Mid-Semester Exam Revision
The Flow of Fund- the financial system allows the flow of funds from surplus spending units (SSU’s) to deficit spending units (DSU’s). Providers of funds (SSU) receive a financial instrument (which stipulates the terms of the deal – i.e. amount lent, stream of future income, maturity date, etc.) issued either by the receiver of the funds (DSU) or by a financial intermediary.
Direct Finance- SSU’s lend money to DSU’s and SSU’s hold a financial claim directly issued by the DSU’s. In direct financing, this exchange takes place directly between SSU’s and DSU’s (likely with the help of a third party like an underwriter and broker) BUT in the ABSENCE of a financial intermediary. Indirect Finance:
Two different financial instruments are involved in the channelling process… -The financial institution issues a liability for collecting funds from the ultimate provider of funds. - The financial institution issues (or buys) an asset when providing funds to the ultimate recipient of funds. Financial Intermediaries/Institutions: whilst all financial intermediaries are financial institutions, not all financial institutions are financial intermediaries. For example, a brokerage firm or an investment bank are financial institutions but NOT financial intermediaries. Divergent Needs of Surplus and Deficit Units:
FEATURES| SURPLUS UNITS| DEFECIT UNITS|
Return on funds| High as possible| Low as possible|
Length of contract| Flexible and short| Inflexible and long| Risk exposure| Mainly risk averse| Risk taker|
Amount of funds| Usually small| Usually large|
Benefits of Financial Intermediation:
* Aggregation/Denomination divisibility
* LESS RISK AND LESS COST!!!
LESS RISK AND LESS COST!!!
Economies of scale – buy big amount of shares in less transactions to save $ (commission). * Credit risk diversification
* Maturity transformation/ liquidity (companies using my short term money to make long term investments) * Currency transformation
* Overcome informational asymmetries to reduce risks (expertise and lower cost as economies of scale). +Less moral hazard as more expertise in monitoring the borrowers +more expertise in screening out the good from bad risks Types of Financial Intermediaries:
ADI’s (Authorised Deposit-Taking Institutions) = CB + BS + CU * Commercial Banks: - Retail Commercial Banks (i.e. ANZ, NAB etc. who provide banking for personal customers by taking many small deposits and offer many small loans and overdrafts to consumers, businesses and gov’t). *Big four banks represent ¾ of all ADIs (increased share mainly due to acquisitions in 2008 of next tier banks: Westpac bought St George) CUBS: Many still exists but 30 years of merging and decreasing numbers: now 116 instead of 170 in 2005 (11BS + 105 CU’s) CUBS: Many still exists but 30 years of merging and decreasing numbers: now 116 instead of 170 in 2005 (11BS + 105 CU’s) : - Wholesale commercial banks (banking for large companies, financial insto’s by taking many large deposits and/or raise funds in the financial markets and make loans). * Building Societies: - traditional emphasis on home loan (Heritage Building Society) * Credit Unions: - customers used to have a common membership to a profession, religion etc. (Queensland Teacher’s Credit Union) Financial Companies: Loans but no deposits. Issue commercial paper and equity (bonds, shares) to finance their activities. E.g. GE Money. Managed Funds
Money-Market Corporations (Investment/ Merchant Banks): Raise funds in the financial markets and invest in capital market, advise on acquisitions and mergers. E.g. Macquarie, JP Morgan, Merril Lynch
THE REST…| Insurance Companies| Superannuation Funds| Unit Trusts| Investment Trusts| Source of Funds| Collect premium from policy-holders in exchange for protection against financial losses due to the occurrence of a...