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Lecture Fundamentals of financial management - Chapter 4: The financial environment: Markets, institutions, and interest rates

Lecture Fundamentals of financial management - Chapter 4 "The financial environment: Markets, institutions, and interest rates". This chapter presents the following content: Financial markets, types of financial institutions, determinants of interest rates, Yield curves. | CHAPTER 4 The Financial Environment: Markets, Institutions, and Interest Rates Financial markets Types of financial institutions Determinants of interest rates Yield curves What is a market? A market is a venue where goods and services are exchanged. A financial market is a place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds. Types of financial markets Physical assets vs. Financial assets Money vs. Capital Primary vs. Secondary Spot vs. Futures Public vs. Private How is capital transferred between savers and borrowers? Direct transfers Investment banking house Financial intermediaries Types of financial intermediaries Commercial banks Savings and loan associations Mutual savings banks Credit unions Pension funds Life insurance companies Mutual funds Physical location stock exchanges vs. Electronic dealer-based markets Auction market vs. Dealer market (Exchanges vs. OTC) NYSE vs. Nasdaq Differences are narrowing The cost of money The price, or cost, of debt capital is the interest rate. The price, or cost, of equity capital is the required return. The required return investors expect is composed of compensation in the form of dividends and capital gains. What four factors affect the cost of money? Production opportunities Time preferences for consumption Risk Expected inflation “Nominal” vs. “Real” rates k = represents any nominal rate k* = represents the “real” risk-free rate of interest. Like a T-bill rate, if there was no inflation. Typically ranges from 1% to 4% per year. kRF = represents the rate of interest on Treasury securities. Determinants of interest rates k = k* + IP + DRP + LP + MRP k = required return on a debt security k* = real risk-free rate of interest IP = inflation premium DRP = default risk premium LP = liquidity premium MRP = maturity risk premium Premiums added to k* for different types of debt IP MRP DRP LP S-T Treasury L-T Treasury S-T Corporate L-T Corporate | CHAPTER 4 The Financial Environment: Markets, Institutions, and Interest Rates Financial markets Types of financial institutions Determinants of interest rates Yield curves What is a market? A market is a venue where goods and services are exchanged. A financial market is a place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds. Types of financial markets Physical assets vs. Financial assets Money vs. Capital Primary vs. Secondary Spot vs. Futures Public vs. Private How is capital transferred between savers and borrowers? Direct transfers Investment banking house Financial intermediaries Types of financial intermediaries Commercial banks Savings and loan associations Mutual savings banks Credit unions Pension funds Life insurance companies Mutual funds Physical location stock exchanges vs. Electronic dealer-based markets Auction market vs. Dealer market (Exchanges vs. OTC) NYSE vs. Nasdaq Differences are narrowing .