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1、Part Financial Markets,Chapter 1 Functions of Financial MarketsChapter 2 Money MarketsChapter 3 Capital MarketsChapter 4 Foreign Exchange Markets,Chapter 1Functions of Financial Markets,1.1 SignificanceThe word“finance”signifies capital in monetary form,that is,in the form of funds lent or borrowed,
2、normally for capital purposes,through financial markets or financial institutions.When finance goes international,it is then an international finance.What is a financial market?It is a place where financial transactions take place.Financial markets facilitate the lending of funds from savers to thos
3、e who wish to undertake investments.Those that wish to borrow to finance investment projects sell financial instruments to savers.,When an investor purchases the securities issued by ultimate borrowers(those who use the funds to invest in real assets),capital market operations for equities,bonds wou
4、ld fall largely into this category.When an investor chooses to invest in the obligations of financial intermediaries,which in turn lend the funds to those who invest in real assets,they are operations in money market for term deposits and loans,interbank transactions of such nature.The primary disti
5、nction between the two channels is that,in the first case,i.e.direct financing,the investor is faced directly with the credit risk of the issuer,while in the second case,i.e.financing through financial intermediation,a financial institution,such as a bank,interjects itself between users and provider
6、s of funds.Any analysis of the sector of money market dominated by financial intermediaries must be very much concerned with these financial institutions themselves(their policies,financial conditions and official regulatory environment)in addition to those factors governing the suppliers and users
7、of funds.International financial transactions include purchases and sales of foreign currency,securities,gold bullion,and lending and borrowing.,Foreign exchange marker deals with the exchanges of different means of payment.These exchanges are necessary for international capital flows.As the relativ
8、e values among different currencies(the exchange rates)will fluctuate according to economic and political circumstances of the currencies of the relative countries,international investors or financiers face exchange risks.To this end,foreign exchange markets provide services,such as forward transact
9、ions and foreign currency futures to eliminate such risks.1.2 Functions Apart from borrowing from banks,a firm or an individual can obtain funds in a financial market in two ways.The most common method is to issue a debt instrument,such as a bond or a mortgage,which is a contractual agreement by the
10、 borrower to pay the holder of the instrument fixed amounts at regular intervals(interest and principal payments)until a specified date(the maturity date),when a final payment is made.The maturity of a debt instrument is short-term if its maturity is less than a year and long-term if its maturity is
11、 ten years or long.Debt instruments with a maturity between one and ten years are said to be intermediate-term.,The second method of raising funds is by issuing equities,such as common stock,which are claim to share in the net income(income after expenses and taxes)and the assets of a business.Equit
12、ies usually earn periodic payment(dividends)and are considered long-term securities because they have no maturity date.A primary market is a financial market in which new issues of a security,such as a bond or a stock,are sold to initial buyers by the corporation or government agency borrowing the f
13、unds.A secondary market is a financial market in which securities that have been previously issued(and are thus secondhand)can be resold.The primary market for securities is not well known to the public because the selling of securities to initial buyers take place behind doors.An important financia
14、l instrument that assists in the initial sale of securities in the primary market is the investment bank.It does this by underwriting securities,that is,it guarantees a price for a corporations securities and then sells them to the public.,When an individual buys a security in the secondary market,t
15、he person who sold the security receives money in exchange for the security,but the corporation that issued the security acquires no new funds.A corporation acquires new funds only when its security are first sold in the primary market.Nonetheless,the secondary market serves two important functions.
16、First,financial instruments are more liquid.The increased liquidity of the instruments makes them more desirable and thus easier for the issuing firm to sell in the primary market.Second,they determine the price of the security that the issuing firm sells in the primary market.The firms that buy sec
17、urities in the primary market will pay the issuing corporation no more than the price that they think the secondary market will set for this security.The higher the securitys price in the secondary market,the higher the price that the issuing firm will receive for a security in the primary market an
18、d hence the greater the amount of capital it can raise.Conditions in the secondary market are therefore the most relevant to corporations issuing securities.It is for this reason that studies dealing with financial market focus the behavior of secondary markets rather than primary markets.,Another w
19、ay of distinguishing market is on the basis of the maturity of the securities traded in each market.The money market is a financial market in which only short-term debt instruments(maturity of less one year)are traded;the capital market is the market in which long-term debt(maturity of one year or l
20、onger)and equity instruments are traded.Money market securities are usually more widely traded than long-term securities and so they are more liquid.In addition,short-term securities have smaller fluctuations in prices than long-term securities,making them the safer investment.As a result,corporatio
21、ns and banks actively use this market to earn interest on surplus funds that they expect to have only temporarily.Capital market securities,such as stocks and long-term bonds,are often held by individuals and financial intermediaries such as insurance companies and pension funds,which have little un
22、certainty about the amount of funds they will have available in the future.,Chapter 2 Money Markets,2.1 CharacteristicsMoney market instruments,which are discussed in detail later in this chapter,have three basic characteristics in common:They are usually sold in large denominations.They have low de
23、fault risk.They mature in one year or less from their original issue date.Most money market instruments mature in less than 120 days.The well-developed secondary market for money market instruments makes the money market an ideal place for a firm or financial institution to“warehouse”surplus funds f
24、or short periods of time until they are needed.Similarly,the money market provide a low-cost source of the funds to firms,the government,and intermediaries that need a short-term infusion of funds.,Most investors in the money market who are temporarily warehousing funds are ordinarily not trying to
25、earn unusually high returns on their money market funds.Rather,they use the money market as an interim investment that provides a higher return than holding cash or money in banks.They may feel that market conditions are not right to warrant the purchase of additional stock,or they may expect intere
26、st rates to rise and hence not want to purchase bonds.Idle cash represents an opportunity cost in terms of lost interest income.The money markets provide means to invest idle funds and to reduce this opportunity cost.At the same time,the sellers of money market instruments find that the money market
27、 provide a low-cost source of temporary funds.Why do corporations and the government sometimes need to get their hands on funds quickly?The primary reason is that cash inflows and outflows are rarely synchronized.The money market provides an efficient,low-cost way of solving these problems.,2.2 Part
28、icipants of Money Market1.The GovernmentIn money market,the government is unique because it is always a supplier and demander of money market funds.The U.S.Treasury is the largest of all money market borrowers worldwide.It issues Treasury bills(often called T-bills)and other securities that are popu
29、lar with other money market participants.Short-term issues enable the government to raise the maturing issues.2.The Central BankThe Central Bank is the Treasurys agent for the distribution of government securities.The central bank holds vast quantities of Treasury securities that it sells if it beli
30、eves that the money supply should be reduced.Similarly,the central bank purchases Treasury securities if it believes that the money supply should be expanded.The central banks responsibility for the money supply makes it the single most influential participant in the money market.,3.Commercial Banks
31、 Commercial banks hold a larger percentage of government securities than any other group of financial institutions.This is partly because of regulations that limit the investment opportunities available to banks.Specifically,banks are prohibited from owning risky securities,such as stocks or corpora
32、te bonds.There are no restrictions against holding Treasury securities because of their low risk and high liquidity.Banks are also the major issuer of negotiable certificates of deposit(CDs),bankers acceptances,and repurchase agreements.In addition to money market securities to help manage their own
33、 liquidity,many banks trade on behalf of their customers.Not all commercial banks deal for their customers in the secondary money market.The ones that do are among the largest in the country and are often referred to as money center banks.,4.BusinessesMany businesses buy and sell securities in the m
34、oney market.Such activity is usually limited to major corporations because of the large transactions involved.As discussed earlier,the money market is used extensively by businesses both to warehouse surplus funds and to raise short-term funds.5.Investment CompaniesLarge diversified brokerage firms
35、are active in money markets.The primary function of these dealers is to“make a market”for money market securities by maintaining an inventory from which to buy or sell.These firms are very important to the liquidity of the money market because they help ensure that both buyers and sellers can readil
36、y market their securities in the primary market as well as in the secondary market.,6.Insurance CompaniesProperty and casualty insurance companies must maintain liquidity because of their unpredictable need for funds.To meet this demand,the insurance companies sell some of their money market securit
37、ies to raise cash.As to the life insurance companies,because their obligations are reasonably predictable,large money market security holdings are unnecessary.However,it is a common practice that an individual can have his/her money invested in the money market through the agent department of banks
38、and investment companies,to earn a higher interest rate than otherwise deposited in the banks.2.3 Instruments of Money Market Securities with maturities within one year are referred to as money market instruments.A variety of money market instruments are available to meet the diverse needs of market
39、 participants.,1.Treasury BillsTo financial the national debt,the government issues a variety of debt securities.The most widely held liquid security is the Treasury bill,which is commonly issued by the ministry of finance.However,some Treasury bills,like the Treasury bill of the U.S.government,do n
40、ot actually pay interest.Instead they are issued at a discount from par(their value at maturity).The investors yield comes from the increase in the value of the security between the time it was purchased and the time it matures.2.Inter-bank MarketsInter-bank markets are money markets in which short-
41、term funds transferred(loaned or borrowed)between financial institutions,usually for a period of one day,that is,they are usually overnight investment.The interest rate for borrowing these funds is close to,but always slightly higher than rate that is available from the central bank.3.Commercial Pap
42、erCommercial paper is a short term debt instrument issued only by well-known,larger and creditworthy corporations.,It is typically unsecured,and the interest rate placed on it reflects the firms level of risk.It is normally issued to provide liquidity or finance a firms investment and accounts recei
43、vable.The issuance of commercial paper is an alternative to short-term bank loan.4.NCDs or CDsA negotiable certificate of deposit is a bank-issued security that documents a deposit and specifies the interest rate and the maturity date.It was firstly issued in 1961 by Citibank.Because a maturity date
44、 is specified,a CD is a term security as opposed to a demand deposit.Term securities have a specified maturity date while demand deposits can be withdrawn at any time.A CD is also called a bearer instrument.This means that whoever holds the instrument at maturity receives the principal and interest.
45、The CD can be bought and sold until maturity.5.Banks AcceptancesA banks acceptance is an order to pay a specified amount of money to the bearer on a given date.Bankers acceptances have been in use since the twelfth century,and are commonly used for international trade transactions.,Chapter 3 Capital
46、 Markets,3.1 Purpose and ParticipantsFirms that issue capital market securities and the investors who buy them have very different motivations than they have when they operate in the money market.Firms and individuals use the money market primarily to warehouse funds for short periods of time until
47、a more important need or a more productive use for the funds arises.By contrast,firms and individuals use the capital market for long-term investments.The capital markets provide an alternative to investment in assets such as real estate or gold.Meanwhile,the primary reason that individuals and firm
48、s choose to borrow long-term funds is to reduce the risk that interest rates will rise before they pay off their debt.This reduction in risk comes at a cost.However,Most long-term interest rates are higher than short-term rates due to risk premiums.Despite the need to pay higher interest rates to bo
49、rrow in the capital markets,these markets remain very active.,The primary issuers of capital market securities are governments and corporations.However,governments never issue stocks.Corporations both issue bonds and stocks.One of the most difficult decisions a firm faces can be whether it should fi
50、nance its growth with debt or equity.The distribution of a firms capital between debt and equity is its capital structure.3.2 Trading in the Capital MarketCapital market trading occurs in either the primary market or the secondary market.Investment funds,corporations,and individual investors can all
