Direct finance and Indirect finance

Chapter 2

• An Overview of the Financial System

Function of Financial Markets

• Perform the essential function of channeling funds from economic players that have saved surplus funds to those that have a shortage of funds
• 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

Direct finance and Indirect finance

• Direct finance – funds are directly transferred from lenders to borrowers
• Indirect finance – financial intermediaries receive funds from savers and lend them to borrowers
• Securities are assets for the holder and liabilities for the issuer

• Allows transfers of funds from person or business without investment
• opportunities to one who has them
• 2. Improves economic efficiency

Structure of Financial Markets

• Debt and Equity Markets
• Debt instruments – contractual obligation to pay the holder fixed payments at specified dates (e.g., mortgages, bonds, car loans, student loans)
• Short-term debt instruments have a maturity of less than one year
• Intermediate-term debt instruments have a maturity between 1 and 10 years
• Long-term debt instruments have a maturity of ten or more years
• Equity – sale of ownership share (owners are residual claimants).
• Owners of stock may receive dividends

Structure of Financial Markets

• Primary and Secondary Markets
• Primary market = financial market in which newly issued securities are sold.
• Secondary market = financial market in which previously owned securities are sold.
• Investment Banks underwrite securities in primary markets
• Brokers and dealers work in secondary markets
• Broker – match buyers and sellers
• Dealers – buy and sell securities