FIN80004 Lecture1

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Lecture 1: Chapter 1 A Modern Financial System Presented By Dr Sarod Khandaker 1 Presented by Dr Sarod Khandaker

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FIN80004 Lecture1FIN80004 Lecture1

Transcript of FIN80004 Lecture1

  • Lecture 1: Chapter 1

    A Modern Financial System

    Presented ByDr Sarod Khandaker

    *Presented by Dr Sarod Khandaker

    Presented by Dr Sarod Khandaker

  • THE ROLE OF THE FINANCIAL SYSTEMThe financial system consists of financial markets, institutions and money.

    The roles of the financial system are:To facilitate the flow of fundsTo provide the mechanism to settle transactionsTo generate and disseminate informationTo provide the means to transfer and manage riskTo provide ways of dealing with incentive problemsPresented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • THE FLOW OF FUNDSThe financial system allows the flow of funds from surplus spending units (SSUs) to deficit spending units (DSUs). Figure 1.2 Flow of fundsPresented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • SSUs and DSUsEconomic units can be classified as:HouseholdsBusinessesGovernmentsA surplus unit is a unit whose income exceeds planned expenditure.A deficit unit is a unit whose expenditure exceeds its receipts.The flow of funds from SSUs (mainly households) to DSUs (mainly business firms and governments) is a fundamental function of the financial system. Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • DIRECT FINANCINGSSUs lend money to DSUs and accept a financial claim in return.

    In direct financing, this exchange takes place directly without an intermediary.

    The limitations of direct financing create a role for financial intermediaries to intervene between DSU and SSU. Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • INDIRECT FINANCINGDirect financing requires DSUs to find SSUs that want direct claims and the denominations involved are usually very large.

    These problems are resolved through the involvement of a financial intermediary.

    Financial intermediaries purchase direct claims from DSUs, transform them into indirect claims and sell them to SSUs. Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • BENEFITS OF FINANCIAL INTERMEDIATIONWhen intermediaries transform direct claims into indirect ones, they perform five services: Denomination divisibilityCurrency transformationMaturity flexibilityCredit risk diversificationLiquidity Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • TYPES OF INTERMEDIARIESAustralian financial intermediaries include: Banks, building societies and credit unionsForeign bank representativesGeneral and life insurersFriendly societiesMoney market corporations, finance companies and securitisesLicensed trusteesSuperannuation entities. Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • Presented by Dr Sarod Khandaker*AUSTRALIAN FINANCIAL INTERMEDIARIES

    Presented by Dr Sarod Khandaker

  • Presented by Dr Sarod Khandaker*GROWTH OF FINANCIAL INTERMEDIARIES

    Presented by Dr Sarod Khandaker

  • COMMERCIAL BANKSCommercial banks are the largest and most diversified intermediaries. Australian-owned commercial banks hold more than $2.85 trillion in financial assets (end 2013). These assets consist of loans to consumers, businesses and governments.Commercial banks liabilities consist of deposit accounts and other sources of funds.Commercial banks might also be engaged in other activities such as underwriting. Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • NONBANK FINANCIAL CORPORATIONSNBFCs provide many of the same services and products that commercial banks provide.

    NBFCs may be classified into four groups: Building SocietiesCredit UnionsMoney-market CorporationsFinance CompaniesPresented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • Presented by Dr Sarod Khandaker*AUSTRALIAN OWNED BANK ASSETS

    Presented by Dr Sarod Khandaker

  • OTHER FINANCIAL INSTITUTIONSSeveral groups of other financial institutions operate in the financial system.

    These include: Life insurance companiesGeneral insurance companiesSuperannuation fundsManaged FundsSecuritisersPresented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • INTERNATIONAL ORGANISATIONSIn addition to domestic institutions, there are a number of important international organisations.

    These include: The Bank of International SettlementsThe World BankThe International Monetary FundThe Asian Development BankPresented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • PRIMARY AND SECONDARY MARKETSPrimary markets are where financial claims are initially sold by DSUs.

    This might take place through an initial public offering of shares to the public.

    Secondary markets are where previously issued financial claims are exchanged among investors.Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • ORGANISED AND OVER-THE-COUNTER MARKETSOnce issued, the exchange of claims can take place on an organised exchange. In Australia, an example is the Australian Stock Exchange (ASX).

    Financial claims can also be exchanged over-the-counter. (OTC)OTC markets have no central location.Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • OTHER MARKETSOther types of financial markets include:The futures marketThe options marketForeign exchange marketsInternational markets

    For example: the eurocurrency markets and eurobond markets where domestic or overseas firms can borrow or lend Australian dollars deposited in overseas banks.Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • MONEY MARKETSWe usually sort financial markets into either money or capital markets.

    Money markets are where a certain type of financial claim are traded.

    Specifically, a wholesale short term to maturity (less than 12 months) claim is classified as a money market transaction.Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • MONEY MARKETSBanks and businesses adjust their liquidity positions by borrowing and lending for a short time on the money market.

    The RBA also conducts monetary policy on the money markets.

    The money market consists of a collection of markets each trading a different financial instrument.

    All of instruments have characteristics very similar to money: high liquidity and low default risk. Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • MONEY MARKET INSTRUMENTSTreasury notesCommercial paperCommercial billsNegotiable certificates of depositSecured and unsecured notesPresented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • CAPITAL MARKETSCapital markets: where longer term (greater than 12 months) securities are traded.

    On capital markets, capital goods are financed with stock or longer-term debt instruments.

    Capital market instruments are less marketable, have varying default levels and have maturities ranging from five to thirty years. Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • CAPITAL MARKET INSTRUMENTSThe instruments traded on the capital market include: SharesCorporate bondsGovernment bondsMortgagesPresented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • Presented by Dr Sarod Khandaker*INTERNATIONAL ASSETS AND LIABILITIES OF AUSTRALIAN BANKS

    Presented by Dr Sarod Khandaker

  • RISKS FACED BY FINANCIAL INSTITUTIONSFinancial institutions are exposed to a variety of risks. These include:Credit riskInterest rate riskLiquidity riskForeign exchange riskPolitical riskReputational riskEnvironmental riskPresented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • MANAGING RISKThe risks faced by financial institutions is managed by:

    Diversification of loans and investmentsCareful credit analysis of borrowersCareful monitoring of borrowers over timeThe undertaking of appropriate hedging strategies on the financial markets.Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • SUMMARYYou should now be able to:Explain the role of the financial system and why it is important.Explain the function of direct and indirect financial markets.Describe the different types of financial intermediaries.Describe the various types of financial markets.Explain the economic function of money and capital markets.Identify the risks that financial institutions face and describe how these risks are managed.

    Presented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker

  • THANK YOUPresented by Dr Sarod Khandaker*

    Presented by Dr Sarod Khandaker