Financial Markets and Services: Introduction and Overview

Financial Markets and Services (FMS) Lecture 1 Introduction and Overview of Financial System

Module Objectives:
This module examines the role of the financial markets, its players and the instruments on the economy and the status of Singapore as a financial centre. The module will also trace the relationship between the various markets and its participants with emphasis given to current events, trends and development in the markets.

Module Assessment
Module Schedule of topics (Appendix 1)
Coursework Components (Appendix2) including Project Outline/ Plagiarism Form/Peer Assessment

Reference Text:
Financial Markets and Institutions in Singapore
Tan Chwee Huat 11th edition Singapore University Press

Other Sources:
Web sites of financial institutions, IBF, MAS, SGX, Investopedia, Wikidpedia and other finance sites.

Module Leader/Lecturer/tutors:

Name
Telephone Numbers
E-mail
Module Leader & tutor
Mrs. Tay Gek Huan
64606953 / 97830378 [e-mail] Tutor
Mr. Chong Kek Weng
64606910
[e-mail]
Tutor
Mr. Mark Terence
64606810
[e-mail]
Tutor
Ms Michelle Lim Yun Pei
64606536
[e-mail]

Lecture 1 Objectives Introduce the economic, financial system and markets Understand the economic role of financial markets Understand how funds are transferred

Lecture Outline
1.1 Definitions and concept of economic, financial system and markets
1.2 Economic role of financial markets
1.3 Two ways of Transfer of funds (direct vs indirect)

1.1 Introduction

Economic and Financial System
Economics
Study of how society decides what gets produced and how, and who gets what. The 2 branches of Economics, _____________ and ___________________________ studies individual decision making units such as households, business firms and aggregate or total behaviour of all households and firms.

Finance
The study of how the ______________ coordinates and channels the flow of funds from lenders to borrowers and vice versa and how new funds are created by financial intermediaries during the borrowing process.
Broadly speaking, it studies the ________________and _________________ of the production, spending and lending decisions.

Money
Something acceptable and generally used as payment for goods and services

Surplus Spending Units (SSUs)
Spending Units such as households or firms whose ________________ exceed their ___________________.

Deficit Spending Units (DSUs)
Spending Units such as households or firms whose spendings _________________ their incomes.

Definition and Concept of a Financial Systems
A well organized, efficient, smoothly functioning financial system is an important of a modern, highly specialised economy.

The financial system provides a mechanism of whereby an individual unit that is an SSU may conveniently make available funds to DSUs who intend to spend more than their current income. It is a framework of ________________, _____________and _________ to facilitate the ______________of saved funds from ______________ (savers or SSUs) to _______________ (borrowers or DSUs).

Financial system interposed between ______________ of ______________, ___________________ and financial instruments (financial _________________of savers and financial ___________________ of borrowers).

Exchanges through lending and borrowing made possible by participants’ ____________ __________ ____________ in favour of future consumption.

Total Saving Household Saving

(income not spent on consumption)

Investment in newly constructed Surplus funds available to houses be lent in financial markets

Business Saving (Income not distributed to owners of business firm)

Investment in new capital Surplus funds available to be lent to in financial markets Investment + Surplus Funds

Markets
In economics, the term market means the aggregate of possible buyers and sellers of a thing and the transactions between them.

The term “market” is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities e.g. a stock exchange or commodity exchange. This may be a physical location (NYSE) or an electronic system (NASDAQ). Financial markets can be domestic or they can be international.

Characteristics of a market

__________________________________________________________________________________________________________

___________________________________________________________________________________________________________

Financial Markets
A market is the organizational institutional or mechanisms for creating and exchanging financial assets.

Characteristics of a financial market

__________________________________________________________________________________________________________

Can you think of some other markets?

_________________________________________________________________________________________________________

_______________________________________________________________________________________________________

Physical or virtual?
It may be a ___________________________ or a _______________________________of buyers and sellers who deal with each other over the telephone or computer screen

Financial institutions
Firms that provide financial services to SSUs and DSUs; the most important financial institutions are financial _______________.

Financial Intermediaries
Financial institutions that borrow from SSUs for the purpose of lending to DSUs.

1.2 Economic function of financial markets
Economic activity is characterised by many exchange transactions which involve the buying and selling of goods, services and productive resources.

Distinction made between “_______________________” and “_______________________l” aspects of these transactions.
e.g. In a sales transaction, a buyer takes physical possession of goods in exchange for a payment of money or a promise to pay in the future. The former aspect of the transaction is “real” and the latter “financial” with the goods categorised as “real assets” and the payment is with a “financial asset”. In a barter system, there is an absence of the “financial” element to economic transactions

The financial system includes both markets for financial instruments and those institutions concerned with financial transactions, just as the “real” component of the economic system includes both markets for goods and services and the institutions that collectively bring the parties and resources to produce the goods and services.

The financial system is thus a vital component of the total economic system to increase the capacity to satisfy the needs and wants of individuals for goods.

The economic role of the financial system can be mainly characterised as one of facilitating real and financial transactions.

The simple economic system consists of a ___________ ___________________, a ____________ _______________ and a __________________ ___________________. In terms of real flows, the business sector produces goods and services which are purchased by the household sector for consumption. The household sector provides _________________________ and other necessary productive inputs to the business sector in exchange for _____________________, ___________________ and other compensation. The government sector collects ____________________ ______________________ from the household and the business sectors and uses the receipts to buy goods, services and productive inputs which are used to supply government services (infrastructure, law and order enforcement etc) to the other sectors

Diagram 2 (Exchange Flows in an economic system) depicts the relationship between the financial system and various real and financial flows in the economy.

Exchange Flows in an economic system

The Financial System
Financial obligations (Markets, instruments Financial assets & Borrowed funds institutions) Loaned funds (Investments) (Savings)

Payment for goods and services Goods and services

Tax payments Tax payments Business Government Household Sector Government Sector Government Sector services services

Productive inputs (labour etc)

Payments for inputs (wages, salaries etc)

Turning to the role of the financial system, it is interposed between flows of saving, investment and financial instruments (financial assets of savers and financial obligations of investors).

The flows reflect the exchanges of resources use over time rather than exchanges of real resources at points in time. Exchange of resource uses over time (lending and borrowing) is made possible by some economic participants’ forgoing current consumption in favour of future consumption. The postponement of consumption or saving is encouraged by the prospect that future consumption opportunities can be enlarged as the result of the productive use of the current resources made available for investment purposes.

The existence of _________________________ in an economic system provides the opportunity for the business sector to ________________________. Households use saved receipts to lend to business firms or to purchase equity in business firms. Such transfers of purchasing power supply the business sector with __________________________________, the financial resources that enable firms to gather and use real resources for investment and thereby increase output for goods and services. The investment of these funds in turn provides the __________________ by means of paying a return on savings – _____________________ in the case of loaned funds and ________________________ in the case of purchase of ownership shares.

Economic units whether in the household, business or government sectors that spend less than their net receipts are called surplus economic/spending units. This excess of net receipts over expenditures for a period of time is called _________________ when it occurs in the household sector, ______________________ in the business sector and a ____________________________ in the government sector.

An economic unit which elects to spend more than its net receipts by drawing on past savings (__________________________) or by borrowing are called deficit economic/spending units.

Which economic units are generally DSUs?

Any economic unit can be DSUs

________________________________________________________________________________________________________
1.3 Ways to Transfer Funds
Transfer of funds can be accomplished by an SSU lending money to and accepting an IOU from a DSU
An IOU – written promise to pay a specific sum of money (principal) plus fee (interest rate) for the privilege of borrowing money over a period of time (maturity of loan)
IOUs are financial claims. Claims against someone else’s money at a future date.

Financial Liabilities or Claims
To a DSU, financial claim is a liability
To a SSU, financial claim is an asset
SSU may hold it till maturity or sell it in the markets

A deficit spending unit may borrow from a surplus unit by exchanging a financial instrument (a promise to make future payments) for the latter’s saved funds.
The issuer of the instrument (borrower) thus incurs a __________________ ____________
The recipient of the instrument (lender) obtains a __________________ ___________

Exchanges of saved funds for financial assets are __________________ and _________________ accomplished in financial markets.

Important contribution to this process is made by the third component of the financial system – financial institutions in their role as ____________________________________ between lenders and borrowers.

Diagram 3: Transfer of funds from Surplus to Deficit Spending Units

Claims Claims

Dollars Dollars

Purchasing power flows one way Legal obligations flow back

The transfer of funds from DSUs to SSUs in the most efficient manner either for investment or for consumption can be done via
1. Direct financing
Direct financing involves lending directly to DSUs.
Exchange of money and financial claims direct where DSUs issue______________________________ on themselves and sell them for money to SSUs and the SSUs hold the financial claims in their portfolios as interest bearing assets. Financial claims are bought and sold in financial markets such as the ______________________ or ___________________________________.

Examples of direct financing include

___________________________________________________________________________________________________________

2. indirect financing or commonly known as intermediation financing
Indirect financing involves lending to a financial intermediary that borrows from SSUs to relend to DSUs.

Financial intermediaries transform financial claims to make them more attractive to the ultimate investor where direct claims (IOUs) are purchased from DSUs and transformed into with a different set of characteristics to sell to the SSU. SSUs residual claim is against financial institution rather than the DSU.

Examples of Indirect financing include

__________________________________________________________________________________________________________

_______________________________________________________________________________________________________

Financial intermediaries such as commercial banks tailor financial claims to meet the investment needs of SSUs while simultaneously buying a variety of financial claims from DSUs. In the direct credit markets, SSUs buy whatever type of claims DSUs sell.

Summary
This lecture introduces the students to the concept of the financial system, financial markets and the economic roles which it plays. The markets serve as a conduit for the transfer of funds from surplus to deficit spending units with transfers taking place directly or indirectly.