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Financial Instruments
transfer of available funds
buying and selling offinancial instruments or
securities
A financial instrument is the written legal
obligation of one party to transfer something of
value, usually money, to another party at some
future date, under certain conditions.
Financial Instruments
1) binding, enforceable contract under the rule of
law, protecting potential buyers.
2) transfer of value between two parties, where a
party can be a bank, insurance company, a
government, a firm, or an individual.
The future dates may be very specific (like a monthly
mortgage payment) or may be quite uncertain and
depend on certain events (like an insurance policy)
Financial instruments
can function as a means of payment or a store of value
means of payment
fall well short of money in terms of liquidity, divisibility,
and acceptance
better stores of value since they allow for greater
increases in wealth over time, but with higher levels of
risk
Financial instruments
3) function of these instruments is risk
transfer
buyers are shifting risk to the seller
paying the seller to assume certain risks
Ex. insurance
Financial instruments
standardized in that they have the same
obligations and contract for buyers
Ex. Stocks, loans
Uniformity reduce cost
Financial instruments
provide certain relevant information about
the issuer, the characteristics and the risks
of the security
even the playing field among different
parties and reduce unfair advantages
Financial instruments
size, timing and certainty of cash flows are all important
The larger amount promised, the greater the value
The sooner the payments are promised, the greater
the value
The more certain the payments, the greater the value
The more needed the payment, the greater the value
Ex. insurance
Instrument type
Asset class
Securities
Other cash
Exchangetraded
derivatives
OTC derivatives
Bondfutures
Optionson
bondfutures
Interest rate
swaps
Interest rate
caps and floors
Interest rate
options
Exotic
derivatives
Forward rate
agreements
Debt (long
term)
>1 year
Bonds
Debt (short
term)
1 year
Short
terminterest
rate futures
Stock
Stockoptions
Equityfutures
Equity
Loans
N/A
http://en.wikipedia.org/wiki/Financial_instrument
Stockoptions
Exotic
derivatives
Foreign
exchangeoptio
Financial Markets
many markets, each dealing with a
particular type of financial instrument
providing a mechanism for quickly and
cheap buying and selling of securities
financial markets offerliquidity
Financial Markets
interaction of buyers and sellers to
determine the price
priceconveys important informationabout
the prospects of the issuer
mechanism for buying and selling the
instruments thattransfer risksbetween
buyers and sellers.
Equity instruments
shares of common stock
claims on the earnings and assets of a
corporation
Entitled to the percentage that you are
holding
Derivatives markets
value from other underlying assets
Financial Institutions
Depository Institutions
Non-depository Institutions
Depository Institutions
Commercial banks- include commercial loans,
consumer loans, mortgages, U.S. government
bonds, municipal bonds.
Savings and Loan Associations- originally
restricted to offering savings accounts and CDs and
making mortgage loans(Mutual Savings banks)
Credit Unions- are nonprofit and credit union
membership is organized around a particular group,
such as company employees, a union, or even a
church parish
Non-depository Institutions
Life insurance companies- buyer of corporate
bonds and mortgages (long term)
Fire and casualty insurance-less predictable
than life insurance. assets are more liquid than life
insurance companies, municipal bonds, corporate
bonds, stocks, and U.S. government bonds
GSEs or Government-sponsored
enterprises- Fannie Mae (home
mortgages), Sallie Mae, Freddie Mac