Even a cursory glance at The Wall Street Journal reveals a bewildering collection of securities, markets, and financial institutions. Although it may appear so, the financial environment is not chaotic: There is rhyme and reason behind the array of instruments and markets. The central message we want to convey in this chapter is that financial markets and institutions evolve in response to the desires, technologies,and regulatory constraints of the investors in the economy. In fact, we could predict the general shape of the investment environment (if not the design of particular securities) if we knew nothing
more than these desires, technologies, and constraints. This chapter provides a broad overview of the investment environment. We begin bym examining the differences between financial assets and real assets. We proceed to the three broad sectors of the financial environment: households,businesses, and government. We see how many features of the investment environment are natural responses of profit-seeking firms and individuals to opportunities created by the demands of these sectors, and we examine the driving forces behind financial innovation. Next, we discuss recent trends in financial
markets. Finally, we conclude with a discussion of the relationship between households and the business sector.