Lecture 1 - Introduction to Financial Markets and Institutions

Financial Markets and institutions: 

Financial Markets and institutions Lecture 1: Introduction

Relevance of the course: 

Relevance of the course Much of the financial crisis of 2008-09 has roots in financial markets and institutions What happened on the financial markets in 2008-09?

PowerPoint Presentation: 

What happened on the financial markets in 2008-09 ? Federal National Mortgage Association and Federal Home Loan Mortgage Corporation, commonly known as Fannie Mae and Freddie Mac were bought by their regulator A week later: A bust of one of the biggest players on the market: a record-breaking bankruptcy of Lehman Brothers A day later: US government takeover of a desperately illiquid American International Group (AIG) A day later: Bank of America bought Merrill Lynch in US; Lloyds bought HBOS in UK Central banks desperately throw liquidity on the markets Stock market indices fell sharply around the world

PowerPoint Presentation: 

Firm TOTAL ($ bn ) 2008 Q3 2008 Q2 2008 Q1 2007 Q4 2007 Q3 Citigroup -61.00 -6.20 -12.00 -19.00 -18.20 -5.60 Wachovia -52.70 -30.30 -13.00 -4.40 -3.20 -1.90 Merrill Lynch -52.20 -6.10 -9.00 -9.70 -18.00 -9.40 Washington Mutual -45.60 -30.90 -5.50 -4.10 -3.50 -1.20 UBS AG -44.20 0.00 -6.00 -19.20 -14.40 -4.70 HSBC -27.40 0.00 -9.50 -4.20 -10.00 -0.90 Bank of America -27.40 0.00 -5.20 -6.70 -6.70 -2.50 J P Morgan Chase -18.80 -6.00 -3.60 -4.70 -1.90 -2.00 Morgan Stanley -15.70 -1.30 -1.80 -2.30 -9.40 -0.90 IKB -14.00 0.00 0.00 -14.00 0.00 0.00

What are we going to study in this course: 

What are we going to study in this course As the name of the course suggests, we shall focus mainly on three areas: Financial Markets Financial Institutions Money and monetary Policy Why to study these three areas?

Why to study Financial Markets: 

Why to study Financial Markets Definition: Financial Markets: Markets in which funds are transferred from people who have an excess of available funds to people who have a shortage of funds Financial markets promote efficiency in economic system Taking funds from those who do not have productive use of funds and Giving to those who can best utilize the funds Affect wealth and behavior of business firms and individuals

kinds of financial markets: 

kinds of financial markets Debt v. Equity Primary v. Secondary Exchanges v. Over-the-counter markets Money v. Capital market

Financial Markets –interest rates: 

Financial Markets –interest rates Some definitions Interest rates: An interest rate is the cost of borrowing or the price paid for the rental of funds (usually expressed as a percentage of the rental of 100 per year) Interest rates affect both individuals’ and corporations’ decisions to spend or save A stock : A share of ownership in a corporation. It is a security, that is a claim on the earnings and assets of the corporation .

PowerPoint Presentation: 

The stock market is where stocks are traded: Can it affect wealth and spending behavior of investors? How is it important for individuals and corporations? KSE in Last 8 years

Bond Market: 

Bond Market Definition: A bond is a debt security that promises to make payments periodically for a specified period of time. The bond market is where bonds are traded. Why is the bond market important? it enables corporations or governments to borrow to finance their activities it is where interest rates are determined

The Foreign Exchange Market: 

The Foreign Exchange Market A foreign exchange market is a market where funds are converted from one currency to another Why do firms and citizen need this conversion? To transfer funds from one country to another for trade For safety reasons

Historical Rupee-Dollar parity: 

Historical Rupee-Dollar parity

PowerPoint Presentation: 

Why this market is important? What happens when rupee becomes cheaper against dollar? For individuals For firms?

B- Banks and Other Financial Institutions: 

B- Banks and Other Financial Institutions Banks are financial institutions that accept deposits and make loans. Fis work like intermediaries, i.e no one can directly lend to corporations We shall study aspects of Fis like Why are financial intermediaries so crucial to well-functioning financial markets? Why do they extend credit to one party but not to another? Why do they usually write complicated legal documents when they extend loans? Why are they the most heavily regulated businesses in the economy?

C - Money supply and Inflation and Interest Rates: 

C - Money supply and Inflation and Interest Rates Money (also referred to as the money supply), is anything that is generally accepted in payment for goods or services or in the repayment of debts. Why study of money is important? Money creates business cycles and inflation ( M. Friedman ). Evidence suggests that money plays an important role in generating business cycles

PowerPoint Presentation: 

The shaded areas representing recessions, periods of declining aggregate output The graph shows that the rate of money growth has declined before every recession The graph indicates that changes in money might be a driving force behind business cycle fluctuations.

Money and Inflation: 

Money and Inflation Inflation is a continual increase in the price level What causes inflation? the price level and the money supply generally move closely together For example, the next two diagrams show the relationships of price level and inflation for a number of countries

Inflation and Money Supply in US: 

Inflation and Money Supply in US

Further evidence on Inflation and Money supply: 

Further evidence on Inflation and Money supply

Money and Interest Rates: 

Money and Interest Rates In addition to other factors, money plays an important role in interest-rate fluctuations, Increased money supply should lower interest rates, but the historical relationship is not clear-cut Monetary Policy? Monetary policy is the management of money and interest rates SBP conducts monetary policy