counter markets
• Which experiences greater trading volume?
• Are the market forces any different across the
  two?
• Money markets
• Capital markets

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• Market for debt assets
• equity markets
• Different types of short term debt assets
  (missing in 7th edition!)
• Treasury bills or T-bills
• Negotiable certificate of deposits (CD)
• Commercial paper
• Repurchase agreement (repos)

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• Federal funds
• Bankers acceptances
• Different types of long and intermediate term
  debt assets (missing in 7th edition)
• Mortgages
• Mortgage backed security
• Corporate bonds
• Treasury bonds or T-bonds

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• US government agency bonds
• Municipal bonds
• Consumer and commercial loans
• Are debt assets risky? If yes what are some of
  the chief types of risk on these?
• Are common stocks risky? What are some of the
  chief types of risk on these?

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• common international debt instruments
• Foreign bonds
• Eurobonds
• Eurocurrencies
• Can you think of a type of asset which is neither
  debt nor equity?

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The Wall Street Journal publishes the rates on
various money market and capital market
instruments, on a daily basis. These are
available at the Market Data Center of the online
edition. Click on Bonds, Rates Credit Markets
and pull down Money Rates and Key Interest Rates
for daily quotes of some of the assets we have
been discussing in this chapter. The Mortgage
and Banking Rate Center of the WSJ has current
information about the various types of adjustable
and fixed rate mortgages. We shall learn how to
read the Treasuries column, when we get to chap
4.
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• III. Role of financial intermediaries
• Recap
• characteristic of an intermediary
• How do intermediaries operate?
• Intermediaries help maintain the competitive
  character of financial markets by
• reducing transaction costs
• reducing problems related to asymmetric
  information
• reducing risk (risk sharing) to small lenders

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• IV. Types of intermediaries
• depository institutions
• characteristics
• examples
• contractual savings institutions
• characteristics
• examples

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• investment intermediaries
• characteristics
• examples
• Which category does investment bank belong to?

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Chief sources and uses of funds of important
intermediaries Intermediaries
sources of funds uses of funds 1.
commercial banks deposits
loans, govt. bonds,

mortgages etc. 2. savings and
loan assoc. deposits
mortgages 3. credit unions
deposits consumer
loans 4. pension funds
contributions stocks and bonds 5.
mutual funds shares
stocks and bonds 6. money market
funds shares
short term assets


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• V. Role of regulation
• Government regulations are essentially aimed at
• providing more information
• providing insurance
• ensuring soundness of the financial system