Chapter 2 Financial Markets and Institutions 31- Private markets versus public markets. Private markets, where transactions are
negotiated directly between two parties, are differentiated from public
markets, where standardized contracts are traded on organized exchanges.
Bank loans and private debt placements with insurance companies are exam-
ples of private market transactions. Because these transactions are private, they
may be structured in any manner to which the two parties agree. By contrast,
securities that are traded in public markets (for example, common stock and
corporate bonds) are held by a large number of individuals. These securities
must have fairly standardized contractual features because public investors do
not generally have the time and expertise to negotiate unique, nonstandard-
ized contracts. Broad ownership and standardization result in publicly traded
securities being more liquid than tailor-made, uniquely negotiated securities.
Other classi! cations could be made, but this breakdown shows that there are many
types of! nancial markets. Also note that the distinctions among markets are often
blurred and unimportant except as a general point of reference. For example, it
makes little difference if a! rm borrows for 11, 12, or 13 months, that is, whether
the transaction is a “money” or “capital” market transaction. You should be aware
of the important differences among types of markets, but don’t be overly con-
cerned about trying to distinguish them at the boundaries.
A healthy economy is dependent on ef! cient funds transfers from people who
are net savers to! rms and individuals who need capital. Without ef! cient trans-
fers, the economy could not function: Carolina Power & Light could not raise capi-
tal, so Raleigh’s citizens would have no electricity; the Johnson family would not
have adequate housing; Carol Hawk would have no place to invest her savings;
and so forth. Obviously, the level of employment and productivity (i.e., the stan-
dard of living) would be much lower. Therefore, it is essential that! nancial mar-
kets function ef! ciently—not only quickly, but also inexpensively.^2
Table 2-1 is a listing of the most important instruments traded in the various
! nancial markets. The instruments are arranged in ascending order of typical
length of maturity. As we go through this book, we will look in more detail at
many of the instruments listed in Table 2-1. For example, we will see that there are
many varieties of corporate bonds, ranging from “plain vanilla” bonds to bonds
that can be converted to common stocks to bonds whose interest payments vary
depending on the in" ation rate. Still, the table provides an overview of the charac-
teristics and costs of the instruments traded in the major! nancial markets.
2-2b Recent Trends
Financial markets have experienced many changes in recent years. Technological
advances in computers and telecommunications, along with the globalization of
banking and commerce, have led to deregulation, which has increased competi-
tion throughout the world. As a result, there are more ef! cient, internationally
linked markets, which are far more complex than what existed a few years ago.
While these developments have been largely positive, they have also created prob-
lems for policy makers. At one conference, former Federal Reserve Board Chair-
person Alan Greenspan stated that modern! nancial markets “expose national
economies to shocks from new and unexpected sources and with little if any lag.”
He went on to say that central banks must develop new ways to evaluate and limit
risks to the! nancial system. Large amounts of capital move quickly around the
Private Markets
Markets in which
transactions are worked
out directly between two
parties.Private Markets
Markets in which
transactions are worked
out directly between two
parties.Public Markets
Markets in which
standardized contracts are
traded on organized
exchanges.Public Markets
Markets in which
standardized contracts are
traded on organized
exchanges.(^2) As the countries of the former Soviet Union and other Eastern European nations move toward capitalism, as
much attention must be paid to the establishment of cost-e" cient! nancial markets as to electrical power, trans-
portation, communications, and other infrastructure systems. Economic e" ciency is impossible without a good
system for allocating capital within the economy.