Chapter 01

Copyright © 2003 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney
Slides prepared by Anthony Stanger
1
Chapter 1
The Financial System

2
Learning Objectives
• Explain the functions of a financial system
• Describe the main classes of financial
instruments issued in a financial system
• Distinguish between various types of
financial markets according to function
• Discuss the flow of funds between savers
and borrowers, including direct and
intermediated finance

3
Learning Objectives (cont.)
• Appreciate the influence of globalization on
financial markets
• Categorize the main types of financial
institutions
• Understand the impact of a financial crisis
on a financial system and a real economy

4
Chapter Organization
1.1 Introduction
1.2 Functions of the Financial System
1.3 Financial Instruments
1.4 Financial Markets
1.5 Impact of Globalization
1.6 Financial Institutions
1.7 Summary

5
Copyright © 2003 McGraw-Hill Australia Pty Ltd PPTs t/a
Financial Accounting by Willis
Slides prepared by Kaye Watson
What if markets and currency did not exist
Double coincidence of wants
Exchange rates
Divisibility problem
Perishable products

6
1.1 Introduction
• Money
– Medium of exchange
– Allows specialization in production
– Solves the divisibility problem, i.e. where medium of
exchange does not represent equal value for the parties
to the transaction
– Facilitates saving
– Store of wealth
“Any commodity that is widely accepted in exchange
transactions”

7
1.1 Introduction (cont.)
• Role of markets
– Facilitate exchange by
 Bringing opposite parties together
 Establishing rates of exchange, i.e. prices
• Surplus units
– Savers of funds available for lending
• Deficit units
– Borrowers of funds for capital investment and
consumption

8
• Financial instrument
– Issued by a party raising funds, acknowledging
a financial commitment and entitling holder to
specified future cash flows
• Flow of funds
– Movement of funds through the financial system
between savers and borrowers giving rise to
financial instruments

9
• Financial system
– Financial institutions, instruments and markets
facilitating transactions for goods and services
and financial transactions
– Overcomes difficulty of
 Double coincidence of wants
• Transaction between two parties meets their mutual
needs

10

11
Chapter Organisation
1.1 Introduction
1.5 Impact of Globalisation
1.7 Summary

12
1.2 Functions of the
Financial System
• Attributes of financial assets
– Return or yield
 Total financial compensation received from an
investment expressed as a percentage of the amount
invested
– Risk
 Probability that actual return on an investment will
vary from the expected return

13
Financial System (cont.)
• Liquidity
– Ability to sell an asset within reasonable time at
current market prices and for reasonable
transaction costs
• Time-pattern of the cash flows
– When the expected cash flows from a financial
asset are to be received by the investor or
lender

14
• The financial system facilitates portfolio
restructuring
– The combination of assets and liabilities
comprising the desired attributes of return, risk,
liquidity and timing of cash flows

15
• An efficient financial system
– Encourages savings
– Savings flow to the most efficient users
– Implements the monetary policy of governments
by influencing interest rates
– The combination of assets and liabilities
comprising the desired attributes of return, risk,
liquidity and timing of cash flows

16
1.1 Introduction
1.7 Summary

17
• Equity
– Ownership interest in an asset
– Residual claim on earnings and assets
 Dividend
 Liquidation
– Types
 Ordinary share
 Preference shares or Equity Hybrid (or quasi-equity)
security
• Preference shares
• Convertible notes

18
(cont.)
• Debt
– Contractual claim to
 Periodic interest payments
 Repayment of principal
– Ranks ahead of equity
– Can be secured or unsecured
– Negotiable and non negotiable

19
(cont.)
• Derivatives
– A synthetic security providing specific future
rights that derives its price from a
 Physical market commodity
• Gold and oil
 Financial security
• Interest rate-sensitive debt instruments, currencies and
equities

20
(cont.)
• Four basic derivative contracts
– Futures Contract
– Forward Contract
– Option Contract
– Swap Contract

21
1.1 Introduction
1.7 Summary

22
• Matching principle
• Primary and secondary market transactions
• Direct and intermediated financial flow
markets
• Wholesale and retail markets
• Money markets
• Capital markets

23
Matching principle
• Short-term assets should be funded with
short-term liabilities
– Inventory funded by overdraft
• Longer-term assets should be funded with
equity or longer-term liabilities
– Equipment funded by debentures

24
Primary and secondary
market transactions
• Primary market transaction
– The issue of a new financial instrument to raise
funds to purchase goods, services or assets by
 Businesses
• Company shares or debentures
 Governments
• Treasury notes or bonds
 Individuals
• Mortgage

25
Primary and secondary
market transactions (cont.)
• Secondary market transaction
– The buying and selling of existing financial
instruments
 No direct impact on original issuer of security
 Transfer of ownership from one saver to another
saver
 Provides liquidity which facilitates restructuring of
portfolios of security owners

26
Direct and intermediated
financial flow markets
• Direct flow markets
– Users of funds obtain finance directly from
savers
 Advantages
• Avoids costs of intermediation
• Increases range of securities and markets
 Disadvantages
• Matching of preferences
• Liquidity and marketability of a security
• Search and transaction costs
• Assessment of risk, especially default risk

27
financial flow markets (cont.)

28
• Intermediated flow markets
– A financing arrangement involving two separate
contractual agreements whereby saver provides
funds to intermediary, and the intermediary
provides funding to the ultimate user of funds
– Advantages
 Asset transformation
 Maturity transformation

29
– Advantages (cont.)
 Credit risk diversification and transformation
 Liquidity transformation
 Economies of scale

30

31
Wholesale and retail markets
• Wholesale markets
– Direct financial flow transactions between
institutional investors and borrowers
 Involves large transactions
• Retail markets
– Transactions conducted primarily with financial
intermediaries by the household and small-
medium business sectors
 Involves smaller transactions

32
Money markets
• Wholesale markets in which short-term
securities are issued and traded
– Securities highly liquid
 Term to maturity of one year or less
 Highly standardised form
 Deep secondary market
– No specific infrastructure or trading place
– Enable participants to manage liquidity

33
Money markets (cont.)
• Money market securities
– Cash deposits (11 a.m. and 24-hour call)
– Commercial bills
– Treasury notes
– Government bonds
– Promissory notes
– Intercompany loans
– Interbank loans

34
• Money market participants
– Reserve Bank
 Financial system liquidity
 Implementation of monetary policy
– Banks
– Finance companies
– Funds managers
– Building societies
– Credit unions
– Companies

35
• Money market sub-markets
– Intercompany market
– Interbank market
– Bills market
– Commercial paper market
– Negotiable certificates of deposit (CDs) market

36
Capital markets
• Markets in which longer-term securities are
issued and traded
– Equity markets
– Corporate debt markets
– Government debt markets
– Foreign exchange markets
– Derivatives markets
• Term to maturity of more than one year

37
1.1 Introduction
1.7 Summary

38
• Globalisation of financial markets
– Refers to the interdependence of national
financial systems
– Global standardisation of financial instruments
– Facilitates the movement of funds between
savers and borrowers in different countries

39
1.1 Introduction
1.7 Summary

40
1.7 Summary (cont.)
• Financial markets may be classified
according to
– Primary and secondary transactions
– Direct and intermediated flows
– Wholesale and retail markets
– Money markets and capital markets
– Financial institutions

Chapter 01

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to Chapter 01

Similar to Chapter 01 (20)

Recently uploaded

Recently uploaded (20)

Chapter 01