Chapter 2
Overview of the Financial System
Function of Financial Markets
Structure of Financial Markets
Debt and Equity Markets
Primary and Secondary Markets
Exchanges and Over-the-Counter Markets
Money and Capital Markets
Internationalization of Financial Markets
International Bond Market, Eurobonds, and Eurocurrencies
Global Box: Are U.S. Capital Markets Losing Their Edge?
World Stock Markets
Function of Financial Intermediaries: Indirect Finance
Transaction Costs
Following the Financial News: Foreign Stock Market Indexes
Global Box: The Importance of Financial Intermediaries Relative to Securities
Markets: An International Comparison
Risk Sharing
Asymmetric Information: Adverse Selection and Moral Hazard
Economies of Scope and Conflicts of Interest
Types of Financial Intermediaries
Depository Institutions
Contractual Savings Institutions
Investment Intermediaries
Regulation of the Financial System
Increasing Information Available to Investors
Ensuring the Soundness of Financial Intermediaries
Financial Regulation Abroad
6 Mishkin/Eakins • Financial Markets and Institutions, Eighth Edition
◼ Overview and Teaching Tips
Chapter 2 is an introductory chapter that contains the background information on the structure and operation
of financial markets that is needed in later chapters of the book. This chapter allows the instructor to branch
out to various choices of later chapters, thus allowing different degrees of coverage of financial markets
and institutions.
The most important point to transmit to the student is that financial markets and financial intermediaries
are crucial to a well-functioning economy because they channel funds from those who do not have a
productive use for them to those who do. Some instructors will want to teach this chapter in detail, and
those who focus on international issues will want to spend some time on the section “Internationalization
of Financial Markets.” However, those who slant their course to public policy issues may want to give this
chapter a more cursory treatment. No matter how much class time is devoted to this chapter, I have found
that it is a good reference chapter for students. You might want to tell them that if in later chapters they do
not recall what particular financial intermediaries do and who regulates them, they can refer back to this
chapter, especially to tables, such as Tables 2.1 and 2.3.
◼ Answers to End-of-Chapter Questions
1. The share of Microsoft stock is an asset for its owner because it entitles the owner to a share of the
2. Yes, I should take out the loan, because I will be better off as a result of doing so. My interest payment
will be $4,500 (90% of $5,000), but as a result, I will earn an additional $10,000, so I will be ahead of
3. Yes, because the absence of financial markets means that funds cannot be channeled to people who
4. The principal debt instruments used were foreign bonds which were sold in Britain and denominated
5. This statement is false. Prices in secondary markets determine the prices that firms issuing securities
6. You would rather hold bonds, because bondholders are paid off before equity holders, who are the
