FICM Ch-I

Advanced Financial
Markets and
Institutions
1
Course Contents
 Chapter 1: An Overview of the Financial System.
 The role of financial system in the economy
 Financial assets
 Financial markets: role, classifications and participants
 Financial Institutions
 Regulation of financial systems
 Chapter 2: Financial Institutions in the Financial System
 Introduction
 Depository financial institutions
 Commercial Banks
 Saving and Loan Associations
 Credit Unions
 Microfinance institutions
 Non Depository Financial Institutions
 Insurance companies
 Pension funds
 Mutual funds
Chapter I Overview of the Financial System
 Investment Banking Firms
…
 Chapter 3: Central Banking System
 Evolution of Central Banking
 Central Banking Functions
 Monetary Policy & its Objectives
 The Money Supply Process
 Chapter 4: Determinants of asset price and interest
rates
 Properties and pricing of financial assets
 The level and structure of interest rates
 The term structure of interest rates

 Chapter 5: Financial Markets In The Financial System
 Organization and Structure of Markets
 Primary and secondary markets
 The Money Market
 Capital Market
 Debt Market
 Equity Market
 Foreign Exchange Markets

 The Derivative Market
 Financial futures market
 Options markets
 Swaps, caps, floor and credit derivatives

MATERIALS TO REFER
 Fabozzi, Frank J, Franco Modigliani, Frank J. Jones. Financial Institutions
and Markets. 4th Edition, USA
 Saunders, Anthony and Marcia Millon Cornett. Financial
markets and institutions, 6th Edition.
 Rose, Peter S. Money and capital markets: The financial
system in an increasingly global economy. 5th Ed,
 Any recent edition of books on the subject of financial institutions and capital
markets
 Websites like: www.nbe.gov.et ; www.MOFEC.gov.et

Course Evaluation
1. Critical Appraisal of a Selected Area/Aspect/Feature of
the Ethiopian Finance Industry – Group Term Paper (30%)
2. Presentation (10%)
3. Review of an article from a reputable journal on the

subject of finance vis-a-vis globalization- Individual (20%)
4. Final Exam (40%)

Chapter one
Overview of the
Financial System.

Why study Financial Markets and
Institutions?
 They are the cornerstones of the overall

financial system in which financial managers
operate.
 Individuals use both for investing.
 Corporations and governments use both for
financing.

Introduction to Financial system
Definition:
The Financial system is a set of global,
regional, or firm specific institutions and
practices used to facilitate the exchange of
funds. It aims at establishing and providing
smooth, regular, efficient and effective
linkage between savers(depositors) and
investors(borrowers).

Introduction ….Cont’d
 Financial systems consist of:
 Financial markets
 Financial institutions/intermediaries/
 Financial Assets and,
 Regulators of financial activities

Financial markets are markets where people buy and sell financial
instruments like stocks, bonds and futures contracts.
Classification of financial Markets

• The following are some of the ways to classify financial markets:
1.By type ( nature) of financial claim.
• Debt market- Debt instruments.
• Equity Market
2.By maturity of financial claim.
• Money market- Short term debt instruments. eg Treasury bills,
• Capital market- Long-term financial instruments. Eg. stocks,
bonds
3.By seasoning of financial claim.
• Primary market- newly issued securities
• Secondary market - previously issued securities
5
4. By immediate delivery or future delivery
• Cash or spot market -immediate and
• Derivative market-future delivery
5. By organizational structure
• Auction Market -
• Over-The-Counter Market (OTC)-
Introduction ….Cont’d
 Financial institutions are what make financial markets work. They

facilitate the flow of funds:
By selling financial claims to generate funds
&
Use the money to buy financial claims
(IOUs) of economic units, there by funding
them.
These are banks, insurance companies, investment banks,

pension funds, credit unions

Types of FIs
 Commercial banks
 Depository institutions whose major assets are loans and
major liabilities are deposits
 Thrifts
 Depository institutions in the form of savings and loans,
credit unions
 Insurance companies
 Financial institutions that protect individuals and
corporations from adverse events

…
 Investment banks
 Financial institutions that underwrite securities and engage
in securities brokerage and trading
 Mutual Funds
 Financial institutions that pool financial resources and invest
in diversified portfolios
 Pension Funds
 Financial institutions that offer savings plans for retirement

Economic Functions Performed by Financial
Institutions
What would economic agents with excess cash do in a world

of No Financial Institutions?
a. Hold the cash
b. Make a direct transfer to those agents in need of funds
for their profitable projects.
Because of (1) monitoring costs, (2) liquidity costs, and

(3) price risk, the agents would likely view direct
investment as an unattractive proposition and prefer to
hold cash. As a result, financial market activity (and
therefore savings and investment) would likely remain
quite low.
… The financial system has developed an alternative and indirect way for

investors (or fund suppliers) to channel funds to users of funds. This is the
indirect transfer of funds to the ultimate user of funds via FIs.

Services Performed by Financial Institutions
1. Services Benefiting Suppliers of Funds

 Reduced Monitoring (and Transaction) costs
 Liquidity and price risk- Through their ability to reduce risk by holding a number
of different securities in a portfolio
 Maturity intermediation
2. Services Benefiting the Overall Economy

 Money supply transmission
 Credit allocation
 Intergenerational wealth transfers
 Payment services

Risks Faced by Financial
Institutions
 Interest Rate Risk
 Foreign Exchange Risk
 Market Risk
 Credit Risk
 Liquidity Risk
 Technology Risk
 Country or Sovereign Risk
 Insolvency Risk

Financial Assets
Real Assets Vs Financial Assets
Real Assets
 The material wealth of a society is determined ultimately by the productive
capacity of its economy
 i.e. the goods and services that can be provided to its members.
 This productive capacity is a function of the real assets of the economy.

Financial Assets
 A financial asset is a legal contract that gives its owner a claim

to payments, usually generated by a real asset.
 Financial instruments are no more than sheets of paper.

 Their value is derived from the value of the underlying real
assets.
 Examples include stocks, bonds, bank deposit, bank loans,
options, futures, etc.

Properties of Financial Assets
 The following are the properties of Financial Assets, which distinguish

them from Physical and Intangible Assets:
1. Currency:
 Financial Assets are exchange documents with an attached value. Their

values are dominated in currency units determined by the government of a
country.

Cont’d
2. Divisibility
 Financial Instruments are divisible into smaller units. The total value
is represented in terms of divisions that can be handled in a trade.
The divisibility characteristic of Financial Assets enables all players,
small or big, to participate in the market.
3. Convertibility
 Financial Assets are convertible into any other type of asset. This
characteristic of convertibility gives flexibility to financial
instruments.

Cont’d
4. Reversibility
 Financial assets are highly reversible. Cost of investing in financial

assets and getting them back into cash is negligible.
5. Liquidity
 The financial asset can be exchanged for currency with another

market participant who does not have immediate cash need, but
expects future benefits.
6. Information Availability
 In many cases, information concerning financial assets is more

readily available than for real assets
Regulation of Financial
Institutions
 FIs provide vital financial services to all sectors of the economy;
therefore, their regulation is in the public interest.
 The numerous rules and regulations directed at financial institutions
are designed to serve several purposes, which fall into the following
categories;
 To prevent issuers of securities from defrauding investors by

concealing relevant information
 Promote competition and fairness in the trading of financial
securities.
 To promote the stability of financial institutions.
 To restrict the activities of foreign concerns in domestic markets
and institutions.
 To control the level of economic activity.
Globalization of Financial
Markets and Institutions
 Financial Markets became more global
as the value of stocks traded in foreign
markets soared
 Foreign bond markets have served as a
major source of international capital
 Globalization also evident in the
derivative securities market


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Advanced Financial

Chapter I Overview of the Financial System

 Foreign Exchange Markets

Chapter I Overview of the Financial System

Chapter I Overview of the Financial System

3. Review of an article from a reputable journal on the

4. Final Exam (40%)

Chapter I Overview of the Financial System

Chapter I Overview of the Financial System

 They are the cornerstones of the overall

Chapter I Overview of the Financial System

Chapter I Overview of the Financial System

 Financial systems consist of:

 Financial Assets and,

 Regulators of financial activities

Chapter I Overview of the Financial System

Classification of financial Markets

 Financial institutions are what make financial markets work. They

These are banks, insurance companies, investment banks,

Chapter I Overview of the Financial System

Chapter I Overview of the Financial System

Chapter I Overview of the Financial System

What would economic agents with excess cash do in a world

Because of (1) monitoring costs, (2) liquidity costs, and

Chapter I Overview of the Financial System

1. Services Benefiting Suppliers of Funds

2. Services Benefiting the Overall Economy

Chapter I Overview of the Financial System

Chapter I Overview of the Financial System

Real Assets Vs Financial Assets

Chapter I Overview of the Financial System

 A financial asset is a legal contract that gives its owner a claim

 Financial instruments are no more than sheets of paper.

Chapter I Overview of the Financial System

 The following are the properties of Financial Assets, which distinguish

 Financial Assets are exchange documents with an attached value. Their

Chapter I Overview of the Financial System

Chapter I Overview of the Financial System

 Financial assets are highly reversible. Cost of investing in financial

 The financial asset can be exchanged for currency with another

 In many cases, information concerning financial assets is more

 To prevent issuers of securities from defrauding investors by

Chapter I Overview of the Financial System

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