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Page 3: Introduction to the Financial System Page 7: Commercial Banks Page 12: The Share Market and the Corporation Page 15: Corporations Issuing Equity into the Share Market Page 19: Investors in the Share Market Page 24: Short-term Debt Page 28: Medium- to Long-term Debt Page 32: Interest Rate Determination and Forecasting Page 37: The Foreign Exchange Market Page 40: Factors that Influence the Exchange Rate Page 42: Futures Contracts and Forward Rate Agreements Page 47: Options

Capital Markets & Institutions – Course Notes – Semester 1 2009


Introduction to the Financial System

Introduction to the Financial System
Medium of Exchange The world’s current medium of exchange is money. Money solves the divisibility problem divisibility (How do you sell you half a cow? Etc.) facilitates saving (You can keep money indefinitely, but what Etc.), about foods?) and represents wealth. The Five Sector Economy The economy can be divided up into five different sectors.

Household Sector

Firms Sector

Financial Sector

Government Sector

Overseas Sector

The household and firms sectors can either be in surplus or deficit in terms of money. The ld financial sector’s purpose is to redistribute that money by taking surplus sector’s savings and lending that to the deficit sector. The financial sector makes money in this way by charging a sum for lending and also giving a small bonus to those that save. The financial sector is not in the middle of the diagram without reason. It is considered the lifeblood of the economy as it redistributes money to keep the flow of money goi The flow of going. money between sectors is what moves the economy. The Financial System The financial system’s function is to provide: • • • Investment products – such as shares and bank deposits. Risk management products – such as insurance. Alternative funding sources – such as bank loans and overdrafts.

As described above, the financial system is mainly used to facilitate the movement of money from surplus holders to deficit holders. An efficient system ensures that surplus units are directed to holders. the most efficient users of those funds. They provide the ability for an economy to also trade with ent these financial assets. The ultimate goal is to keep the flow of money going.

Capital Markets & Institutions – Course Notes – Semester 1 2009


Introduction to the Financial System It should also be noted that the borrowers are the ones issuing the financial instrument to the borrowers and not the other way around. Financial Institutions There are five different types of financial institutions all providing a different financial instrument: • Depository Financial Institutions These institutions are otherwise known as commercial banks (such as the Commonwealth Bank, National Australia Bank etc.). They obtain most of their money through deposits from savers. They lend this money at a rate to borrowers to earn money. This helps to keep the flow of money in the economy whereas as saved money is lent out to be used instead of being kept idle. Over 50% of Australia’s economy’s money is held by these institutions. Investment Banks and Merchant Banks These banks provide advice on things such as mergers, acquisitions, restructuring and risk management. They charge a large fee of which a large portion is used to remunerate employees in these banks. Contractual Savings Institutions Otherwise known as insurance companies. These companies sign a contract with others to which they must pay a premium for. However these companies must also payout the contracted sum if the event specified in the contract happens. Finance Companies These companies borrow from the market at a low rate and then lend out to households and small companies at higher rates. This is sort of like the middle man...
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