Chapter 1 Introduction Foundations of Financial Markets and Institutions 4th edition 2009 Frank J. Fabozzi Franco Modigliani Frank J. Jones

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Introduction
Chapter 1

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Types of Assets
Tangible Assets
Value is based on physical properties
Examples include buildings, land, machinery
Intangible Assets
Claim to future income
Examples include various types of financial assets

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Types of Financial Assets
Bank loans
Government bonds
Corporate bonds
Municipal bonds
Foreign bond
Common stock
Preferred stock
Foreign stock

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Debt vs. Equity
Debt Instruments
Fixed dollar payments
Examples include loans, bonds
Equity Claims
Dollar payment is based on earnings
Residual claims
Examples include common stock, partnership share

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Price of Financial Asset and Risk
The price or value of a financial asset is equal to the present
value of all expected future cash flows.
Expected rate of return
Risk of expected cash flow

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Types of Investment Risks
Purchasing power risk or inflation risk
Default or credit risk
Exchange rate or currency risk

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Role of Financial Assets
Transfer funds from surplus units to deficit units.
Transfer funds so as to redistribute unavoidable risk
associated with cash flows generated from both tangible and
intangible assets.

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Key Points You Should
Understand
Difference between tangible and financial assets
Difference between debt and equity
Cash flow of a financial asset
Three types of risks associated with financial asset
Two principal economic functions of financial assets

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Role of Financial Markets
Determine price or required rate of return of asset.
Provide liquidity.
Reduce transactions costs, which consists of search costs and
information costs.

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Classification of Financial Markets
Debt vs. equity markets
Money market vs. capital market
Primary vs. secondary market
Cash or spot vs. derivatives market
Auction vs. over-the-counter vs. intermediated market

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Financial Market Participants
Households
Business units
Federal, state, and local governments
Government agencies
Supranationals
Regulators

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Key Points You Should
Understand
Three economic functions of financial markets
Ways that financial markets can be classified
Market participants

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Globalization of Financial Markets
Deregulation or liberalization of financial markets
Technological advances
Increased institutionalization

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Classification of Global Financial
Markets
Internal Market
(also called national
market)
External Market
(also called international
market, offshore market,
and Euromarket)
Domestic Market Foreign Market

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Motivation for Using Foreign Markets and
Euromarkets
Limited fund availability in internal market
Reduced cost of funds
Diversifying funding sources

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Derivatives Market
Futures/forward contracts are obligations that must be
fulfilled at maturity.
Options contracts are rights, not obligations, to either buy
(call) or sell (put the underlying financial instrument.

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Role of Derivative Instruments
Protect against different types of investment risks, such as
purchasing power risk, interest rate risk, exchange rate risk.
Advantages:
Lower transactions costs
Faster to carry out transaction
Greater liquidity

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Key Points You Should
Understand
Three major factors that have integrated financial markets
Institutionalization of financial markets
Internal and external markets
Motive to raise money outside of domestic market
Two basic types of derivatives
Principal economic role of derivatives
Potential uses of derivatives

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Types of Regulation
Disclosure regulation
Financial activity regulation
Regulation of financial institution
Regulation of foreign participation

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Regulation in the United States
Reasons for regulation
Stock market crash of 1929
Great Depression of 1930s
Regulation primarily by SEC, CFTC, Treasury, and Federal
Reserve
“Blueprint for Regulatory Reform”
Split regulation by functions
Market stability regulator
Prudential regulator
Business conduct regulator

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Key Points You Should
Understand
Explanation for the existence of regulation
Goals sought in regulation
Major forms of regulation
“Blueprint for Regulatory Reform”

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