Lecture 1 Flashcards Preview

Capital Markets > Lecture 1 > Flashcards

Flashcards in Lecture 1 Deck (18):
1

THE ROLE OF THE FINANCIAL SYSTEM

The financial system consists of _______, ________ and ________.

The financial system consists of financial markets, institutions and money.

2

THE ROLE OF THE FINANCIAL SYSTEM

The roles of the financial system are:

To _______________________________

To _______________________________

To ________________________________

To ________________________________

To________________________________

The roles of the financial system are:

To facilitate the flow of funds

To provide the mechanism to settle transactions

To generate and disseminate information

To provide the means to transfer and manage risk

To provide ways of dealing with incentive problems

3

Financial markets: _________________________________

Financial markets: the markets for buying and selling financial instruments

4

THE FLOW OF FUNDS

The financial system allows the flow of funds from ________ to ______________. 

THE FLOW OF FUNDS

The financial system allows the flow of funds from surplus spending units (SSUs) to deficit spending units (DSUs). 

A image thumb
5

THE FLOW OF FUNDS

surplus spending unit: _______________________________________

surplus spending unit: An economic unit whose income in a period exceeds expenditure. SSUs often purchase finacil claims issued by DSUs

6

THE FLOW OF FUNDS

decifit spending unit: ________________________________________

decifit spending unit: An economic unit whose expenditure in a period exceeds current income. A DSU sells financial claims on itself (liabilities) or sells equity to obtain needed funds

7

THE FLOW OF FUNDS

 financial intermediaries:_________________________________________

financial intermediaries: Institutions that issue liabilities to SSUs and use the funds so obtained to acquire liabilities of DSUs

8

ECONOMIC UNITS

Economic units can be classified as:

  • ___________
  • ___________
  • ____________________

 

Economic units can be classified as:

  • Household
  • Businesses
  • Governments (local, state and federal)

9

BUDGET POSITION

Any economic unit can have one of three possible budget positions:

  • a balanced budget position:_____________________________
  • a surplus postion: __________________________________
  • a deficit position: ________________________________________

Any economic unit can have one of three possible budget positions:

  • a balanced budget position: income and planned expenditures are equal
  • a surplus postion: income for the period exceeds planned expenditure 
  • a deficit position: planned expenditure for the period exceeds income

10

The flow of funds from SSUs (_____________) to DSUs (____________________) is a fundamental function of the financial system. 

The flow of funds from SSUs (mainly households) to DSUs (mainly business firms and governments) is a fundamental function of the financial system. 

11

DIRECT FINANCING

In direct financing, SSUs ______money to DSUs and accept a financial claim in return.

In direct financing, this exchange takes place directly ______an intermediary.

The limitations of direct financing ______ a role for financial intermediaries to intervene between DSU and SSU

In direct financing, SSUs 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 _____a role for financial intermediaries to intervene between DSU and SSU

12

INDIRECT FINANCING

 There are some pfind SSus t roblems with direct financing. For one thing, the denominations of the securities sold in direct markets are very large ($1 million or more), so few consumers can transact in these markets. Another problem is that DSUs must find SSUs that want direct claims with precisely the characteristics they can and will sell

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. 

13

Financial intermediation: ______________________________________________________________________________________________________________

Financial intermediation: the purchase of direct claims (IOUs) with one set of characteristics from DSUs and their transformation into indirect claims (IOUs) with a different set of characteristics

14

BENEFITS OF FINANCIAL INTERMEDIATION

 Denominati divisibility: _______________

Denominati divisibility: Financial intermediaries are able to produce a wide range of denominations from $1 to many millions. They can do this by pooling the funds of many individuals and investing them in direct securities of varying sizes. Of particular importance is their acceptance of deposits from individuals who typically do not have money balances large enough to engage in the wholesale transactions ($1 million or more) found in direct financial makets

15

BENEFITS OF FINANCIAL INTERMEDIATION

Currency transformation: _________________________

Currency transformation: Many Australian companies export goods and services to other countries, but few individuals living in Australia are willing to finance the overseas activities of these companies by buying direct financial claims denominated in a foreign currency. Financial intermediaries help to finance the global expansion of Australian companies by buying financial claims denominated in one currency an selling financial claims denominated in other currencies

16

BENEFITS OF FINANCIAL INTERMEDIATION

Credit risk diversification: __________________________

Credit risk diversification: By purchasing a wide variety of securities, financial intermediaries are able to spread risk. If the securities purchased are less than perfectly correlated with each other, the intermediary is able to reduce the fluctuation in the principal value of the portfolio. Portfolio diversification is an application of not putting 'all of your eggs into one basket',, in which they might be 'broken' simultaneously

17

BENEFITS OF FINANCIAL INTERMEDIATION

Maturity flexibility: ________________________________

Maturity flexibility: Financial intermediarites are able to create securities with a wide range of maturities: from one day to more than 30 years. In this way, they are able to buy direct claims issued by DSUs and issue indirect securities with precisely the maurities (usually shorter) desired by SSUs. For example, building societies and credit unions obtain funds by issuing passbook accounts and savings certificates and invest the funds in long-term consumer mortages

18

BENEFITS OF FINANCIAL INTERMEDIATION

Liquidity: ___________________________________

For most consumers, the timing of revenues and expenses rarely coincides. Because of this, most economic units prefer to hold some assets that have low transaction costs associated with converting them into money. Many of the financial commodities produced by intermediaries are highly liquid. For example, a savings account permits consumers to purchase an asset or repay a debt with minimal transaction cost.

Financial intermediaries, therefore, tailor the characteristics of the indirect securities they issue to the desires of SSUs. They engage in one or more distinct types of intermediation: denomination, currency, risk, maturity and liquidity intermediation. They provide these and other services to ear a profit. SSUs and DSUs use these services as long as the cost of doing so is less than providing the services for themselves through the direct credit markets.

SSUs' or DSUs' choice between the direct credit market and the intermediation market depends on which market best meets their needs. Typically, consumers whose transactions are small in dollar amount (retail transactions) find that the intermediation market is most cost effective. In constrast, economic units that deal in large dollar amounts (wholessale transactions) can swith back and forth between the two markets, selecting the market that offers the most favouralbe interest rate. For example, many large businesses take out loans from commercial banks, an intermediation transaction, and also raise money by selling commercial paper in the direct credit market