Maf702 Financial Markets School of Accounting, Economics

8/14/2019 Maf702 Financial Markets School of Accounting, Economics

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MAF702

FINANCIAL MARKETS

SCHOOL OF ACCOUNTING, ECONOMICSAND FINANCE

DEAKIN UNIVERSITY


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MICHAEL DROSARIO

Email: [email protected] Direct line: 9244 6231

Background: Corporate recovery, financial consultancy

and international development.

Teaching responsibilities: Ethics, Business Finance,Financial markets theory

Research interests: development economics, race andidentity studies and Diaspora communities, gametheoretic frameworks in political philosophy, M&ATheory/Governance
mailto:[email protected]:[email protected]


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REQUIRED TEXT

VINEY, C., 2003, FINANCIALINSTITUTIONS, INSTRUMENTS

AND MARKETS, FIFTH

EDITION, MCGRAW HILL,

SYDNEY


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TOPIC 1

OVERVIEW OF A

MODERN FINANCIAL SYSTEM


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SEMINAR OUTCOMES

To have gained a broad understanding ofmodern financial systems

To have a rudimentary understanding of thevarious financial assets

To appreciate the level of integration thatexists between financial systems


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FINANCIAL SYSTEM

A financial system comprises threeprincipal elements which facilitate theflow of funds:

financial institutions financial markets

financial instruments


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FINANCIAL SYSTEM

A financial system facilitates financialtransactions through the creation, sale andtransfer of financial assets


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FINANCIAL ASSETS

Currency or a financial instrument whichrepresents a claim to future cash flows.Examples include:

shares issued by a company

government treasury bonds

bank term deposits


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ATTRIBUTES OF A FINANCIAL ASSET

return or yield

risk

liquidity

time pattern of cash-flows


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FUNCTIONS OF A FINANCIAL SYSTEM

facilitates the efficient conduct oftransactions for goods and services

facilitates the flow of funds between lendersand borrowers

allows the management of portfolios ofassets and liabilities

encourages economic development


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FINANCIAL SYSTEM

the financial system allows both lenders andborrowers to trade-off between the differentattributes to achieve their desired portfoliostructure needs


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Financial SystemFinancial System

InstitutionsInstitutions

BanksBanks

Building societiesBuilding societies

Credit unionsCredit unions

Insurance officesInsurance offices

Superannuation fundsSuperannuation fundsMerchant banksMerchant banks

Investment banksInvestment banks

Finance companiesFinance companies

Unit trustsUnit trusts

InstrumentsInstruments

DebtDebt

EquityEquity

HybridsHybrids

DerivativesDerivatives

MarketsMarkets

MoneyMoney

CapitalCapital

EquityEquity

ForeignForeign

exchangeexchangeDerivativesDerivatives

Regulators and SupervisorsRegulators and Supervisors


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FINANCIAL INSTRUMENTS

1. Equity

shares issued by a company which representan ownership position for the shareholder

shareholder has an entitlement to receive ashare of any distribution of profits of thecompany - dividends


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2. Debt

debt instruments are contractual claims toperiodic cash flows in the form of interestpayments and principal repayments

may be issued with a fixed or floatinginterest rate, or at a discount; secured orunsecured; short to longer-term


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3. Hybrids

combine the elements or characteristics ofboth debt and equity

example - an instrument issued which makesperiodic interest payments, but offers afuture ownership entitlement (example:convertible notes)


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4. Derivatives

a product whose pricing is derived from anexisting product (e.g. gold)

not instruments issued for raising funds a tool for managing risk (e.g. the risk that the

price of gold may change in the future)

types: futures, options, swaps, forwards


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FINANCIAL MARKETS

1. Matching principle

short-term assets should be funded withshort-term liabilities

medium-to-longer-term assets should befunded with equity and/or medium-to-longer-term liabilities

seeking to match the cash-flows on bothsides of the balance sheet


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FINANCIAL MARKETS

2. Primary and secondary markets

primary markets involve the issue of newfinancial instruments (e.g. IPO)

secondary markets trade existinginstruments (securities). No new funds areraised by the original issuer

deep and liquid secondary marketsstrengthen the primary markets


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FINANCIAL MARKETS

3. Direct and intermediated markets

government, business and individuals accessfinance to meet funding needs

access to funding may be categorised as: direct finance, or intermediated finance


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FINANCIAL MARKETS

3.1 Direct markets

supplier of funds contracts directly with theuser of funds

creates an entitlement to dividends andcapital gains (losses) on shares; or interestreceipts and principal repayment on debt

direct finance issues include shares, discountsecurities, bonds and government securities


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DIRECT FINANCIAL FLOWS

ProviderProvider

of Fundsof Funds

UserUser

of Fundsof Funds

BrokerBroker


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FINANCIAL MARKETS

3.1 Direct finance considerations: Benefits: removes cost of financial intermediary diversify funding instruments and sources raise profile in financial markets Disadvantages: documentation; prospectus matching lender and borrower preferences liquidity and marketability of securities legal, financial and expert advice credit ratings


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FINANCIAL MARKETS

3.2 Intermediated markets

supplier of funds (investor) contracts with afinancial intermediary such as a bank (e.g.term deposit);

user of funds (borrower) also contracts withthe intermediary (e.g. housing loan)

claims of each party are with theintermediary; i.e. the investor has no claimagainst the borrower


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INTERMEDIATED FINANCIAL FLOWS

ProviderProvider

of Fundsof Funds

UserUser

of Fundsof Funds

IntermediaryIntermediary


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ADVANTAGES OF INTERMEDIATION

Asset transformation:

range of products

pooling of funds

Maturity transformation:

liquidity

maturity

risk management


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Credit risk diversification:

assessing credit risk

diversified portfolio of loans

Provision of liquidity:

cash flows

risk return trade-off


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Distribution of costs:

infrastructure and technology baseddistribution systems (branches; ATMs)

expertise (financial, legal, economic) standardised documentation


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FINANCIAL MARKETS

4. Wholesale markets and retail markets

wholesale markets - transactions byinstitutional investors and borrowers.

Typically in the millions of dollars

retail markets - generally transactions ofhousehold and small business sectors, usingfinancial institutions


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FINANCIAL MARKETS

5. Money markets

wholesale markets in funds with less than 1year to maturity

deep secondary markets

(e.g. bills of exchange market)

enable participants to manage liquidity


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FINANCIAL MARKETS

5. Money markets

Participants include commercial banks,investment banks, merchant banks, financecompanies, insurance offices, funds

managers, large corporations, central banks


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FINANCIAL MARKETS

5. Money markets

sub-markets include:

central bank managing financial systemliquidity and monetary policy

inter-bank market

bills market

commercial paper market

certificate of deposit market


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FINANCIAL MARKETS

6. Capital Markets

capital market instruments provide medium-to-longer-term funding

encompass both the international anddomestic markets


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FINANCIAL MARKETS

6. Capital Markets

sub-markets include:

equity market

corporate debt market government debt market

supported by:

foreign exchange market

derivatives market


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GLOBALISATION OF THE FINANCIALMARKETS

the integration of financial institutions,instruments and markets into aninternational financial system

changing needs of market participants

use of technology and communicationsystems

removal of most regulations restricting theflow of capital between countries

active foreign exchange markets


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FINANCIAL INSTITUTIONS

in a modern financial system, different typesof institutions provide a wide range ofbalance sheet and off-balance sheet productsand services

institutions are classified by their sources(liabilities) and uses (assets) of funds

products and services provided vary betweeninstitutions depending on regulation, markets

and competition the following five classifications are used


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1. Depository financial institutions

attract savings from depositors and investorsto provide loan facilities to borrowers

includes - banks; building societies; creditunions


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2. Contractual savings institutions

liabilities (source of funds) are contracts thatgenerate periodic cash flows, such asinsurance contract instalments or

superannuation savings accumulated funds are used to purchase

both real and financial assets

includes - insurance offices and

superannuation funds


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3. Finance companies

liabilities (funds) generated from the issue offinancial securities direct into the moneymarkets and capital markets

assets (use of funds) are mainly loans toretail customers (individuals and smallbusiness)


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4. Investment banks and merchant banks

(money market corporations)

generally raise short-term funds in thewholesale money markets

provide short-to-medium-term loans tocorporate clients

specialise in off-balance sheet financialservices to corporate clients and government


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5. Unit trusts and managed funds

investors purchase units in a trust

trustee (using funds managers) investsaccumulated funds in a specified range ofinvestment types

include - cash management trusts; equitytrusts; property trusts; mortgage trusts

Maf702 Financial Markets School of Accounting, Economics

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