[MUSIC] So to summarize, investors holding financial securities like bonds and shares, are lending long-term capital to the firm. They expect that a firm with good ideas will generate more cash then it has taken in from those investors, and thereby create value. However this is not the end of the story, because as we mentioned the market is a system, also includes the vital role of financial institutions. Financial institutions operate in a variety of financial markets. Which are aimed at bringing together those who have money to use, with those who have ideas, but lack money. This goes back to a basic definition of thinking about finance as a process that allocates money for its most productive use. Is this truly what financial markets and their participants do? To explore this question, we need to learn a little bit more about these markets and the players who make decisions about money. That is the financial experts who lead the financial institutions that hold our money, unless your life savings is in your mattress. There are probably more different kinds of financial markets than you expect. Primary markets or where new securities like bonds and stocks are created, whereas secondary markets are where securities are changing hands because they are being resold. We also distinguish between liquid money markets, coins, notes, short term securities, treasuries and so on, worth about $80 trillion, compared with capital markets, which sell products with longer maturities. These include stock markets with a global value of about $70 trillion, and bond and other debt markets, set to be worth a lot more, close to about $200 trillion. Markets we will discuss more in detail in class number two. There are of course many financial markets and participants. Some of the big ones include insurance markets. That we distribute risks associated with property vehicles, health, credit and so on. And in terms of volume, the foreign exchange market is by far the largest market in the world, trading currencies equivalent to trillions of dollars exchange 24 hours a day between participants around the world representing all sectors of the economy. Financial transactions also implicate commodity market, which creating physical agricultural products such as wheat, coffee and those iconic pork bellies as well as mine products such as pot ash, oil and gold. Investors also access over 50 major commodity markets through financial transactions via the enormous market of derivative products. The values of these products, are derived from the underlying value of the commodity or the asset in question. Some of the derivative products Like futures contracts are sold in organized exchanges like the Chicago Mercantile Exchange. Here, the amounts and prices are standardized by one party taking a long position, thinking that the product will increase in price, or a short position, thinking that the product will decrease in price. With the commodity exchange acting as the counter party, which means taking the opposite of a long or short position. This set up ensures that there will be buyers and that there will be sellers, which is required for price determination and for any market to have liquidity. That is, for people to be able to buy and sell at any point in time. Other derivative products like credit swaps, forward contracts and options are sold over the counter or OTC markets. And the trades between investment banks, hedge funds government sponsored enterprises and others are common for these types of products. According the Bank of International Settlements, these derivative markets have a combined value at least ten times more than the total value of goods and services produced by all countries in the world. Most people find this incredible, in other words, if we add up everything that everyone produces to equal, let's say, 60 trillion dollars, then these derivative markets, whose value is derived from these goods and services, are worth at least $600 trillion, with some estimates as high as $1.2 quadrillion. This valuation has happened in our lifetime. That financial markets have created paper values that far exceed what we actually serve or produce. One of the reasons derivative markets have grown exponentially in the past 20 years, is because all derivative contracts have primary been used to alleviate risk by guaranteeing the price of the underlying asset, index or entity. Risk reduction has been a very important factor for professional portfolios managers, who constantly have to balance risk with the ups and downs of the markets. Derivative products have also grown because of another paradox. Whereas, they were created to reduce risk, they also attract speculators who bet on the underlying price changes. But these bets also affect the value of the derivative instrument itself. Speculators, who like gamblers, can therefore find enormous payoffs in derivatives. But the problem is, like in gambling for every winner there is an equal loser. It's what we call a zero sum game. We will explore the mechanics of valuing derivatives later in the specialization, and we'll talk more about market excesses in the next video segment. That looks at the impact of derivatives in sub prime mortgage bank securities blamed for the 2007-2008 financial crash. But before you watch that segment, it's a good idea to familiarize yourself a little with the movers and shakers in these different types of financial markets. They are sometimes symbolically refered to as Wall Street in the United States. Or in the city of London in the UK, or Bay Street in Canada. These terms refer generally to the institutional players who distinguish themselves by having access to large pools of capital. Take for example th top ten investment banks, six of which are American. With JP Morgan and Goldman Sachs generating the highest fees in 2016 from trading securities, advising about mergers and acquisitions, and other banking services. Other top ten global commercial banks are big players in terms of market value and the size of assets, which are loans, and include many banks from China and others from the United States, Japan, UK, Germany and France. Institutional players also include two kinds of funds, pension funds which are a source of retirement income for everyone who has contributed and mutual funds, that pool money from investors to buy securities managed by professional portfolio managers. Other players worth noting include private equity funds and hedge funds, that target high net worth individuals with fewer restrictions on borrowing and short-selling assets. Making these kinds of funds generally more aggressive and rewarding than the more conservative mutual funds. They differ in that private equity funds tend to invest in firms, hoping to turn these around over a long period of time. Whereas hedge funds invest in anything and everything, including stocks, bonds, commodities, currencies, derivatives, and so on. And these are hedge funds are singularly geared to generate the highest investment returns as quickly as possible. In 2014, the top 25 hedge fund managers made over $11 billion or over $400 million each and this was considered a bad year as they made twice as much the year before. To summarize, this video segment has argued that healthy financial markets and the institutions that inhabit them are necessary elements of a free market system, at the core of the economic engine that is capitalism. Most of the economies of the world have different versions of the free market. Some are freer than others and most governments have instituted policies that embody Schumpeter's version of productivity and wealth creation. In the next video, we will explore some of the side effects and the repercussions of the same financial markets and institutional players that have the public questioning whether the market power and the influence that they have exerted, are creating dangerous situations. That ironically, inhibit competition, exaggerate their share of profits, and worsen inequity within the broader economic system.
