FINANCIAL MARKETS AND INSTITUTIONS
A Strong Financial System Is Necessary for a Growing and Prosperous Economy Financial managers and investors don’t operate in a vacuum—they make decisions within a large and complex financial environment. This environment includes financial markets and institutions, tax and regulatory policies, and the state of the economy. The environment both determines the available financial alternatives and affects the outcomes of various decisions. Thus, it is crucial that investors and financial managers have a good understanding of the environment in which they operate. History shows that a strong financial system is a necessary ingredient for a growing and prosperous economy. Companies raising capital to finance capital expenditures as well as investors saving to accumulate funds for future use require well-functioning financial markets and institutions. Over the past few decades, changing technology and improving communications have increased cross-border transactions and expanded the scope and efficiency of the global financial system. Companies routinely raise funds throughout the world to finance projects all around the globe. Likewise, with the click of a mouse an individual investor in Nebraska can deposit funds in a European bank or purchase a mutual fund that invests in Chinese securities. It is important to recognize that at the most fundamental level well-functioning markets and institutions are based heavily on trust. An investor who deposits money in a bank, buys stock through an online brokerage account, or contacts her broker to buy a mutual fund places her money and trust in the hands of the financial institutions that provide her with advice and transaction services. Similarly, when businesses approach commercial or investment banks to raise capital, they are relying on these institutions to provide them with funds under the best possible terms, and with sound, objective advice. While changing technology and globalization have made it possible for more and more types of financial transactions to take place, a series of scandals in recent years have rocked the financial industry and have led many to
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Part 2 Fundamental Concepts in Financial Management
question whether some of our institutions are serving their own or their clients’ interests. Many of these questionable practices have come to light because of the efforts of a single man: the Attorney General of New York, Eliot Spitzer. In 2001, Spitzer exposed conflicts of interest within investment banking firms regarding dealings between their underwriters, who help companies issue new securities, and their analysts, who make recommendations to individual investors to purchase these securities. Allegations were made that to attract the business of firms planning to issue new securities, investment banks leaned on their analysts to write glowing, overly optimistic research reports on these firms. While such practices helped produce large underwriting fees for the investment banks, they compromised their ability to provide the objective, independent research on which their clients depended. A few years later, Spitzer turned his attention to the mutual fund industry, where he exposed unethical fee structures and trading practices of some of the leading funds. More recently, Spitzer has questioned whether some insurance brokers have compromised their clients’ interests in order to steer business toward insurers, who provide the broker with rebates of different types.1 While some have criticized Spitzer for being overly zealous and politically ambitious, his efforts have appropriately brought to light many questionable practices. Hopefully, this spotlight will put pressure on the institutions to establish practices that will restore the public’s trust and...