Fundamenta

ls of
Corporate
Finance

Chapter 2
Financial Markets and
Institutions

Sixth Edition

Richard A. Brealey
Stewart C. Myers
Alan J. Marcus

Instructor: Sanam Taimoor

Institute of Business
Management

Topics Covered
The Importance of Financial Markets
and Institutions
The Flow of Savings to Corporations
Functions of Financial Markets and of
Financial Intermediaries
Value Maximization and the Cost of
Capital

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The Flow of Savings to Corporations

The money that corporations invest
in real assets comes from the savings
by the investors
That money may pass through
financial markets, financial
intermediaries or both.

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Financial Markets
Financial markets
Stock markets
Fixed-income markets
Money markets
Markets for
Commodities
Foreign exchange
Corporation Reinvestment
Derivatives
Investment
in real assets

Investors
worldwide

Financial
Intermediaries
Mutual Funds
Pension funds
Financial
Institutions
Banks
Insurance
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Myers & Marcus 6
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companies

Financial Markets
Is a market where securities are
issued and traded.
Securities are financial assets such
as a share of stock
Example:
Stock Market AKA Equity Market
Fixed-income market Market for debt
securities
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The Stock Market

IPO Initial Public Offering
Primary Market
For the sale of new securities by corporations

Secondary Market
Markets in which previously issued securities
are traded among investors

Over the Counter Market

In the OTC market,trading occurs via a
network of middlemen, called dealers, who
carry inventories of securities to facilitate the
buy and sell orders of investors
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Fixed Income Markets

Fixed income securities
An investment that provides a return in the
form of fixed periodic payments and the
eventual return of principal at maturity.
Unlike a variable-income security, where
paymentschange based on some
underlying measure such as short-term
interest rates, the payments of a fixedincome security are known in advance.
Example - Bonds
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 An example of a fixed-income
security would be a 5%fixedrategovernment bond where a
$1,000investment would result in an
annual$50 paymentuntil maturity
when the investor would receive the
$1,000 back. Generally, these types
of assets offer a lower return on
investment because they guarantee
income.
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 Capital Markets
A marketin whichindividuals and institutions
tradelong term financial securities.
Organizations /institutions in the public and
private sectors also often sell securities on
the capital markets in order to raise funds.
Thus, this type of market is composed of both
theprimary and secondary markets.

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 Money Market
Asegment of the financialmarket in which
financial instruments with high liquidity and
very short maturities are traded.
The money marketis used by participants
as a means for borrowing andlending in
the short term, from several days to just
under a year.
Money market securities consist of
negotiable certificates of deposit (CDs),
bankers acceptances, U.S. Treasury bills,
commercial paper, municipal notes, federal
fundsand repurchase agreements (repos).
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Other Financial Markets

Foreign-exchange markets
The market in which participants are
able to buy, sell, exchangeand
speculate on currencies.Foreign
exchange marketsare made up of
banks, commercial companies, central
banks, investment management firms,
hedge funds, and retail forex brokers
and investors.
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 Commodities markets
An entity, usually an incorporated nonprofit association, that determines and
enforces rules and procedures for the
trading of commodities and related
investments, such as commodity
futures.Commodities exchange also
refers to the physical center where
trading takes place.
Examples Wheat, cotton, fuel, copper,
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 Markets for options and derivatives

the derivatives market is the financial market
for derivatives, financial instruments like
futures contracts or options, which are
derived from other forms of assets.
a derivative is a financial instrument (or,
more simply, an agreement between two
parties) that has a value, based on the
expected future price movements of the asset
to which it is linkedcalled the underlying
assetsuch as a share or a currency
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Financial Intermediaries
An institution that acts as the
middleman between investors and
firms raising funds.
Financial intermediation consists of
channeling funds between surplus
and deficit agents
Examples mutual funds and pension
funds
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Mutual Funds
An investment company that pools the savings of
many investors and invests in a portfolio securities
such as stocks, bonds, money marketinstruments
and similar assets.
Mutual funds are operated by money mangers, who
invest the fund's capital and attempt to produce
capital gains and income for the fund's investors
Advantages:
givesmall investors access toprofessionally managed,
diversified portfolios of equities, bonds and other
securities, which would be quite difficult
each shareholder participates proportionally in the gain
or loss of the fund.
Diversification
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Pension Funds
A fund established by an employer to
facilitate and organize the
investment of employees'
retirementfunds contributed bythe
employer andemployees.
They are designed for long term
investments
They provide tax advantage
contributions are tax deductible.
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Financial Institutions
A financial institution is a financial
intermediary which does more than
just pool and invest savings
Examples
Banks
Commercial Banks
Investment Banks

Insurance companies
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Functions of Financial Markets and

Intermediaries

Transporting cash across time

Risk transfer and diversification
Liquidity
The payment mechanism
Providers of information

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