2-Financial Markets Page 21 Wednesday, February 4, 2004 1:15 PM

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CHAPTER

2

Overview of Financial Markets,

Financial Assets, and Market

Participants

n a market economy, the allocation of economic resources is driven by

the outcome of many private decisions. Prices are the signals that

direct economic resources to their best use. The types of markets in an

economy can be divided into (1) the market for products (manufactured

goods and services), or the product market; and (2) the market for the

factors of production (labor and capital), or the factor market. Our pri-

mary application of the mathematical techniques presented in this book

is to one part of the factor market, the market for financial assets, or,

more simply, the financial market. In this chapter we review the basic

characteristics and functions of financial assets and financial markets,

the major players in the financial market, and the major financial assets

(common stock, bonds, and derivatives).

FINANCIAL ASSETS

An asset is any possession that has value in an exchange. Assets can be

classified as tangible or intangible. The value of a tangible asset depends

on particular physical properties—examples include buildings, land, or

machinery. Tangible assets may be classified further into reproducible

assets such as machinery, or nonreproducible assets such as land, a

mine, or a work of art. Intangible assets, by contrast, represent legal

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