W.J.S
FIM 2023
CONTENTS
Chapter 1: Why study financial markets and institutions? ..................................................................................... 2
Chapter 2: Overview of the financial market ......................................................................................................... 3
Chapter 3: What do Interest Rate Mean and What is their Role in Valuation? ..................................................... 9
Chapter 4: Why do Interest Rate Change? ........................................................................................................... 11
Chapter 5: Are Markets Efficient? ........................................................................................................................ 14
Chapter 6: How do Risk and Term structure affect interest rates? ...................................................................... 17
Risk Structure.................................................................................................................................................... 17
Term Structure.................................................................................................................................................. 20
Chapter 7: Bonds .................................................................................................................................................. 22
Bond Terminology ............................................................................................................................................ 24
Chapter 8: The Stock Market ................................................................................................................................ 25
Chapter 9: Financial Crises .................................................................................................................................... 28
Chapter 10: Why do Financial Institutions Exist? ................................................................................................. 31
1
,W.J.S
CHAPTER 1: WHY STUDY FINANCIAL MARKETS AND INSTITUTIONS?
FINANCIAL MARKETS = platform where financial assets (stocks, bonds, and derivatives) are bought and sold
- Financial markets are CRUCIAL in our ECONOMY
o 1. Channels funds from a person or business without investment opportunities (Lende -
Saver) to one who has them (Borrower - Spender) → Improves economic efficiency.
o E.g. amazon, Elon Musk
▪ The first couple of years, they didn’t make any money, they were investing and
building factories without profits
o 2. Market activity affects: personal wealth, business firms, and the economy
STOCK MARKET = where stocks are traded
- STOCK = share that represents ownership in a company, first sold on the primary market to raise
money for a certain company, then traded amongst investors in the secondary market
THE FOREIGN EXCHANGE MARKET = where international currencies are traded, and exchange rates are set
- SEO = Secondary Equity Offering
o When an investor sells their shares to the public on the secondary market (trading on the
secondary market)
DEBT MARKETS = they are segments of the financial market that allow governments, corporations, and
individuals to borrow
- BOND = debt security that promises to make payments periodically for a specified amount of time
- INTEREST = cost of borrowing
- SECURITY = financial instrument which is a claim on the issuer’s future income or asset
2
,W.J.S
CHAPTER 2: OVERVIEW OF THE FINANCIAL MARKET
FUNCTION of the financial markets: CHANNELING FUNDS from a person or business without investment
opportunities (Lende - Saver) to one who has them (Borrower - Spender)
- It improves economic efficiency and the well-being of consumers
Who is saving money?
- Usually a cultural thing e.g. in Italy they save money by living with their parents for a long time
- Government might be saving money due to being in debt
- Companies such as Apple that have a large amount of money in cash (billions)
- Foreigners: people in Belgium borrow in dollars
- Sometimes governments can spend a lot of money while saying that they’re investing: healthcare
SEGMENTS of the financial markets
- DIRECT FINANCE = borrowers borrow directly from lenders in the financial markets by selling financial
instruments which are claims on borrower’s future income or asset (usually used in the US)
- INDIRECT FINANCE = borrowers borrow indirectly from lenders via financial intermediaries by issuing
financial instruments which are claims on the borrower’s future income or assets (usually used in EU)
o FINANCIAL INTERMEDIARIES = institutions or entities that act as a MIDDLEMAN between
savers and borrowers in the financial system (intermediaries are the core business of the
banks, banks take more risk → borrow too much = not enough return = bankrupt = crisis)
- E.g. if you save $1,000, but there are no financial markets, then you can earn no return on this →
might as well put money under your mattress
o You can invest this money by lending it so that your carpenter can buy a new saw (increasing
productivity), and then he is willing to pay you some interest for the use of the funds
3
, W.J.S
/!\ exam: two questions about the structure of financial markets
/!\ possible exam question: do banks play only play a role in indirect finance? NO
/!\ How are banks involved in direct finance e.g. when a company has an account BUT they also help increase
capital (still the bank that takes the commission)
- Another e.g. in Belgium we have brokers that are subsidiaries of a bank = bank charging commissions
→ direct finance
STRUCTURE of financial markets
1. DEBT MARKETS (divided into two categories)
o Short-term (maturity < 1 year)
o Long-term
2. EQUITY MARKETS
o Pay dividends (in theory forever)
o Represents an ownership claim in the firm
MARKETS
1. PRIMARY MARKET
o New securities issues are sold to the initial buyers, typically involving an investment bank
that underwrites (or ‘buys’) the offerings
2. SECONDARY MARKET
o Securities previously issued are bought and sold
o E.g. NYSE or Nasdaq
o Involves both BROKERS and DEALERS
▪ BROKERS = help clients to buy and sell securities while overseeing their accounts
▪ DEALERS = they are individuals or firms that buy and sell securities for their own
accounts and own good
- The firms don’t get any money for the secondary market, but it serves TWO important roles
o PROVIDES LIQUIDITY, making it easy to buy and sell the securities of the companies,
ESTABLISHES a price for the securities
o Gives an idea at what price a company can realize a CAPITAL INCREASE
/!\ Possible exam question: is the secondary market important for companies?
- Share price is up/down today: should I worry? → normally not
- BUT when I want to raise money, when I need more capital as a company then it’s important to know
the shares
o Companie can always issue more shares and will need money → It can better sell shares at a
very high price to raise the capital
o Less shares = better for the shareholders (since they’re getting more profit)
▪ Then it’s important to have high share prices
4
FIM 2023
CONTENTS
Chapter 1: Why study financial markets and institutions? ..................................................................................... 2
Chapter 2: Overview of the financial market ......................................................................................................... 3
Chapter 3: What do Interest Rate Mean and What is their Role in Valuation? ..................................................... 9
Chapter 4: Why do Interest Rate Change? ........................................................................................................... 11
Chapter 5: Are Markets Efficient? ........................................................................................................................ 14
Chapter 6: How do Risk and Term structure affect interest rates? ...................................................................... 17
Risk Structure.................................................................................................................................................... 17
Term Structure.................................................................................................................................................. 20
Chapter 7: Bonds .................................................................................................................................................. 22
Bond Terminology ............................................................................................................................................ 24
Chapter 8: The Stock Market ................................................................................................................................ 25
Chapter 9: Financial Crises .................................................................................................................................... 28
Chapter 10: Why do Financial Institutions Exist? ................................................................................................. 31
1
,W.J.S
CHAPTER 1: WHY STUDY FINANCIAL MARKETS AND INSTITUTIONS?
FINANCIAL MARKETS = platform where financial assets (stocks, bonds, and derivatives) are bought and sold
- Financial markets are CRUCIAL in our ECONOMY
o 1. Channels funds from a person or business without investment opportunities (Lende -
Saver) to one who has them (Borrower - Spender) → Improves economic efficiency.
o E.g. amazon, Elon Musk
▪ The first couple of years, they didn’t make any money, they were investing and
building factories without profits
o 2. Market activity affects: personal wealth, business firms, and the economy
STOCK MARKET = where stocks are traded
- STOCK = share that represents ownership in a company, first sold on the primary market to raise
money for a certain company, then traded amongst investors in the secondary market
THE FOREIGN EXCHANGE MARKET = where international currencies are traded, and exchange rates are set
- SEO = Secondary Equity Offering
o When an investor sells their shares to the public on the secondary market (trading on the
secondary market)
DEBT MARKETS = they are segments of the financial market that allow governments, corporations, and
individuals to borrow
- BOND = debt security that promises to make payments periodically for a specified amount of time
- INTEREST = cost of borrowing
- SECURITY = financial instrument which is a claim on the issuer’s future income or asset
2
,W.J.S
CHAPTER 2: OVERVIEW OF THE FINANCIAL MARKET
FUNCTION of the financial markets: CHANNELING FUNDS from a person or business without investment
opportunities (Lende - Saver) to one who has them (Borrower - Spender)
- It improves economic efficiency and the well-being of consumers
Who is saving money?
- Usually a cultural thing e.g. in Italy they save money by living with their parents for a long time
- Government might be saving money due to being in debt
- Companies such as Apple that have a large amount of money in cash (billions)
- Foreigners: people in Belgium borrow in dollars
- Sometimes governments can spend a lot of money while saying that they’re investing: healthcare
SEGMENTS of the financial markets
- DIRECT FINANCE = borrowers borrow directly from lenders in the financial markets by selling financial
instruments which are claims on borrower’s future income or asset (usually used in the US)
- INDIRECT FINANCE = borrowers borrow indirectly from lenders via financial intermediaries by issuing
financial instruments which are claims on the borrower’s future income or assets (usually used in EU)
o FINANCIAL INTERMEDIARIES = institutions or entities that act as a MIDDLEMAN between
savers and borrowers in the financial system (intermediaries are the core business of the
banks, banks take more risk → borrow too much = not enough return = bankrupt = crisis)
- E.g. if you save $1,000, but there are no financial markets, then you can earn no return on this →
might as well put money under your mattress
o You can invest this money by lending it so that your carpenter can buy a new saw (increasing
productivity), and then he is willing to pay you some interest for the use of the funds
3
, W.J.S
/!\ exam: two questions about the structure of financial markets
/!\ possible exam question: do banks play only play a role in indirect finance? NO
/!\ How are banks involved in direct finance e.g. when a company has an account BUT they also help increase
capital (still the bank that takes the commission)
- Another e.g. in Belgium we have brokers that are subsidiaries of a bank = bank charging commissions
→ direct finance
STRUCTURE of financial markets
1. DEBT MARKETS (divided into two categories)
o Short-term (maturity < 1 year)
o Long-term
2. EQUITY MARKETS
o Pay dividends (in theory forever)
o Represents an ownership claim in the firm
MARKETS
1. PRIMARY MARKET
o New securities issues are sold to the initial buyers, typically involving an investment bank
that underwrites (or ‘buys’) the offerings
2. SECONDARY MARKET
o Securities previously issued are bought and sold
o E.g. NYSE or Nasdaq
o Involves both BROKERS and DEALERS
▪ BROKERS = help clients to buy and sell securities while overseeing their accounts
▪ DEALERS = they are individuals or firms that buy and sell securities for their own
accounts and own good
- The firms don’t get any money for the secondary market, but it serves TWO important roles
o PROVIDES LIQUIDITY, making it easy to buy and sell the securities of the companies,
ESTABLISHES a price for the securities
o Gives an idea at what price a company can realize a CAPITAL INCREASE
/!\ Possible exam question: is the secondary market important for companies?
- Share price is up/down today: should I worry? → normally not
- BUT when I want to raise money, when I need more capital as a company then it’s important to know
the shares
o Companie can always issue more shares and will need money → It can better sell shares at a
very high price to raise the capital
o Less shares = better for the shareholders (since they’re getting more profit)
▪ Then it’s important to have high share prices
4
