Summary Lecture 1 – Financial Markets and Instruments Outline 2

Lecture 1 – Financial Markets and Instruments

Outline 2

Direct financing

 Wholesale market
 Few participants
 Large transactions

Indirect financing

 Many participants
 Small transactions
 Larger market in aggregate

Sources of external capital

Capital markets

Debt and Equity

Debt: Bank loans, bonds, supplier credit, leases, informal

Equity: Ordinary shares, preference shares, warrants, informal



Debt and equity

- Debt holders have a contract specifying that their claims must be paid in full before the firm can
make payments to its equity holders ie debt claims are senior

- Payments to debt holders are generally viewed as a tax-deductible expense of the firm

Financial instruments - A financial instrument (also called security) is a claim on the issuer’s future
income or assets.

 Financial assets – money market instruments, bonds (debt instruments)
 Real assets – capital market instruments, stocks (equity)

Financial assets vs real assets

 Financial assets are claims against real assets. Real assets are houses, equipment, human
resources etc.
 Generally, borrowers obtain funds from lenders by selling newly issued claims (“IOU’s”)
against their (borrower’s) real assets. IOUs are essentially financial assets.



Money market instruments - Money market instruments is shorter-term security generally with one
year or less remaining to maturity

Capital market instruments - More than one year to maturity. Stock, residential mortgages, long-term
bonds, consumer loans etc.

Bond - A bond is a debt security/instrument that promises to make payments periodically for a
specified period of time