Financial Institutions and Markets
What CB1 tests in financial institutions and markets
This domain examines how savers and borrowers are matched, how securities trade, and how prices and yields convey information. CB1 expects you to distinguish institution roles from market mechanisms and to apply pricing logic, not just define terms.
Core rules and concepts
- Intermediaries reduce search and information costs, diversify risk and transform maturity and liquidity; banks are exposed to runs because deposits are short-term and loans are illiquid.
- Primary markets raise new capital; secondary markets provide liquidity and price discovery. Money markets cover short-term debt; capital markets cover longer-term debt and equity.
- Exchange trading is centralised and transparent; OTC trading is bilateral, flexible and carries counterparty risk.
- A market maker quotes a bid and an ask; the spread compensates for inventory, adverse selection and processing costs.
- Weak-form efficiency says past prices are uninformative; semi-strong says public information is impounded; strong says all information, including private, is impounded.
Worked example
A dealer quotes 99.50 bid and 99.80 ask per 100 nominal. An investor buys at 99.80 and immediately sells at 99.50, losing 0.30, or 0.30/99.80 = 0.301% before commissions. The round-trip spread is a real cost, so a short-horizon strategy must overcome it.
Traps that cost marks
Do not equate market efficiency with prices always being correct; it concerns information incorporation. Do not call a secondary-market purchase “raising capital”. Ignore taxes and transaction costs only when the question permits it.