Topic 5Financial Markets

Year 11 Economics (Preliminary)

http://www.shiftfrequency.com/susanne-posel-morgan-stanley-is-insolvent-only-a-matter-of-time-before-total-financial-collapse/

Syllabus: Students Learn To

Examine economic issues

examine the contribution of financial markets to the economic welfare of individuals and firms

investigate the extent of competition in financial markets

discuss the need for regulation in financial markets

Apply economic skills

compare and contrast financial markets with product markets

explain the role of institutions in the operation of financial markets

analyse the impact of financial innovations on individuals and the economy

work in groups to investigate the economic role of the superannuation industry

analyse the factors that influence the level of interest rates

predict trends in interest rates in hypothetical situations.

Financial markets in Australia

Types of financial markets

primary and secondary markets

consumer credit, housing loans, business loans, short term money market, bond market, financial futures, foreign exchange

the share market – its role, function and effect on the economy

domestic and global markets

Regulation of financial markets – the role and functions of current institutions

Reserve Bank of Australia

Australian Prudential Regulation Authority

Australian Securities and Investments Commission

Australian Treasury

Council of Financial Regulators

Financial aggregates measured by the Reserve Bank of Australia

currency

broad money

credit

Interest rates

types of rates in the short term and long term

lending rates

borrowing rates

role of the Reserve Bank of Australia in determining the cash rate

influence of the cash rate on interest rates.

Syllabus: Students Learn About

Borrowers

individuals

business

government

Factors affecting the demand for funds

transactions and speculative motives

financial innovations

Lenders

individuals

business

government

international

The Role of Financial Markets

Financial markets are the factor market for capital.

Financial Markets provide a way for those with excess funds to earn interest on their asset by lending to those with a shortage of funds.

Finance plays a key role in the economy, allowing firms, individuals and governments to access additional funds.

The significant influence that financial markets have mean that they need to be more highly regulated than some other markets.

Financial markets provides an efficient way to connect lenders and borrowers – through financial intermediaries.

Our five sector model sees “households” as savers and businesses as “borrowers” in the economy… but in reality savings and investment come from all parts of the economy…

Examples? (textbook p171)

Sources of Funds (Savings):

Uses of Funds (Borrowings)

Financial Intermediaries connect those with excess funds (savers) to those who a shortage of funds for their wants (borrowers).

These have traditionally been broken into banks and non-bank financial intermediaries (NBFIs), with banks being considered the more significant (although this distinction is less relevant today).

Non Bank Financial Institutions

Credit Unions

Building Societies

Finance Companies

eg GE Money

Investment (Merchant) Banks

eg Macquarie Bank

Mortgage Originators

eg Aussie; RAMS

Superannuation Funds

Financial Intermediaries

Banks

Authorised deposit taking institutions.

Specially regulated and backed by government guarantee.

Securities

Any form of financial instrument, including shares and bonds, that provide the holder of that instrument with a claim over real assets or a future income stream.

WTF?

Secondary Financial Market

Where already existing financial securities are bought and sold (traded).

This is where investors trade with each other using previously purchased securities.

Think secondary market = second hand goods.

Primary vs Secondary

Primary Financial Market

Where newly formed financial securities/assets are bought and sold.

Typically the sale of shares, such as when a company sells new shares, could also be new government or corporate bonds.

Securities sold in the primary financial market lead to the company directly receiving the money. This is not the case when shares are bought and sold on the stock exchange.

Main Financial Markets & Products

Share/Equity Markets

Where ownership shares in companies are issued or exchanged. Mostly done in ASX in Australia.

Debt Market

Where debt securities are exchanged or cash is lent or borrowed.

Derivatives Market

Where people buy and sell financial assets that are based on the value of other financial assets.

Foreign Exchange Market

Where financial assets defined in one country’s currency are exchanged for assets defined in another country’s currency.

Products

Consumer Credit

Housing Loans

Business Loans

Short Term Money Market

Bonds

Financial Futures/Options

Foreign Exchange (Forex)

Share Market Products

Examples of Financial Market Products

Identify the financial market product the following examples represent and the financial market they exist in.

Tim wants to buy Christmas presents but doesn’t have enough cash.

Telstra needs to borrow $10m for 72 hours.

Nic, a small businessman, wants finance to purchase new factory equipment.

Farmer Damien has sold this year’s crop to a Chinese company.

Big Johnny D needs money to purchase a new car.

Wesfarmers needs to finance the acquisition of Coles.

Finn wants to lock in an $AUD price for his products over the coming months.

Banker Sahil has surplus funds at the end of the day’s trading.

Gina Rinehart wants to invest $10m in Fairfax.

Which Product? Which Market?

Consumer Credit

Housing Loans

Business Loans

Short Term Money Market

Bonds

Financial Futures/Options

Foreign Exchange (Forex)

Share Market Products

Bonds!

What is a bond?

A bond is a special type of loan taken out by governments and large companies.

Also known as a debt security, it is a written financial document issued by the borrower to the lender, who is known as a bondholder.

The initial price (the loan amount) is known as the face value of the bond.

The bondholder is entitled to a fixed stream of payments (known as coupon payments), which are like interest payments.

The bondholder is also entitled to repayment of the original loan amount when the bond matures.

Trading bonds?

Bonds can be bought and sold in a secondary market (the bond market).

The rate of financial return is known as the yield. This is calculated by dividing the coupon payment by the bond price.

After the bond has been issued, the price on the secondary market will fluctuate according to changes in the level of interest rates.

Yield

Example: a $1,000,000 bond with annual coupons of $50,000 has a yield of 5%.

If interest rates increases, the value of the bond (in the secondary market) will go down, because buyers will want higher return.

Because the annual coupon payment is fixed, a lower price increases the yield.

If you buy a bond with a 10% coupon at its $1,000 face value, the yield is 10% ($100/$1,000). Pretty simple stuff.

If the price falls to $800, the yield increases to 12.5% ($100 payment/$800 value).

Conversely, if the price increases to $1,200, the yield shrinks to 8.33% ($100/$1,200).

http://www.investopedia.com/university/bonds/bonds3.asp