Chapter 1_why study FMI

Financial Markets and Institutions
Ninth Edition
Part 1: Introduction
Chapter 1
Why Study Financial
Markets and
Institutions?
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Chapter Preview (1 of 4)
The evening news features a segment about the bond market and
interest rates. What does this mean for your small retail business?
Should you borrow money? Issue stock instead of using a bank
loan?
What does all this mean? Do I care about interest rates? What
about the turmoil in Europe? Are imports more expensive?
These are good questions. Of course, the answer to these
questions can be found in this book. In fact, this books touches on
a variety of topics, including the Fed, stocks markets, bond
markets, and banks. We will begin to appreciate many exciting
issues related to these topics during the course of this term.
We preview subjects of interest to anyone who is a part of a
productive society. Topics include:
• Why Study Financial Markets?
• Why Study Financial Institutions?
• Applied Managerial Perspective
• How Will We Study Financial Markets and Institutions
We preview subjects of interest to anyone who is a part of a
productive society. Topics include: Web Exercise
• Concluding Remarks
Why Study Financial Markets? (1 of 2)
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
Why Study Financial Markets? (2 of 2)
• Well functioning financial markets are key factors in producing
high economic growth.
• We will briefly examine each of these markets, key statistics,
and how we will examine them throughout this course.
Why Study Financial Markets?
Debt Markets & Interest Rates (1 of 3)
• Debt markets allow governments, corporations, and individuals
to borrow.
• Borrowers issue a security, called a bond, offering interest and
principal over time.
• The interest rate is the cost of borrowing.
Why Study Financial Markets? Debt
Markets & Interest Rates (2 of 3)
• Many types of market interest rates: mortgage rates, car loan
rates, credit card rates, etc.
• The level of these rates are important. For example, mortgage
rates in the early part of 1983 exceeded 13%.
• Understanding the history of interest rates is beneficial.
• We will study these further in the book: types and characteristics
of bonds; theories on how rates are determined.
Figure 1.1 Interest Rates on Selected
Bonds, 1950–2016
Source: Federal Reserve Bank of St. Louis, FRED database: https://fred.stlouisfed.org/series/TB3MS;

https://fred.stlouisfed.org/series/GS10; https://fred.stlouisfed.org/series/BAA.
• For the moment, we will turn to other topics, but revisit these
topics.
• In chapters 2, 11, 12, and 14, we will examine the role of debt
markets in the economy.
• In chapters 3 through 5, we will examine the characteristics of
interest rates.
The Stock Market (1 of 3)
• The stock market is the market where common stock (or just
stock) are traded.
• Companies initially sell stock (in the primary market) to raise
money. After that, the stock is traded among investors
(secondary market).
• The stock market receives the most attention from the media.
Figure 1.2 Stock Prices as Measured by the
Dow Jones Industrial Average, 1950–2016
Source: Federal Reserve Bank of St. Louis, FRED database: https://fred.stlouisfed.org/series/DJIA.
Companies, not just individuals, also watch the market.
• Often seeking additional funding
• The success of SEOs is dependent on the company’s stock
• In chapter 2, we will examine the role of the stock market in the
financial system.
• In chapters 6 and 13, we will further look at how stock prices
behave to information in the marketplace.
The Foreign Exchange Market (1 of 3)
• The foreign exchange market is where international currencies
trade and exchange rates are set.
• Although most people know little about this market, it has a
daily volume around $5 trillion!
Figure 1.3 Exchange Rate of the U.S.
Dollar, 1970–2016
Source: Federal Reserve Bank of St. Louis, FRED database:

https://fred.stlouisfed.org/series/TWEXMMTH.
• These fluctuations matter!
– In recent years, consumers have found that vacationing in
Europe is expensive, due to a weakening dollar relative to
the Euro.
– When the dollar drops, Americans decrease their purchases
of foreign goods (such as travel in the US or purchases the
American goods. This will hurt American businesses.
– A strong dollar means U.S goods exported abroad will cost
more in foreign countries, hence foreigners will buy fewer of
them
In chapter 15, we will examine how exchange rates are
determined in both the short- and long-run.
Why Study Financial Institutions? (1 of 3)
We will also spend considerable time discussing financial
institutions - the corporations, organizations, and networks that
operate the so-called “marketplaces.” We will look at:
1. Structure of the Financial System
– Helps funds move from savers to investors, typically through
financial intermediaries
2. Financial Crisis
– The “Great Recession” of 2007–2009 was the worst
financial crisis since the Great Depression. Why did it
happen? Default in subprime residential mortgage.
3. Central Banks and the Conduit of Monetary Policy
– The role of the Fed, and foreign counterparts, in the
management of interest rates and the money supply
(anything that is generally accepted in payment for goods &
services or repayment of debt)
4. The International Financial System
– Capital flows between countries impacts domestic
economies
– Need to understand exchange rates, capital controls, and
the role of agencies such as the IMF
5. Banks and Other Financial Institutions
– Includes the role of insurance companies, mutual funds,
pension funds, etc.
6. Financial Innovation
– Focusing on improvements in technology and the impact on
financial product delivery
7. Managing Risk in Financial Institutions
– Focusing on risk management in the financial institution
Applied Managerial Perspective
• Financial institutions are among the largest employers in the
U.S. and often pay high salaries.
• Knowing how financial institutions are managed may help you
better deal with them.
How We Study Financial Markets and
Institutions (1 of 2)
Basic Analytic Framework
1. Simplified models are constructed, explained, and then
manipulated to illustrate various phenomena.
2. “Practicing Manager” cases are used to tie theoretical and
empirical aspects.
How We Study Financial Markets and
Institutions (2 of 2)
Other features
1. Case studies
2. Applications and Numerical Examples
3. Special Interest Boxes
4. Hundred of analytical end-of-chapter problems
5. Predicting the Future problems
Exploring the Web (1 of 2)
Web Exercise
The World Wide Web is an enormous resource for present and
historical information. We will periodically present web
exercises to introduce some of the important locations for
information, and how to use it.
Exploring the Web (2 of 2)
Web Exercise
The next three slides (starting on page 11 in the text) show you
how to (1) find historical interest rates from the Fed and save
the information, (2) how to import the data into Excel, and (3)
how to examine the information using an Excel chart.
Figure 1.4 Federal Reserve Bank of St.
Louis, FRED Database
Source: https://fred.stlouisfed.org/series/GS10.
Figure 1.5 Excel Spreadsheet with
Interest-Rate Data
Source: Used with permission from Microsoft Corporation; https://fred.stlouisfed.org/series/GS1;

https://fred.stlouisfed.org/series/GS10.
Figure 1.6 Excel Graph of Interest-Data
Source: Used with permission from Microsoft Corporation.
Concluding Remarks
• This field is an exciting one, and this book will help you develop
skills to further your career and your understanding of financial
events.
• You will also have a better understanding of the controversies to
hotly debated in the political arena.
Chapter Summary (1 of 2)
• Why Study Financial Markets?: the three primary markets
(bond, stock, and foreign exchange) were briefly introduced.
• Why Study Financial Institutions?: the market, institutions, and
key changes affecting these were outlined.
Chapter Summary (2 of 2)
• Applied Managerial Perspective: the book will often present
material to better understand how actual managers use the
information in daily operations.
• How We Will Study Financial Markets and Institutions: we
outlines the three key components: analytical framework,
features, and web exercises.
Copyright
Tutorial
•
1. Explain the link between well-performing financial

markets and economic growth. Name one channel
through which financial markets might affect
economic growth and poverty
•
2. How would bank benefit when interest rates fall?
•
3. what effect might a fall in stock prices have on
business investment
•
4. explain the main difference between a bond and
a common stock.

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Financial Markets and Institutions

Source: Federal Reserve Bank of St. Louis, FRED database: https://fred.stlouisfed.org/series/TB3MS;

Source: Federal Reserve Bank of St. Louis, FRED database: https://fred.stlouisfed.org/series/DJIA.

Source: Federal Reserve Bank of St. Louis, FRED database:

Source: Used with permission from Microsoft Corporation; https://fred.stlouisfed.org/series/GS1;

Source: Used with permission from Microsoft Corporation.

1. Explain the link between well-performing financial

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