Week 2_Introduction to Financial Markets

INTRODUCTION TO BUSINESS FINANCE
INTRODUCTION TO FINANCIAL MARKETS
LECTURE SLIDS
(with voice notes explanation)
Page 1
• Meaning of Financial Markets

• Types of Financial Markets
• Efficient Market Hypothesis
• Types of Efficient Markets
Page 2
• Financial Intermediary
Financial Intermediary Diagram
A financial intermediary is an institution which links lenders with
borrowers, by obtaining deposits from lenders and then re-lending
them to borrowers.
• Examples of financial intermediaries are; Commercial banks,

Finance houses, Building societies etc.
• Financial Markets
They are places where surplus and deficits units meet to do business.
They provide a mechanism to match providers of funds (lenders) with users of funds (borrowers).
• Financial instruments are traded on the financial markets
Page 3
Functions of Financial Markets/Financial intermediaries
1. Avenue for raising funds 2. Providing liquidity
3. Minimize transactional cost 4. Establishing fair prices
5. Diversification 6. Risk shifting
7. Hedging – risk reduction approach
8. Arbitrage profit – buying security at a low price in one financial market and simultaneously
selling in another market to make risk free profit
Types of financial markets

• Primary and Secondary markets
• Capital and money markets
• Other forms of markets
Page 4
• Primary Markets
• They are markets for new or fresh issues. They enable organisations to raise new finance, by issuing
new shares or new bonds.
• Secondary markets
They are markets for subsequent issues. they enable existing investors to sell their investments, should
they wish to do so.
• Capital markets
They are markets for trading in long-term finance, in the form of long-term financial instruments such
as equities and corporate bonds. Two major capital markets are the Stock market and the Bond market
Page 5
• Money markets
They are markets for trading short-term financial instruments and short-term lending and borrowing
Examples of money instruments
1. Treasury bills
2. Overnight placement – funds borrowed or lent for one business day
3. Re-purchase agreement
4. Commercial paper – issued by large firms to obtain funds to meet short-term debt. Its an unsecure
promissory notes with a fixed maturity
5. Negotiable instrument
• The Foreign Exchange Markets: they trade in currencies
• The Derivative Markets: they arrange derivative contracts such as Forward contract, future
contracts, currency options, swaps etc.
Page 6
• Efficient Markets Hypothesis
The efficient market hypothesis is the hypothesis that the stock market reacts immediately to all the
information that is available. Thus a long term investor cannot obtain higher than average returns from
a well diversified share portfolio.
• Efficient Markets
Is a market where prices fully and instantaneously reflect all available information. Thus, prices
accurately and rapidly adjust to reflect the true intrinsic value of securities
• Definition of efficiency
i. Allocate Efficiency –if it directs savings towards the most productive firms.
ii. Operational efficiency – low transactional cost
iii. Information Processing Efficiency – extent to which information regarding future prospects of a
security is reflected in its current price.
Page 7
• Features of efficient market
1. The prices of securities bought and sold reflect all the relevant information which is available to
2. the buyers and sellers: in other words, share prices change quickly to reflect all new information
3. about future prospects
4. No individual dominates the market.
5. Transaction costs of buying and selling are not so high as to discourage trading significantly.
6. Investors are rational.
7. There are low, or no, costs of acquiring information.
Varying degrees of efficiency/Types of market efficiency

1. Weak market efficiency
prices reflect the information contained in the record of past prices. If markets are efficient in the weak
sense, then it is impossible to make consistently superior profits by studying past returns. Prices will
follow a random walk
Page 8
2. Semi-strong market efficiency
Prices reflect not just past prices but all other public information, for example, from the Internet or the
financial press. prices will adjust immediately to public information such as the announcement of the
last quarter’s earnings, a new issue of stock, or a proposal to merge two companies.
3. Strong-market efficiency
Prices reflect all the information that can be acquired by painstaking analysis of the company and the
economy. In such a market we would observe lucky and unlucky investors, but we wouldn’t find any
superior investment managers who can consistently beat the market
Page 9

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INTRODUCTION TO BUSINESS FINANCE

INTRODUCTION TO FINANCIAL MARKETS

• Meaning of Financial Markets

• Examples of financial intermediaries are; Commercial banks,

Types of financial markets

Varying degrees of efficiency/Types of market efficiency

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