Tài chính doanh nghiệp - Chapter 1: A modern financial system an overview

Chapter 1A modern financial system—an overview Websites:www.rba.gov.auwww.treasury.gov.auwww.bis.orgwww.ny.frb.orgwww.asx.com.auwww.ft.com/asia/Learning objectivesExplain the functions of a financial systemCategorise the main types of financial institutionsDescribe the main classes of financial instruments issued in a financial systemDiscuss the flow of funds between savers and borrowers, and through the financial system and economyDistinguish between various types of financial markets according to functionAppreciate the importance of globalisation of financial marketsUnderstand the effects and consequences of a financial crisis on a financial system and economyChapter organisation1.1 Functions of a financial system1.2 Financial institutions1.3 Financial instruments1.4 Financial markets1.5 Flow of funds, market relationships and stability1.6 Summary1.1 Functions of a financial systemMoneyActs as medium of exchangeAllows specialisation in productionSolves the divisibility problem; i.e. where medium of exchange does not represent equal value for the parties to the transactionFacilitates savingRepresents a store of wealth(cont.)1.1 Functions of a financial system (cont.)Role of marketsFacilitate exchange of goods and services by:bringing opposite parties togetherestablishing rates of exchange; i.e. pricesSurplus unitsSavers of funds available for lendingDeficit unitsBorrowers of funds for capital investment and consumption(cont.)1.1 Functions of a financial system (cont.)Financial instrumentIssued by a party raising funds, acknowledging a financial commitment and entitling the holder to specified future cash flowsDouble coincidence of wants satisfiedA transaction between two parties that meets their mutual needs(cont.)1.1 Functions of a financial system (cont.)Flow of fundsMovement of funds through the financial system between savers and borrowers giving rise to financial instrumentsFinancial systemComprises financial institutions, instruments and markets facilitating transactions for goods and services and financial transactions(cont.)1.1 Functions of a financial system (cont.)(cont.)1.1 Functions of a financial system (cont.)Attributes of financial assetsReturn or yieldTotal financial compensation received from an investment expressed as a percentage of the amount investedRiskProbability that the actual return on an investment will vary from the expected return(cont.)1.1 Functions of a financial system (cont.)Attributes of financial assets (cont.)LiquidityAbility to sell an asset within a reasonable time at current market prices and for reasonable transaction costsTime-pattern of cash flowsWhen the expected cash flows from a financial asset are to be received by the investor or lender(cont.)1.1 Functions of a financial system (cont.)Facilitation of portfolio restructuringThe combination of assets and liabilities comprising the desired attributes of return, risk, liquidity and timing of cash flowsImplementation of monetary policyActions of a central bank taken to influence interest rate levels to achieve certain economic outcomesPrimary target is inflation(cont.)1.1 Functions of a financial system (cont.)An efficient financial system:encourages savingsdirects savings to the most efficient usersimplements the monetary policy of governments by influencing interest ratesis a combination of assets and liabilities comprising the desired attributes of return, risk, liquidity and timing of cash flows(cont.)1.1 Functions of a financial system (cont.)Since 2007, the financial markets have been characterised by a great deal of volatilityWhat started as a liquidation of credit derivatives sparked by a fall in house prices in the United States has become a watershed moment in modern financial historyAs nations continue to battle the economic effects of the GFC, debate continues to rage about the regulatory response necessary to bring stability to the systemChapter organisation1.1 Functions of a financial system1.2 Financial institutions1.3 Financial instruments1.4 Financial markets1.5 Flow of funds, market relationships and stability1.6 Summary1.2 Financial institutionsMost people have used the services of a financial institution at some stage, even if the service was simply a basic bank accountFinancial institutions may specialise in:taking deposits, providing advice to corporate and government clients or offering financial contracts such as insuranceFinancial institutions are essential to the operation of the modern financial system(cont.)1.2 Financial institutions (cont.)Financial institutions permit the flow of funds between borrowers and lenders by facilitating financial transactionsInstitutions may be categorised by differences in the sources and uses of funds(cont.)1.2 Financial institutions (cont.)Categories of financial institutionsDepository financial institutionsInvestment banks and merchant banksContractual savings institutionsFinance companiesUnit trustsCategories of financial institutionsDepository financial institutionsMainly attract the savings of depositors through on-demand deposit and term deposit accounts; e.g. commercial banks, building societies and credit cooperatives Mainly provide loans to borrowers in household and business sectors(cont.)Categories of financial institutions (cont.)Investment banks and merchant banksMainly provide off-balance-sheet (OBS) advisory services to support corporate and government clients; e.g. advice on mergers and acquisitions, portfolio restructuring, finance and risk managementMay also provide some loans to clients but are more likely to advise on raising funds directly in capital markets(cont.)Categories of financial institutions (cont.)Contractual savings institutionsThe liabilities of these institutions are contracts that require, in return for periodic payments to the institution, the institution to make payments to the contract holders if a specified event occurs; e.g. life and general insurance companies and superannuation fundsThe large pool of funds is then used to purchase both primary and secondary market securitiesPayouts are made for insurance claims and to retirees(cont.)Categories of financial institutions (cont.)Finance companiesFunds are raised by issuing financial securities, such as commercial paper, medium-term notes and bonds, directly into money markets and capital marketsFunds are used to make loans and provide lease finance to customers in the household and business sectors(cont.)Categories of financial institutions (cont.)Unit trustsFormed under a trust deed and controlled and managed by a trusteeFunds raised by selling units to the public; investors purchase units in the trustFunds are pooled and invested by fund managers in a range of asset classes specified in the trust deedTypes of unit trusts include equity, property, fixed interest and mortgage trusts1.2 Financial institutions (cont.)Chapter organisation1.1 Functions of a financial system1.2 Financial institutions1.3 Financial instruments1.4 Financial markets1.5 Flow of funds, market relationships and stability1.6 Summary1.3 Financial instrumentsEquityOwnership interest in an assetResidual claim on earnings and assetsDividendLiquidationTypesOrdinary shareHybrid (or quasi-equity) securityPreference sharesConvertible notes(cont.)1.3 Financial instruments (cont.)DebtContractual claim to:periodic interest paymentsrepayment of principalRanks ahead of equity Can be:short-term (money market instrument) or medium- to long-term (capital market instrument)secured or unsecurednegotiable (ownership transferable; e.g. commercial bills and promissory notes) or non-negotiable (e.g. term loan obtained from a bank)(cont.)1.3 Financial instruments (cont.)DerivativesA synthetic security providing specific future rights that derives its price from:a physical market commoditygold and oilfinancial securityInterest-rate-sensitive debt instruments, currencies and equitiesUsed mainly to manage price risk exposure and to speculate (cont.)1.3 Financial instruments (cont.)Four basic derivative contracts1. Futures contract (Chapter 18 and 19)2. Forward contract (Chapters 17, 18 and 19)3. Option contract (Chapters 18 and 20)4. Swap contract (Chapters 18 and 21)Chapter organisation1.1 Functions of a financial system1.2 Financial institutions1.3 Financial instruments1.4 Financial markets1.5 Flow of funds, market relationships and stability1.6 Summary1.4 Financial marketsMatching principlePrimary and secondary market transactionsDirect and intermediated financeWholesale and retail marketsMoney marketsCapital marketsMatching principleShort-term assets should be funded with short-term (money market) liabilities; e.g. seasonal inventory needs funded by overdraftLonger term assets should be funded with equity or longer term (capital market) liabilities; e.g.:equipment funded by debentureslack of adherence to this principle accentuated effects of frozen money markets with the ‘sub-prime’ market collapsePrimary and secondary market transactionsPrimary market transactionThe issue of a new financial instrument to raise funds to purchase goods, services or assets by:businessescompany shares or debenturesgovernmentsTreasury notes or bondsindividualsmortgageFunds are obtained by the issuer(cont.)Primary and secondary market transactions (cont.)Secondary market transactionThe buying and selling of existing financial securitiesNo new funds raised and therefore no direct impact on original issuer of securityTransfer of ownership from one saver to another saver Provides liquidity, which facilitates the restructuring of portfolios of security ownersDirect and intermediated financeDirect financeUsers of funds obtain finance through primary market via direct relationship with providers (savers)AdvantagesAvoids costs of intermediationIncreases access to diverse range of marketsGreater flexibility in range of securities users can issue for different financing needsDisadvantagesMatching of preferencesLiquidity and marketability of a securitySearch and transaction costsAssessment of risk, especially default risk(cont.)Direct and intermediated finance (cont.)(cont.)Direct and intermediated finance (cont.)Intermediated financial flow marketsA financing arrangement involving two separate contractual agreements whereby the saver provides funds to an intermediary and the intermediary provides funding to the ultimate user of the funds(cont.)Direct and intermediated finance (cont.)(cont.)AdvantagesAsset transformationBorrowers and savers are offered a range of productsMaturity transformationBorrowers and savers are offered products with a range of terms to maturityCredit risk diversification and transformationSaver’s credit risk limited to the intermediary, which has expertise and informationLiquidity transformationAbility to convert financial assets into cashEconomies of scaleFinancial and operational benefits of organisational size and business volumeDirect and intermediated finance (cont.)Wholesale marketsDirect financial flow transactions between institutional investors and borrowersInvolves larger transactionsRetail marketsTransactions conducted primarily with financial intermediaries by the household and small- to medium-sized business sectorsInvolves smaller transactions(cont.)Wholesale and retail marketsWholesale and retail markets (cont.)Wholesale markets in which short-term securities are issued (primary market transaction) and traded (secondary market transaction)Securities highly liquidTerm to maturity of one year or lessHighly standardised formDeep secondary marketNo specific infrastructure or trading placeEnable participants to manage liquidity(cont.)Money markets(cont.)Money markets (cont.)Money market submarkets exist for:central bank—system liquidity and monetary policyinter-bank marketbills marketcommercial paper marketnegotiable certificates of deposit (CDs) marketMoney markets (cont.)Capital marketsMarkets in which longer term securities are issued and traded with original term-to-maturity in excess of one yearEquity marketCorporate debt marketGovernment debt marketAlso incorporate use of foreign exchange markets and derivatives marketsParticipants include individuals, business, government and overseas sectorsChapter organisation1.1 Functions of a financial system1.2 Financial institutions1.3 Financial instruments1.4 Financial markets1.5 Flow of funds, market relationships and stability1.6 Summary1.5 Flow of funds and market relationshipsSectorial flow of fundsThe flow of funds between business, financial institutions, government and household sectors and the rest of the worldNet borrowing and net lending of these sectors of an economy vary between countriesInfluenced by:the impact of fiscal and monetary policy on savings and investment decisionspolicy decisions like compulsory superannuationThe GFC has significantly impacted on flow of funds(cont.)1.5 Flow of funds and market relationships (cont.)The flow of funds between deficit and surplus units is an important contributor to economic growthFor these benefits to be fully realised, the flow of funds must be characterised by relative stabilityThe GFC interrupted the functioning of the financial system and inflicted serious damage on the ‘real’ economy in many countriesThe role of regulators is to balance the benefits of a free financial system against the costs of instabilityChapter organisation1.1 Functions of a financial system1.2 Financial institutions1.3 Financial instruments1.4 Financial markets1.5 Flow of funds, market relationships and stability1.6 Summary1.6 SummaryThe financial system is composed of financial institutions, instruments and markets facilitating transactions for goods and services and financial transactionsFinancial instruments may be equity, debt or hybridFinancial markets may be classified according to:primary and secondary transactionsdirect and intermediated flowswholesale and retail marketsmoney markets and capital marketsfinancial institutions