Mishkin Econ13e PPT 02
Mishkin Econ13e PPT 02
Financial Markets
Thirteenth Edition
Global Edition
Chapter 2
An Overview of the
Financial System
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• To study the effects of financial markets and financial
intermediaries on the economy, we need to acquire an
understanding of their general structure and operation.
• This chapter begins that process by presenting an
overview of the study of financial markets and institutions.
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Learning Objectives (1 of 2)
2.1 Compare and contrast direct and indirect finance.
2.2 Identify the structure and components of financial
markets.
2.3 List and describe the different types of financial market
instruments.
2.4 Recognize the international dimensions of financial
markets.
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Learning Objectives (2 of 2)
2.5 Summarize the roles of transaction costs, risk sharing,
and information costs as they relate to financial
intermediaries.
2.6 List and describe the different types of financial
intermediaries.
2.7 Identify the reasons for and list the types of financial
market regulations.
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Function of Financial Markets (1 of 2)
• Performs the essential function of channeling funds from
economic players that have saved surplus funds to those
that have a shortage of funds
• Direct finance: borrowers borrow funds directly from
lenders in financial markets by selling them securities
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Function of Financial Markets (2 of 2)
• Promotes economic efficiency by producing an efficient
allocation of capital, which increases production
• Directly improve the well-being of consumers by allowing
them to time purchases better
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Figure 1 Flows of Funds Through the
Financial System
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Structure of Financial Markets (1 of 2)
• Debt and Equity Markets
– Debt instruments (maturity)
– Equities (dividends)
• Primary and Secondary Markets
– Investment banks underwrite securities in primary
markets.
– Brokers and dealers work in secondary markets.
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Structure of Financial Markets (2 of 2)
• Exchanges and Over-the-Counter (OTC) Markets:
– Exchanges: NYSE, Chicago Board of Trade
– OTC markets: Foreign exchange, Federal funds
• Money and Capital Markets:
– Money markets deal in short-term debt instruments
– Capital markets deal in longer-term debt and equity
instruments
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Financial Market Instruments (1 of 2)
Table 1 Principal Money Market Instruments
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Financial Market Instruments (2 of 2)
Table 2 Principal Capital Market Instruments
Type of Instrument Amount ($ Amount ($ Amount ($ Amount ($
billions, end billions, end billions, end billions, end
of year) of year) of year) of year)
1990 2000 2010 2016
Corporate stocks (market value) 3,530 17,628 23,567 38,685
Residential mortgages 2,676 5,205 10,446 10,283
Corporate bonds 1,703 4,991 10,337 12,008
U.S. government securities (marketable long-term) 2,340 3,171 7,405 12,064
U.S. government agency securities 1,446 4,345 7,598 8,531
State and local government bonds 957 1,139 2,961 3,030
Bank commercial loans 818 1,497 2,001 3,360
Consumer loans 811 1,728 2,647 3,765
Commercial and farm mortgages 838 1,276 2,450 2,850
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Function of Financial Intermediaries:
Indirect Finance (1 of 3)
• Lower transaction costs (time and money spent in
carrying out financial transactions)
– Economies of scale
– Liquidity services
• Reduce the exposure of investors to risk
– Risk sharing (asset transformation)
– Diversification
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Function of Financial Intermediaries:
Indirect Finance (2 of 3)
• Deal with asymmetric information problems:
– Adverse Selection (before the transaction): try to
avoid selecting the risky borrower by gathering
information about them
– Moral Hazard (after the transaction): ensure borrower
will not engage in activities that will prevent him/her to
repay the loan.
▪ Sign a contract with restrictive covenants.
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Function of Financial Intermediaries:
Indirect Finance (3 of 3)
• Financial intermediaries can also achieve economies of
scope; that is, they can lower the cost of information
production for each service by applying one information
resource to many different services, but they can also
create potential costs in terms of conflicts of interest.
• Overall conclusion:
– Financial intermediaries allow “small” savers and
borrowers to benefit from the existence of financial
markets.
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Types of Financial Intermediaries (1 of 6)
Table 3 Primary Assets and Liabilities of Financial Intermediaries
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Types of Financial Intermediaries (2 of 6)
[Table 3 Continued]
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Types of Financial Intermediaries (3 of 6)
[Table 3 Continued]
Investment intermediaries
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Types of Financial Intermediaries (4 of 6)
Table 4 Primary Financial Intermediaries and Value of Their
Assets
Commercial banks,
savings and loans, and 4,744 7,687 12,821 16,834
mutual savings banks
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Types of Financial Intermediaries (5 of 6)
[Table 4 Continued]
Type of Intermediary Value of Assets Value of Assets Value of Assets Value of Assets
($ billions, end ($ billions, end ($ billions, end ($ billions, end
of year) of year) of year) of year)
1990 2000 2010 2016
Life insurance companies 1,367 3,136 5,168 6,764
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Types of Financial Intermediaries (6 of 6)
[Table 4 Continued]
Investment intermediaries
Type of Intermediary Value of Assets Value of Assets Value of Assets Value of Assets
($ billions, end of ($ billions, end ($ billions, end ($ billions, end
year) of year) of year) of year)
1990 2000 2010 2016
Finance companies 612 1,140 1,589 1,385
Mutual funds 608 4,435 7,873 13,616
Money market mutual 493 1,812 2,755 2,728
funds
https://www.federalreserve.gov/releases/z1/current/data.htm , Tables L110, L114, L115, L116, L118, L120, L121, L122, L127.
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Regulation of the Financial System (1 of 4)
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Regulation of the Financial System (2 of 4)
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Regulation of the Financial System (3 of 4)
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Regulation of the Financial System (4 of 4)
[Table 5 Continued]
State banking and insurance State-chartered depository Charter and examine the books of
commissions institutions and insurance state-chartered banks and insurance
companies companies, impose restrictions on
assets they can hold, and impose
restrictions on branching
Federal Deposit Insurance Commercial banks, mutual Provides insurance of up to
Corporation (FDIC) savings banks, savings and $250,000 for each depositor at a
loan associations bank, examines the books of
insured banks, and imposes
restrictions on assets they can hold
Federal Reserve System All depository institutions Examines the books of commercial
banks and systemically important
financial institutions; sets reserve
requirements for all banks
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