Week 1 A Flashcards
(21 cards)
What is the Financial System and What does it do?
The financail system is an umbrella term covering:
- Financial Markets - e.g stock exchanges, money markets
- Financial Institutions - e.g banks, building societies, insurance companies and pension funds
- Financial Securities - e.g mortgages, bonds, bills & equity shares
The FS
- Channels funds from lenders to borrowers
- Provides a mechanism for payments - e.g direct debits, cheque clearing system
- Creates liquidity and money e.g banks create money through increasing their lending
- Provides financial services such as insurance and pensions
The role of financial markets
Within each sector of the economy there are times when there will be cash surpluses and cash deficits.
FM are mechanisms where those requiring finance can get in touch with those able to supply it.
In the case of surpluses, the role of FM will be to allow people to invest funds to earn an economic return
in the case of a deficit, the FM will lend money to help people manage their liquidty position
What are Money Markets
Money Markets deal in short term funds and transactions tend to be conducted by phone or online
*it is not one market but a number of closely-connected markets
*participants include
commercial banks, central banks, private individuals & building societites
Certificate of Deposit
A Certificate of deposit is a product offered by banks that provides a interest rate premium in exchange for the customer agreeing to leave a lump deposit untouched for a predetermined amount of time. Banks can then use this money to invest it also.
If the customer decides that they want to access their deposit quickly, they must sell the certificate of deposit to another bank which might be able to carry it to maturity or sell it to another of the other banks.
Can be either short or long term.
Role of Money Markets
Can provide short tem liquidity to companies, banks and the public sector - might need help to deal with seasonality of their businesses.
Provide short-term trade finance
Where a business might engage in a large trade deal there could be a time delay between cash outflows to make the product and receipt of payment - might choose to manage this by using bankers acceptances by creating a ‘letter of credit’
Allowing an organisation to manage its exposure to foreign currency risk and interest rate risk.
What are Capital Markets
Capital markets deal in longer-term finance, mainly via a stock exchange. The major types of securities dealt on capital markets are:
- Public sector and foreign bonds
- Company securities (shares and corporate bonds)
- Eurobonds/International bonds
International Capital Markets
Exists where domestic funds are supplied to a foreign user or foreign funds are supplied to a domestic user. The currieses used need not to be those of either the lender or borrower.
Include:
The Eurocurrency Market
The Eurobond Market
Euro Currency Market
international capital market
- A market for borrowing and lending eurocurrencies for the short-to-medium-term.
- Deposits vary from overnight to 5 years.
- Much of the business on the Eurocurrency market is interbank, but also large number of governments, LAs and multinational companies - firms wishing to use the market should have excellent credit standing and wish to borrow/deposit large amounts.
The Eurobond/International Bond Market
international capital market
- A Eurobond is a bond issued in a currency that is different from that of the country or market in which it is issued.
- May be used to finance a company’s explansion into a foreign exchange market
- The bond raises the money needed in the currency that is needed, without the foreign exchange risk
- An investor may gain exposure to a foreign market while investing in an established domestic company.
e.g a company like Molson Coors wants to enter a new market by establishing a manufacturing facility in India. Expenses for the facility will require a large amount of capital in the local currencys. As it is new to India, the company may not have the necessary credit in the Indian markets, which can lead to a high cost for borrowing locally. Molson Coors decides to source the money locally and issues a rupee-denominated eurobond in the U.S. Investors with Indian rupees in their U.S.-based accounts may purchase the bond, effectively loaning money in Indian rupees to the company.
Both Money and Capital markets and Primary and Secondary markets.
Explain both
Give examples of how secondary markets help investors
Primary
- provide a focal point to borrowers and lenders to meet.
- deal in new issues of loanable funds, they raise new finance for the deficit units
Secondary
- Allows holders of surplus units to realise their investment before the maturity date by selling them to other investors.
- A well-developed SM should reduce price volatility of securities - should ensure smoother price changes and encourage investors to supply funds.
Secondary markets help by providing:
Diversification
- gives investors the opportunity to invest in a wide range of enterprises and spread their risk
Risk Shifting
- Companies issue various types of security on the financial markets, giving investors the choice of the degree of risk they take
Hedging
- Offers participants the opportunity to reduce risk through hedging through taking out counterbalancing contracts to offset exisiting risks.
The Role of Speculation
Any consideration of a stock market has to face up to the problem of speculation i.e gambling
Speculation helps smooth price fluctuations. The skilled speculator will be buying hen others are selling and selling when others are still buying and therefore removes the peaks and troughs and makes price changes less violent.
Role of Stock Market
Types of Stock Markets
A countries stock market is the instituion that embodies many of the processes of the captial maket.
- it is the market for the issued securities to public companies, government bonds.
- Has the ability to sell long-term securities easily
if the market thinks highly of a company, that companies shares will rise in calue and it will be able to raise fresh capital through a new issue of shares at a relativley low cost.
UK e.g’s
The london stock exchange - the main uk market, shares of large public companies are quoted
The AIM
- a serparate market for the securities of smaller comapnies.
Entry and reporting requirements are significantly less than those for the main market of the london stocke exchange.
Role of Financial Institutions
- Lenders and borrowers can contact eachother directly
- rare, high cost involved - Lenders and borrowers use an organised financial market
- e.g may purchase corporate bonds and effectively lend money to the company, can then sell before maturity to another invester - Lenders and borrowers use financial institutions as intermediaries
The lender obtains an asset which cannot usually be traded and can only be returned to the intermediary, e.g a loan.
What is a financial intermediary and what is their roles
Examples
Refers to the process whereby potential borrowers are brought together with lenders by a third party
Reduce risk -
By lending to a wide range of individuals, FI reduce the risk in a total loss of assets
Aggregation
By pooling together small deposits, FI can lend larger amounts
Maturity Transformation
Most borrowers want long term, savers short term - FIs are able to satisfy both by developing a floating pool of deposits
Banks, factors, insurance companies, building societies
Money Market Instruments
- Definition
- Examples
A type of security that is traded in the money market
- usually sold in large denominations (1m or more)
- low default risk
- mature in 1 year or less
- Coupon Bearing Securities
- Discount Securities
- Derivatives
Money Market Instruments
- Coupon Bearing Securities
Definition & Examples
Have a fixed maturity and a specified rate of interest
Certificate of Deposits
- Evidence of a deposit with an issuing bank
- procide banks with a deposit for a fixed period at a fixed interest rate
Sale and repurchase agreements (REPOs)
- A company sells securities to another party with the agreement of buying them back at a later date at a higher price
- can be arranged through a repo desk at a major bank
- in effect, short term loan
- learn how to calc effective interest rate
Money Market Instruments
- Discount Instruments
Definition & Examples
Funds are raised by issuing bills at a discount from their maturity value.
Treasury bills
- issued mainly by governments via central banks
- usually 1-3 month maturity
Commercail bills
- similar to treasury but issued by large corporations
Commercial paper
- Initial maturity betwene 7-45 days
- generally unsecured, so credit ratings are important
Learn calc
Money Market Instruments
- Derivatives
Definition & Examples
An asset whos performance is derived from the behaviour of the value of an underlying asset
Cash Generator
Cash Consumer
Cash generator - will look to lay off cash on short-term markets or return surplus funds to investors via dividend (mainly retailers)
Cash Consumer - will look to borrow short term (new, fast growing firms)
What is a treasury function and what is its role
Involves the management of money and financial risks in a business.
Short-term management of resources:
Its priority is to ensure the business has the money it needs in the short term to amnage day to day obligations.
Long term maximsation of SH wealth
Should also help to raise long term finance, make investment decisions and review its dividend policy to meet its long term strategies.
Risk Management
- Should carry out duties with effective risk management through reveiwing risk exposure, interest rate risk and hedging of foreign exchange risk.
Advantages and Disadvantages of a centralised Treasury function
+no need for treasury skills to be duplicated
+the groups foreign currency risk can be managed much more effectively, as they have total exposure to the situation
+transfer prices can be established to minimise the overall group tax bill
+funds can be quickly returned to companies requiring cash via direct transfers
- Can lead to greater motivation, individual companies will manage their cash balances more attentively if they are responsible for them
- Local operating units should have a better feel for ,local conditions and can respond quicker to local developments.
