The document defines and describes key components of a financial system. It explains that a financial system consists of financial institutions and markets that facilitate the transfer of funds between entities with excess capital and those with deficits. It outlines the main participants in financial systems as households, companies, governments, and foreigners. It also describes various financial intermediaries like banks, investment funds, pension funds, and insurance companies. Finally, it provides examples of different types of financial markets and securities.

1. 2.1. Financial System and Financial Markets
Financial System = the set of financial institutions and the relationships between
these, which serve to money transfer between persons/
companies/institutions that have excess funds to the persons/
companies/institutions that have deficits of funds
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Basic Finance – Financial Systems
Flows of Funds Through the Financial System
LENDERS
(SAVERS)
Households
Companies
Government
Foreigners
BORROWERS
(SPENDERS)
Government
Companies
Households
Foreigners
FINANCIAL
MARKETS
FUNDS FUNDS
Direct finance
FINANCIAL
INTERMEDIARIES
FUNDS
FUNDS FUNDS
FUNDS
FUNDS
Indirect finance

2. 2
Basic Finance – Financial Systems
Participants in the financial systems
Households (including individuals)
- L - interested to get a normal return for funds (proportional with the risk)
- B- financing consumption and/or personal investments
Companies
- B - financing investments and working capital
- L - interested to invest (temporary) excess cash
Government
- B - financing expenditures (temporarily - treasury bills / for long terms (>1 year) –
government bonds)
- L - placing temporary excess cash
Foreigners
- L - import loans and foreign investments
- B - export loans and investments of domestic entities abroad

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Basic Finance – Financial Systems
Issues related to financial investments:
Adverse Selection – the inability of the investors to differentiate between the
investment opportunities due to an asymmetry in information
(lack of information at investors level)
Moral Hazard – the possibility that the borrowers to change their behaviour after
the investment decision or to provide misleading information about its
assets, liabilities or credit capacity (fraud risk)

4. Financial intermediaries
Depository Institutions (Commercial Banks, Saving Banks) offer passive interest rate
for savers’ deposits. Partly, (except for reserve requirements), from these sources, banks grant
loans, charging the active interest.
Active interest rate > Passive interest rate
Bank’s Interest Margin = Active interest rate - Passive interest rate
Investment Intermediaries (Mutual Funds; Investment Funds) – professionally
managed type of collective investment scheme that pools money from many investors and
invests it in stocks, bonds, short-term money market instruments, and/or other securities.
Contractual Savings Institutions
- Pension funds - pool of assets forming an independent legal entity that are bought with the
contributions to a pension plan for the exclusive purpose of financing pension plan benefits.
- Insurance companies - compensate loss (including death or illness – for life insurance)
when these incur from the insurance premiums.
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Basic Finance – Financial Systems

5. * Intermediaries in the financial markets (especially in the capital market)
 Brokers (Brokerage firms) – trade securities on behalf of their customer , based on
brokerage fees charged (to customers).
.
 Dealers - trade securities for their own account.
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Basic Finance – Financial Systems
Financial Markets = the mechanisms that allow individuals, companies and institutions to
easily trade financial securities, commodities and other fungible items of
value.
Types of financial markets
Primary Mk.
Secondary Mk.
Organized Mk.
(Exchanges)
Over the counter
Mk. (OTC)

6. Primary mk. vs. Secondary mk.
Primary mk. – the first sale of securities - issuance (usually without any negotiation).
Companies, governments or public sector institutions can obtain funds through the sale of
a new stock or bond issue. This is typically done through a syndicate of securities dealers.
The process of selling new issues to investors is called underwriting. In the case of a new
stock issue, this sale is an initial public offering (IPO).
Secondary mk. (aftermarket) – the market of previously issued securities
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Basic Finance – Financial Systems
Exchange mk. vs. Over the counter mk.
Organized mk. (Exchange mk.) - fixed trading rules; established physical location; trading
is usually conducted by auction + standardized securities. (NYSE; BSE)
Over the counter mk. (OTC) - directly trade of securities, between two parties, located in a
variety of places and a variety of ways (by telephone or by computer ) + unstandardized
securities (NASDAQ; former RASDAQ)

7. Basic Finance – Financial Systems
2.2. Financial markets
Examples:
Money Market– market of short term and highly liquid securities issued by government or
banks;
Banking System – both market of deposits and market of bank loans for households and
companies;
Capital Market – market of long term securities;
FOREX Market – market of foreign currencies;
Government Securities (T-bills) Market – market of government bills (≤1 year) with
“zero” default risk (by extension this market refers to the market of any maturities and also
to the securities issued by municipalities);
Insurance Market;
Real Estate and Other Alternative Assets Market.
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Remember the issues ?
- Moral hazard
- Adverse Selection
need of Market Supervisory Authorities

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Basic Finance – Financial Systems
Supervisory Authorities
Money Market; Banking System & FOREX Market, including Government
Securities Market (with maturities < 1 year) - CENTRAL BANK (National Bank of
Romania – NBR (BNR));
Capital Market, including Government Securities Market (with maturities ≥1 year) –
Securities and Exchange Commission (National Securities Commission
(CNVM)) ;
Insurance Market - Insurance Supervisory Commission;

9. Basic Finance – Financial Systems
Financial Securities
- PRIMARY (BASIC)
- DERIVATIVES
- SYNTHETIC
1. Primary (Basic)
• Shares = equity investments (company ownership & associated risks and
benefits), (in public or private -unlisted- companies)
- common shares - proportional vote in General Shareholders Meetings;
- right to be voted as manager;
- right to received the proportional dividends from distributed net profit;
- in the case of bankruptcy, the common shareholders are the last ones
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to benefit from the capital recuperated;
(unlimited risk& unlimited return)
- preferred shares - no vote in General Shareholders Meetings;
(fixed income) - right to receive fixed dividends, independent of the company’s result;
- in the case of bankruptcy, the preferred equity is redeemed before
common equity.
(limited risk& limited return)

10. Basic Finance – Financial Systems
• Bonds (fixed income) = debt securities, in which the issuer owes the holders a
debt
(at its par value /face value) and, depending on the terms of the bond, is
obliged
to pay fixed interest (the coupon – sometimes variable) and/or to repay the
principal at a later date, termed maturity.
- in case of bankruptcy, bond holders have priority in receiving the money, after
the liquidation of the bond issuer’s assets;
- the coupon and the principal may be indexed with the inflation rate;
- the risk of non-payment for coupon or reimbursement price is lower than in the
case of stock;
- price is inverse correlated with the market interest rate
- no decision right.
(limited risk& limited return)
• Money market instruments
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- Commercial Papers
- Negotiable Certificates of Deposit
- T - Bills
- Municipal Notes

11. Basic Finance – Financial Systems
2. Derivative securities
• Convertible bonds – offer the options to choose, at the maturity, between
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reimbursement or share conversion
• Futures contracts/ Forward contracts - represent standardized (futures) /
unstandardized (forward) contracts between sellers and buyers to transfer a number of
securities, at a price established at the moment of the contract signing, traded on
exchanges (futures)/on OTC markets (forward).
• Options – standardized contracts that give the right, but not the obligation, of one of the
parties (buyer) to buy (CALL opt.) or to sell (PUT opt.) a certain number of securities
at an exercise price and at a certain pre-established maturity date. This right is
compensated by payment of a premium, which is traded on exchanges. (examples)
3. Synthetic securities
• Market index contracts (index futures)
*Types of orders on capital market
1. Market orders
2. Limit orders
3. Short sales – Margin requirements (examples)
4. Stop loss

12. Main types of financial systems:
I. Anglo-Saxon Financial System
- Based on capital markets (capital markets oriented)
- Good treatment for shareholders
- Investors are protected at the highest level
- Information is largely available on the market
- Market is considered the best regulator (by the way of the securities market prices)
- Competition is very important
Main Goal - maximisation of the shareholders’ wealth
II. Continental European Financial System
- Based on banks (banks oriented);
- Low number of IPOs
- Banks regulate the system
- The competition is not so important
- Strong labor unions
Main Goal - harmonisation of stakeholders’ interests
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Basic Finance – Financial Systems

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Basic Finance – Financial Systems
Main types of financial systems:
III. Japanese Financial System
- Based on typically business groups (keiretsu), formed by banks, companies; insurance
companies;
- This groups are centered on a bank (so mainly this system is a bank oriented system)
- Low level of protection for minority shareholders;
- Competition between groups.
* Islamic Financial System