Chapter 1 Introduction

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall1

Introduction

Chapter 1


Types of AssetsTangible Assets

Value is based on physical propertiesExamples include buildings, land, machinery

Intangible AssetsClaim to future incomeExamples include various types of financial

assets


Types of Financial AssetsBank loansGovernment

bondsCorporate

bondsMunicipal

bondsForeign bond

Common stockPreferred stockForeign stock


Debt vs. EquityDebt Instruments

Fixed dollar paymentsExamples include loans, bonds

Equity ClaimsDollar payment is based on earningsResidual claimsExamples include common stock, partnership

share


Price of Financial Asset and RiskThe price or value of a financial asset is

equal to the present value of all expected future cash flows.Expected rate of returnRisk of expected cash flow


Types of Investment Risks

Purchasing power risk or inflation risk

Default or credit risk

Exchange rate or currency risk


Role of Financial AssetsTransfer funds from surplus units to deficit

units.Transfer funds so as to redistribute

unavoidable risk associated with cash flows generated from both tangible and intangible assets.


Key Points You Should Understand Difference between tangible and financial

assets Difference between debt and equity Cash flow of a financial asset Three types of risks associated with

financial asset Two principal economic functions of

financial assets


Role of Financial MarketsDetermine price or required rate of return

of asset.Provide liquidity.Reduce transactions costs, which consists

of search costs and information costs.


Classification of Financial MarketsDebt vs. equity marketsMoney market vs. capital marketPrimary vs. secondary marketCash or spot vs. derivatives marketAuction vs. over-the-counter vs.

intermediated market


Financial Market ParticipantsHouseholdsBusiness unitsFederal, state, and local governmentsGovernment agenciesSupranationalsRegulators


Key Points You Should UnderstandThree economic functions of financial

markets Ways that financial markets can be

classified Market participants


Globalization of Financial MarketsDeregulation or liberalization of financial

markets

Technological advances

Increased institutionalization


Classification of Global Financial Markets

Internal Market(also called national

market)

External Market(also called internationalmarket, offshore market,

and Euromarket)

Domestic Market Foreign Market


Motivation for Using Foreign Markets and Euromarkets

Limited fund availability in internal market

Reduced cost of funds

Diversifying funding sources


Derivatives MarketFutures/forward contracts are obligations

that must be fulfilled at maturity.Options contracts are rights, not

obligations, to either buy (call) or sell (put the underlying financial instrument.


Role of Derivative InstrumentsProtect against different types of

investment risks, such as purchasing power risk, interest rate risk, exchange rate risk.

Advantages:Lower transactions costsFaster to carry out transactionGreater liquidity


Key Points You Should UnderstandThree major factors that have integrated

financial markets Institutionalization of financial markets Internal and external markets Motive to raise money outside of domestic

market Two basic types of derivatives Principal economic role of derivatives Potential uses of derivatives


Types of RegulationDisclosure regulation Financial activity regulation Regulation of financial institution Regulation of foreign participation


Regulation in the United States Reasons for regulation

Stock market crash of 1929 Great Depression of 1930s

Regulation primarily by SEC, CFTC, Treasury, and Federal Reserve

“Blueprint for Regulatory Reform” Split regulation by functions

Market stability regulator Prudential regulator Business conduct regulator


Key Points You Should UnderstandExplanation for the existence of regulation Goals sought in regulation Major forms of regulation “Blueprint for Regulatory Reform”


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Chapter 1 Introduction

Business

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financial assets difference

prentice h20 regulation

offshore market

international market

intermediated market

equity markets money

regulation stock market