CH1 FINANCIAL SYSTEM
- Money: medium of exchange solves divisibility problem.
- Financial system provides investment products (shares & deposits), risk management products (insurance), alternative funding sources (loans). Transfer funds from surplus to deficit economic unit by new financial assets in primary market & trading of existing financial assets in secondary market.
- Portfolio structuring is buying/selling assets/liabilities to meet savings, investments and funding needs.
- Financial institutions:
- Depository financial institutions (commercial banks - deposits & loans)
- Investment banks (off-balance sheet, advice on merger, acquisition, portfolio restructure, risk management)
- Contractual savings institutions (insurance & super)
- Finance companies (borrow from market at low rate and lend out at higher)
- Unit trusts (mutual funds - public buys unit of trust & money is invested specified by trust deed)
- Financial instrument is broader term for financial assets and other assets where there is no secondary market to trade them. Financial assets provide future CF and if they can be traded in secondary market they are financial securities. Asset portfolio - return of yield, risk, liquidity, time period of CF.
- Financial instruments (non-negotiable means ownership cannot legally be transferred)
- Equity (ownership of shares, preference shares, ordinary shares/common stock)
- Debt (matching principle, short term is money market instrument, long term is capital market instrument, secured debt will have asset as collateral) (banks- debentures, promissory notes, unsecured notes, govt- treasury notes, ADI- certificate of deposit)
- Derivative (off-balance sheet, synthetic security, no funds, manages risk exposure)
- Future contract – exchange-traded agreement to buy/sell at specific price at fixed date
- Forward contract – over-the-counter agreement that locks the price with interest or exchange rate applied in future
- Option contract – right to buy/sell at fixed price, no obligation and pays premium
- Swap contract – agreement to swap future CF, fixes exchange rate and currency swaps)
- Hybrid security (attributes of equity and debt, share that has debt)
- Primary market is issuance of new instrument and funds raised. Secondary market is trading and transfer ownership of existing, no new funds raised thus encouraging investment in primary market.
- Direct financial flow market where issuer contacts saver directly, avoids intermediation costs and not very liquid (broker & dealer). Intermediated flow market is where a third party (bank) manages funds/contracts between saver & borrower, exposed to default risk (asset transformation - provide products to meet customer preference, maturity transformation, credit risk diversification, liquidity transformation, lower search costs & standardisation documentation lowers cost - economies of scale)
- Wholesale market uses direct financial flow between investors/borrowers of transactions of large sums to businesses. Retail markets are intermediated and used by households/small businesses of smaller transactions.
- Money market is for short-term securities and is liquid (negotiable cert of deposit, promissory note) Capital markets are for long-term securities (debentures, unsecured notes) and mainly governments and overseas sectors (foreign exchange market, derivatives market)...
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