The opening chapter of Money and Capital Markets presents us with an introduction to the global financial system in which the money and capital markets play central roles. It also highlights the principal institutions that shape the character and functioning of the world’s financial marketplace.

• The financial system produces and distributes financial services to the public. Among its most important services is a supply of credit which allows businesses, households, and governments to invest and acquire assets they need for daily economic activity. The financial system of money and capital markets determines both the amount and cost of credit available. In turn, the supply and cost of credit affect the health and growth of the global economy and our own economic welfare.



• Credit and other financial services are offered for sale in the institution we call a market. Markets allocate financial and physical resources that are scarce relative to demand.



• Another key role played by markets operating within the financial system is to stimulate an adequate volume of savings (i.e., funds left over after current consumption spending by households and earnings retained by businesses) and to transform those savings into an adequate volume of investment (i.e., the purchase of capital goods and the buildup of inventories of goods to sell). In turn, investment generates new products and services and creates new jobs and new businesses, resulting in faster economic growth and a higher standard of living. By determining interest rates within the financial system, the money and capital markets bring the volume of savings generated by the public into balance with the volume of investment in new plant and equipment and in inventories of goods and resources available for sale.



• One important way to view the financial system of money and capital markets is by examining its seven key functions or roles in meeting the financial needs of individuals and institutions, including generating and allocating savings, stimulating the accumulation of wealth, providing liquidity for spending, providing a mechanism for making payments, supplying credit to aid in the purchase of goods and services, providing risk protection services, and supplying a channel for government policy in helping achieve the nation’s economic goals (including maximum employment, low inflation, and sustainable economic growth).



• The markets that serve the financial system may be classified in several different ways, including money markets, supplying short-term loans (credit) of less than a year, and capital markets, supplying long-term loans (credit) lasting longer than a year. There are also open markets where anyone may participate as buyer or seller versus negotiated markets where only a few bidders seek to acquire assets. There are primary versus secondary markets; in the former, new financial instruments are traded in contrast to the latter where existing instruments are exchanged. Additional types of financial markets that make up the global financial system include markets that deal in the immediate purchase or sale of goods or services, called spot markets, and those that promise future delivery, known as futures, forward, or option markets.



• While many different segments make up the money and capital markets around the globe, all these markets share the common purpose of supplying credit to answer global demands for borrowed funds and all encourage saving to make investment (and, therefore, economic growth) possible. Funds flow easily and, for the most part, smoothly from one segment of the marketplace to another, spurred by such forces as arbitrage and speculation. For example, arbitrage causes credit, savings, and investment to flow toward those market segments that offer the most favorable returns, helping different markets to price resources more consistently and eliminate price disparities for the same goods and services. Prices are also brought into balance from market to market by the force of speculation, which seeks out underpriced and overpriced services and goods.



• Finally, the money and capital markets have revealed themselves to be efficient institutions, gathering and quickly using all relevant information to price credit and other financial services. Some are nearly perfect markets where competition sets prices and allocates resources. However, important imperfections do exist within the financial system where competition is sometimes restricted and excess profits are sometimes earned by those who stifle competition or gain access to inside information not freely available to all due to asymmetries within the marketplace.