Jamil Ahmed Assistant Professor

Financial System
Financial System channels funds from savors (lenders/saving surplus units) to users (borrowers/saving deficit units). Therefore, a Financial System comprises of some intermediaries and financial markets who bridge gape between the surplus units and deficits units. The system actually provides a meeting point or focal point for who have recourses to spare and who need them. The intermediaries in turn are composed of institutions classified under three categories i.e. Deposit Institutions, Investment Institutions and Contractual Institutions.
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Flow of Funds

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Components of Financial System

Individuals, businesses, national governments, govt. agencies, local/state governments who form financial market. Financial Intermediaries. Regulators i.e. SBP/SECP & other participants like security exchanges.

Financial Markets
Financial markets provide a forum in which suppliers of funds and demanders of funds can transact business directly.

Its a market where financial assets are traded/exchanged.

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Real Assets / Financial Assets

Real Assets: Assets owned by an entity having physical shape or are tangible in nature i.e. Land, building, equipment etc. Financial Assets: They are intangible assets representing claim against the future cash flows. Both assets are linked as to acquire the real assets a firm has to issue financial assets.
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The Role of Financial Assets

They help in transfer of funds from those have the surplus to the ones who are in deficit. They redistribute the risk associated with cash flow generated by tangible assets among those seeking and those providing the assets.

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Role of Financial Markets

Determine the price or required rate of return of an asset. Provide liquidity i.e. ability to convert an asset to cash. Reduces the transaction cost, which consists of search costs and information costs. Payment Mechanism
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Classification of Financial Markets - Primary Vs Secondary Markets Primary Markets

A financial market dealing with financial claims that are newly issued, is called the primary market. These markets distribute the newly issued securities to investors.

Market Participants:
Corporations & governments as issuers. Various investors i.e. which include individuals, all categories of businesses and governments. Investment bankers who act as agents for issuers.

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Primary Markets (Cont)

Process of issuing the new Securities:

The issuers usually involve an investment banker to facilitate the issue by:
advising the issuers of financial assets on the terms and timing of the offering (termed as financial innovation function). Buying the securities from the issuer (termed Underwriting of securities and the firm doing so is called Underwriter). The deal is called firm commitment as the underwriter agrees to pay a set price to issuer. Distribute the issue to the public.
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Primary Markets
Process of issuing the new Securities (Cont) :
The fee earned by underwriter is difference between the price paid to the issuer and security re-offered to the investors, termed as Gross Spread or Underwriter Discount. However, when underwriter only facilitates issue using its expertise, the arrangement is referred as best Effort. The New issue of securities issued through Primary Markets are referred to as IPOs Initial Public Offerings. Due to risk in taking whole issue, usually a number of investment banker undertake an IPOs issue, called a Syndicate. The spread in this case is divided among syndicate members.

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Primary Markets
Process of issuing the new Securities (Cont) :

The IPOs may also be issued by following processes:

Bought deals Auction Process Preemptive Rights offering

Private Placements: The distribution of shares to a limited number of institutional investors.

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Secondary Markets
The financial Market where already issued financial assets are traded. Key feature is that the issuer of the security does not benefit from and does not play any role in this market i.e. issuer does not get funds from buyers of his securities. Existing issue change hands.

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Secondary Market
Functions of Secondary Markets Provides information about the value of a financial assets and in turn a firm issuing the securities. How investors value both. Non Corporate companies analyze the prices of their bonds and the rate of interest investors expect and demand. They provide the investors/financial assets liquidity. Reduces the cost of transactions.

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Secondary Markets
What constitutes Secondary Markets:

Stock Exchange
Stock Indices: Market Value Weighted Index: measures the total value of all the outstanding stock issued by the various companies in the index. Float Adjusted Index: the value of the index reflects the value available in the public markets. Price Weighted Index: index is calculated using a stock price instead of the company value.

OTC Markets: Represents group of traders dispersed in a geographical area and linked to an stock exchange.

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Debt Vs Equity Market:

Debt Market: is a financial market where all sorts of debt instruments or financial assets characterized as debt are traded.
Examples of debt instruments includes T-Bills, notes, bonds and CDs. Participants: Institutional Investors, Govt.s, Traders, Individuals.

Equity Market: is financial market where equity instruments or financial assets representing equity are traded.

Participants: Institutional Investors, traders and individuals, Govt.s etc.

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Money Vs Capital Market

Money Market: A financial Market where Short Term Debt securities are traded e.g. bankers acceptance, commercial papers, repos, negotiable certificates of deposits, Treasury bills of maturity of one year or less. Capital Market: is the market of financial assets, where issuers can raise long term funds and such assets are traded e.g. stocks and bonds.
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Broker Markets and Dealer Markets

Broker markets consists of national and regional securities exchanges, which are organizations that provide a marketplace in which firms can raise funds the sale of new securities and purchasers can resell securities Dealer markets consist of both the Nasdaq market and and the over-the-counter (OTC) market, where the (unlisted) shares of smaller firm are sold and traded.
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Broker Markets and Dealer Markets (continued)

The key difference between broker and dealer markets is a technical point dealing with the way trades are executed. When a trade occurs in a broker market, buyers and sellers are brought together and the trade takes place on the floor of the exchange. In contrast, buyers and sellers are never actually brought together in a dealer transactions are executed by securities dealers that make markets in certain securities.
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Broker Markets and Dealer Markets (cont.)

The New York Stock Exchange (NYSE) is the most famous of all broker markets and accounts for about 60% of the value of shares traded in the U.S. stock markets. Trading is conducted through an auction process where specialists make a market in selected securities. As compensation for executing orders, specialists make money on the spread (bid price ask price).

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Broker Markets and Dealer Markets (cont.)

The over-the-counter (OTC) market is intangible market for securities transactions. an

Unlike organized exchanges, the OTC is both a primary market and a secondary market. The OTC is a computer-based market where dealers make a market in selected securities and are linked to buyers and sellers through the NASDAQ System. Dealers also make money on the spread.
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International Capital Markets

In the Eurobond market, corporations and governments typically issue bonds denominated in dollars and sell them to investors located outside the United States.
The foreign bond market is a market for foreign bonds, which are bonds issued by a foreign corporation or government that is denominated in the investors home currency and sold in the investors home market.

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International Capital Markets (cont.) Finally, the international equity market allows corporations to sell blocks of shares to investors in a number of different countries simultaneously.
This market enables corporations to raise far larger amounts of capital than they could raise in any single national market.

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Money Market Instruments

Following are commonly used money market instruments:

Treasury Bills Federal Funds Repurchase Agreements Negotiable Certificates of Deposit Commercial Papers Bankers Acceptance Eurodollars
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Capital Market Instruments

Following are commonly used money market instruments:

T Bonds Corporate Bonds Municipal Bonds Stocks

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