Topic 1: The Financial System Topic 2
Contents: Topic 1: The Financial System Topic 2: Banks Topic 3: Non-‐bank Financial Institutions Topic 4: Equity Topic 5: Investors in the Share Market Topic 6: Financial Mathematics Topic 7: Short-‐term Debt Topic 8: Medium to Long-‐term Debt Topic 9: Forex Topic 10: Futures and Forward Rate Agreements Topic 11: Options
TOPIC 1: The Financial System Money: • Acts as a medium of exchange • Is divisible • Can be stored • Allows specialisation in production Functions on a Financial System: • Facilitates exchange of goods and services • Brings together SURPLUS units and DEFECIT units (suppliers of funds with users of funds • Uses Financial Instruments: o Financial Instruments are issued by a party raising funds acknowledging a financial commitment and entitling the holder to specified future cash flows • The Financial System: o Comprises of financial institutions, instruments and markets facilitation transactions for goods and services. Attributes of Financial Instruments: (RRLT) Return or yield: • Financial compensation for taking on risk of the investment expressed as a percentage of the amount invested. Risk: • The probability that the actual return on investment varies from the expected return. Liquidity: • The ability to sell an asset within a reasonable amount of time at current market prices. Time-‐pattern of cash flows: • When the expected cash flows from the investment are expected to be received. Different Financial Instruments: (EDD) Equity: • Ownership interest in an asset. • Residual (quantity left over at end) claim in earnings and assets. Debt: • Contractual claim to interest payments and repayment of principal amount. • Ranks ahead of equity. • Can be short-‐term or medium to long-‐term, secured or unsecured, and negotiable. Derivatives: • Synthetic security providing specific future rights. • Derives its value/price from physical market commodities or financial securities. Synthetic security. • Mainly used to manage price risk exposure and to speculate. • 4 basic derivatives: Futures, Forward, Options, Swap. FFOS Matching Principle: • Short-‐term assets – funded with – Short-‐term liabilities. (Money market) • Long-‐term assets – funded with – Long-‐term liabilities. (Capital Market) Primary Market: • Issue of new financial instrument to raise funds. Businesses, Govt, or Individuals. • The issuer receives the funds Secondary Market: • The buying and selling of existing financial securities • No new funds raised. • Transfer of ownership from one saver to another. • Provides liquidity. Direct and Intermediated Finance: • Direct: o Users of funds obtain finance directly from savers o Avoids costs, but reduces liquidity. • Intermediated: o Saver provides funds to intermediary, intermediary provides funds to the user o Large range of products available, liquid, knowledge of brokers, main disadvantage is extra costs for savers.
Wholesale markets: • Involves larger transactions • Institutional investors (big investors, banks, insurance companies, unit trusts, retirement/pension funds, hedge funds, superannuation, investment/merchant banks etc) Retail markets: • Involves smaller transactions • Household and small to medium sized businesses • Primarily done via intermediaries Structure of Money and Capital Markets:
Money Markets: • Retail and whole markets in which short-‐term securities are issued and traded • Highly liquid • Maturity one year of less • Large and deep secondary market • No specific infrastructure or trading place Capital Markets: • Longer-‐term securities are traded with maturity more than one year • Equity, corporate debt, government debt markets • Foreign exchange and derivative markets included • Individuals, businesses, government, and overseas sectors all participate
TOPIC 1: The Financial System Money: • Acts as a medium of exchange • Is divisible • Can be stored • Allows specialisation in production Functions on a Financial System: • Facilitates exchange of goods and services • Brings together SURPLUS units and DEFECIT units (suppliers of funds with users of funds • Uses Financial Instruments: o Financial Instruments are issued by a party raising funds acknowledging a financial commitment and entitling the holder to specified future cash flows • The Financial System: o Comprises of financial institutions, instruments and markets facilitation transactions for goods and services. Attributes of Financial Instruments: (RRLT) Return or yield: • Financial compensation for taking on risk of the investment expressed as a percentage of the amount invested. Risk: • The probability that the actual return on investment varies from the expected return. Liquidity: • The ability to sell an asset within a reasonable amount of time at current market prices. Time-‐pattern of cash flows: • When the expected cash flows from the investment are expected to be received. Different Financial Instruments: (EDD) Equity: • Ownership interest in an asset. • Residual (quantity left over at end) claim in earnings and assets. Debt: • Contractual claim to interest payments and repayment of principal amount. • Ranks ahead of equity. • Can be short-‐term or medium to long-‐term, secured or unsecured, and negotiable. Derivatives: • Synthetic security providing specific future rights. • Derives its value/price from physical market commodities or financial securities. Synthetic security. • Mainly used to manage price risk exposure and to speculate. • 4 basic derivatives: Futures, Forward, Options, Swap. FFOS Matching Principle: • Short-‐term assets – funded with – Short-‐term liabilities. (Money market) • Long-‐term assets – funded with – Long-‐term liabilities. (Capital Market) Primary Market: • Issue of new financial instrument to raise funds. Businesses, Govt, or Individuals. • The issuer receives the funds Secondary Market: • The buying and selling of existing financial securities • No new funds raised. • Transfer of ownership from one saver to another. • Provides liquidity. Direct and Intermediated Finance: • Direct: o Users of funds obtain finance directly from savers o Avoids costs, but reduces liquidity. • Intermediated: o Saver provides funds to intermediary, intermediary provides funds to the user o Large range of products available, liquid, knowledge of brokers, main disadvantage is extra costs for savers.
Wholesale markets: • Involves larger transactions • Institutional investors (big investors, banks, insurance companies, unit trusts, retirement/pension funds, hedge funds, superannuation, investment/merchant banks etc) Retail markets: • Involves smaller transactions • Household and small to medium sized businesses • Primarily done via intermediaries Structure of Money and Capital Markets:
Money Markets: • Retail and whole markets in which short-‐term securities are issued and traded • Highly liquid • Maturity one year of less • Large and deep secondary market • No specific infrastructure or trading place Capital Markets: • Longer-‐term securities are traded with maturity more than one year • Equity, corporate debt, government debt markets • Foreign exchange and derivative markets included • Individuals, businesses, government, and overseas sectors all participate
