Finance Terms• Finance: The proper management ofmoney.• Money: The current medium ofexchange or means of payment.• Credit or Loan: A sum of money to bereturned normally with interest.
Classification of finance1. Public finance– It studies the sources of funds of publicauthorities such as states, local self-governmentsand the Central Government.– It is concerned with the income and expenditureof public authorities and with the adjustment ofone to another.Contd…
• Private finance– An individual– Profit-seeking business organizations• External finance (outside sources)– Direct financing (through issuing securities)– Indirect financing (through middlemen)• Internal finance (ploughing back of profits)– A non-profit organizationClassification of finance
A set of institutions, instruments andmarkets which promote savings andchannel them to their most efficientuse.Financial systemContd…
Financial Institutions• Banking– These are participate in the economy’s paymentsmechanism– Their deposit liabilities constitute a major part ofthe national money supply– They can, as a whole, create deposits or credit,which is money
• Non-Banking– Lend only out of resources put at their disposal bythe savers.– LIC, UTI, IDBIFinancial Institutions
Financial Markets• These are the centers or arrangements thatprovide facilities for buying and selling offinancial claims and services.• These are classified into– Primary and secondary markets– Money and capital markets
Primary and Secondary Markets• Primary Markets– deal in the new financial claims or new securities(new issue markets)– these are mobilize savings and they supply freshor additional capital• Secondary Markets– deal in securities already issued or existing oroutstanding.– these do not contribute directly to the supply ofadditional capital
Money and Capital Markets• Both are perform the same function oftransferring resources to the producers.• Money markets deals short-term claims• Capital markets deals long-term claims
Financial Instruments and Services• Financial asset– A sum of money sometime in future(repayment of principal) and/or a period(regular/intervals) payment in the form ofinterest or dividend.• Financial instruments
Technology in Financial System• Financial Services will be provided by a widevariety of institutions.• Small financial service firms will be able to obtainaccess to the technologies they will require toremain viable.• Large number of small, specialized financialservice organizations will prevent the few fromdominating the market.• Networks are permitting electronic fund transfersfrom the merchant’s counter.• Systems providing access to funds from virtuallyany place in the Nation and are likely to be in usein the next few years.Contd…
Technology in Financial System• Advanced communication technologies includingsatellite relays, video cable, fiber optics and cellularradio will find wide application in the financial serviceindustry.• Decreasing computer costs will create the opportunityfor large numbers of individual consumers andmanagers of small businesses to take advantage oftechnology in using financial services.• Large computers will be used to support the databases.• Computers that accept voice inputs and recognizefingerprints may become cost effective for financialservice delivery.
Financial System instability• Increased cross-border integration and thepresence of large international financialinstitutions facilitate the dissemination offinancial shocks across countries.• Financial innovation in products and markets,together with the existence of large financialcompanies facilitate the transmission offinancial shocks in domestic financialmarkets.• Strong growth in asset prices and the growingimportance of household credit are potentialsources of financial instability.
Financial System Stability• Monitoring and analysis of financial systemdevelopments• Designing and building up financial system safety nets• Regulation of the banking system• Market Infrastructure• Safety Buffers• Adoption of Common International Standards• Corporate Bonds and Securities Market• Risk management• Market discipline (through prudential regulation andsupervision)
Development Finance Institution (DFI)• It refers to a range of alternative financialinstitutions including microfinance institutions,community development financial institutionand revolving loan funds.• These institutions provide a crucial role inproviding credit in the form of higher riskloans, equity positions and risk guaranteeinstruments to private sector investments indeveloping countries.• The purpose of DFIs is to ensure investment inareas where otherwise, the market fails toinvest sufficiently.
Subsidies• There are three main forms of subsidies in theoperations of DFIs in practice– High level of liquidity;– An ability to access technical assistance funds; and– Subsidies passed on directly to beneficiaries.
Universal Banking• Universal banking is a combination of Commercialbanking, Investment banking, Developmentbanking, Insurance and many other financialactivities.• It is a place where all financial products areavailable under one roof.• A universal bank is a bank which offerscommercial bank functions plus other functionssuch as Merchant Banking, Mutual Funds, Creditcards, Housing Finance, Auto loans, Retail loans,Insurance, etc.
Advantages of Universal Banking• Investors Trust• Economics of Scale• Resource Utilisation• Profitable Diversification• Easy Marketing• One-stop Shopping
Disadvantages of Universal Banking• Different Rules and Regulations• Effect of failure on Banking System• Monopoly• Conflict of Interest
Financial Institutions• Provider of financial services such as– transforming financial assets in terms of maturity ofliquidity (these are financial intermediaries)– trading financial assets for themselves and others– creating financial assets and then selling those assetson the behalf of customers– giving professional investment advice to others– managing investment portfolios for others• Depository institutions acquire most of theirfunds through accepting deposits• Non depository institutions receive funds fromother sources
Role of Financial Intermediaries• Make direct investments by purchasingbonds, stocks or making loans. These are theirassets• Raise money for these investments by issuingtheir own financial assets such as deposits,insurance policies, mutual fund shares. Theseare liabilities for the intermediary andare indirect investments for the investors.
Asset/Liability Management• Not all liabilities of financial intermediaries arecreated equal! They differ in terms of thecertainty of their amount and timing– Type I liabilities: timing and amount are certain• example: bank fixed rate CD. Bank knows how much itowes the depositor and when.– Type II liabilities: amount is certain but timing isnot• example: term life insurance policy. Insurancecompany knows amount of policy but uncertain whenthe policy holder will die.
Asset/Liability Management– Type III liabilities: amount is not certain but timing is• example: variable rate Certificate of Deposits (CD). Bankknows the maturity date, but the interest owed is not knownwhen the CD is issued.– Type IV liabilities: time and amount are uncertain• example: auto insurance policy. The timing and payout foran auto accident is not known when the policy is issued.• The type of liabilities created by a financialintermediary will determine how they invest theirfunds (i.e. the type of assets that they hold)
Financial Innovation• What is it?– creation of new financial assets or new ways to usefinancial assets• Why does it happen?– changing circumstances: increased instability in interestrates, stock prices and exchange rates led to thedevelopment of derivative securities– advances in technology make new trading strategiesfeasible– competition among institutions for unique products andstrategies– desire to avoid regulations or tax laws