THỊ TRƯỜNG TIỀN TỆ VÀ THỊ TRƯỜNG VỐN - ĐẠI HỌC KINH TẾ THÀNH PHỐ HỒ CHÍ MINH - UEH

Chapter 1
A modern financial
system—an overview
Websites:
www.rba.gov.au
www.treasury.gov.au
www.bis.org
www.ny.frb.org
www.asx.com.au
www.ft.com/asia/
Copyright  2012 McGraw-Hill Australia Pty Ltd

PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips 1-1
Slides prepared by Peter Phillips
2
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Learning objectives
• Explain the functions of a financial system
• Categorise the main types of financial institutions
• Describe the main classes of financial instruments issued in
a financial system
• Discuss the flow of funds between savers and borrowers,
and through the financial system and economy
• Distinguish between various types of financial markets
according to function

Chapter organisation
1.1 Functions of a financial system
1.2 Financial institutions
1.3 Financial instruments
1.4 Financial markets
1.5 Flow of funds, market relationships and stability
1.6 Summary

• Money
– Acts as medium of exchange
– Allows specialisation in production
– Solves the divisibility problem; i.e. where medium of
exchange does not represent equal value for the parties to
the transaction
– Facilitates saving
– Represents a store of wealth
(cont.)
1.1 Functions of a financial system (cont.)
• Role of markets
– Facilitate exchange of goods and services by:
▪ bringing opposite parties together
▪ establishing rates of exchange; i.e. prices
• Surplus units
– Savers of funds available for lending
• Deficit units
– Borrowers of funds for capital investment and consumption
(cont.)
• Financial instrument
– Issued by a party raising funds, acknowledging a financial
commitment and entitling the holder to specified future cash
flows
• Double coincidence of wants satisfied

– A transaction between two parties that meets their mutual
needs
(cont.)
• Flow of funds
– Movement of funds through the financial system between
savers and borrowers giving rise to financial instruments
• Financial system
– Comprises financial institutions, instruments and markets
facilitating transactions for goods and services and financial
transactions
(cont.)
(cont.)
• Attributes of financial assets
– Return or yield
▪ Total financial compensation received from an investment
expressed as a percentage of the amount invested
– Risk
▪ Probability that the actual return on an investment will vary from
the expected return
(cont.)
• Attributes of financial assets (cont.)
– Liquidity
▪ Ability to sell an asset within a reasonable time at current
market prices and for reasonable transaction costs
– Time-pattern of cash flows

▪ When the expected cash flows from a financial asset are to be
received by the investor or lender
(cont.)
• Facilitation of portfolio restructuring
– The combination of assets and liabilities comprising the
desired attributes of return, risk, liquidity and timing of cash
flows
• Implementation of monetary policy

– Actions of a central bank taken to influence interest rate
levels to achieve certain economic outcomes
– Primary target is inflation
(cont.)
• An efficient financial system:
– encourages savings
– directs savings to the most efficient users
– implements the monetary policy of governments by
influencing interest rates
– is a combination of assets and liabilities comprising the
desired attributes of return, risk, liquidity and timing of cash
flows
(cont.)
• Since 2007, the financial markets have been
characterised by a great deal of volatility
• What started as a liquidation of credit derivatives
sparked by a fall in house prices in the United States
has become a watershed moment in modern financial
history
• As nations continue to battle the economic effects of
the GFC, debate continues to rage about the regulatory
response necessary to bring stability to the system

1.6 Summary

• Most people have used the services of a financial
institution at some stage, even if the service was simply
a basic bank account
• Financial institutions may specialise in:
– taking deposits, providing advice to corporate and
government clients or offering financial contracts such as
insurance
• Financial institutions are essential to the operation of
the modern financial system
(cont.)
1.2 Financial institutions (cont.)
• Financial institutions permit the flow of funds between
borrowers and lenders by facilitating financial
transactions
• Institutions may be categorised by differences in the

sources and uses of funds
(cont.)
• Categories of financial institutions
– Depository financial institutions
– Investment banks and merchant banks
– Contractual savings institutions
– Finance companies
– Unit trusts

Categories of financial institutions
• Depository financial institutions
• Mainly attract the savings of depositors through on-

demand deposit and term deposit accounts; e.g.
commercial banks, building societies and credit
cooperatives
• Mainly provide loans to borrowers in household and

business sectors
(cont.)
Categories of financial institutions (cont.)
Investment banks and merchant banks
• Mainly provide off-balance-sheet (OBS) advisory services to

support corporate and government clients; e.g. advice on
mergers and acquisitions, portfolio restructuring, finance and
risk management
• May also provide some loans to clients but are more likely to
advise on raising funds directly in capital markets
(cont.)
Contractual savings institutions
• The liabilities of these institutions are contracts that require,

in return for periodic payments to the institution, the
institution to make payments to the contract holders if a
specified event occurs; e.g. life and general insurance
companies and superannuation funds
• The large pool of funds is then used to purchase both

primary and secondary market securities
• Payouts are made for insurance claims and to retirees
(cont.)
Finance companies
• Funds are raised by issuing financial securities, such as

commercial paper, medium-term notes and bonds, directly
into money markets and capital markets
• Funds are used to make loans and provide lease finance to

customers in the household and business sectors
(cont.)
Unit trusts
• Formed under a trust deed and controlled and managed by a
trustee
• Funds raised by selling units to the public; investors

purchase units in the trust
• Funds are pooled and invested by fund managers in a range

of asset classes specified in the trust deed
• Types of unit trusts include equity, property, fixed interest

and mortgage trusts



1.6 Summary

• Equity
– Ownership interest in an asset
– Residual claim on earnings and assets
▪ Dividend
▪ Liquidation
– Types
▪ Ordinary share
▪ Hybrid (or quasi-equity) security
• Preference shares
• Convertible notes
(cont.)
1.3 Financial instruments (cont.)
• Debt
– Contractual claim to:
▪ periodic interest payments
▪ repayment of principal
– Ranks ahead of equity
– Can be:
▪ short-term (money market instrument) or medium- to long-term
(capital market instrument)
▪ secured or unsecured
▪ negotiable (ownership transferable; e.g. commercial bills and
promissory notes) or non-negotiable (e.g. term loan obtained
from a bank)
(cont.)
• Derivatives
– A synthetic security providing specific future rights that
derives its price from:
▪ a physical market commodity
• gold and oil
▪ financial security
• Interest-rate-sensitive debt instruments, currencies and equities
– Used mainly to manage price risk exposure and to speculate
(cont.)
• Four basic derivative contracts
1. Futures contract (Chapter 18 and 19)
2. Forward contract (Chapters 17, 18 and 19)
3. Option contract (Chapters 18 and 20)
4. Swap contract (Chapters 18 and 21)

1.6 Summary

• Matching principle
• Primary and secondary market transactions
• Direct and intermediated finance
• Wholesale and retail markets
• Money markets
• Capital markets

Matching principle
• Short-term assets should be funded with short-term

(money market) liabilities; e.g. seasonal inventory
needs funded by overdraft
• Longer term assets should be funded with equity or

longer term (capital market) liabilities; e.g.:
– equipment funded by debentures
– lack of adherence to this principle accentuated effects of
frozen money markets with the ‘sub-prime’ market collapse

Primary and secondary market transactions
• Primary market transaction

– The issue of a new financial instrument to raise funds to
purchase goods, services or assets by:
▪ businesses
• company shares or debentures
▪ governments
• Treasury notes or bonds
▪ individuals
• mortgage
– Funds are obtained by the issuer
(cont.)
Primary and secondary market transactions (cont.)
• Secondary market transaction

– The buying and selling of existing financial securities
▪ No new funds raised and therefore no direct impact on original
issuer of security
▪ Transfer of ownership from one saver to another saver
▪ Provides liquidity, which facilitates the restructuring of portfolios
of security owners

Direct and intermediated finance
• Direct finance
– Users of funds obtain finance through primary market via
direct relationship with providers (savers)
▪ Advantages
• Avoids costs of intermediation
• Increases access to diverse range of markets
• Greater flexibility in range of securities users can issue for different
financing needs
▪ Disadvantages
• Matching of preferences
• Liquidity and marketability of a security
• Search and transaction costs
• Assessment of risk, especially default risk
(cont.)
Direct and intermediated finance (cont.)
(cont.)
• Intermediated financial flow markets

– A financing arrangement involving two separate contractual
agreements whereby the saver provides funds to an
intermediary and the intermediary provides funding to the
ultimate user of the funds
(cont.)
(cont.)
• Advantages
– Asset transformation
▪ Borrowers and savers are offered a range of products
– Maturity transformation
▪ Borrowers and savers are offered products with a range of
terms to maturity
– Credit risk diversification and transformation
▪ Saver’s credit risk limited to the intermediary, which has
expertise and information
– Liquidity transformation
▪ Ability to convert financial assets into cash
– Economies of scale
▪ Financial and operational benefits of organisational size and
business volume

Wholesale and retail markets
• Wholesale markets
– Direct financial flow transactions between institutional
investors and borrowers
▪ Involves larger transactions
• Retail markets
– Transactions conducted primarily with financial
intermediaries by the household and small- to medium-sized
business sectors
▪ Involves smaller transactions
(cont.)
Wholesale and retail markets (cont.)

Money markets
• Wholesale markets in which short-term securities are

issued (primary market transaction) and traded
(secondary market transaction)
– Securities highly liquid
▪ Term to maturity of one year or less
▪ Highly standardised form
▪ Deep secondary market
– No specific infrastructure or trading place
– Enable participants to manage liquidity
(cont.)
Money markets (cont.)
(cont.)
Money markets (cont.)
• Money market submarkets exist for:

– central bank—system liquidity and monetary policy
– inter-bank market
– bills market
– commercial paper market
– negotiable certificates of deposit (CDs) market

Capital markets
• Markets in which longer term securities are issued and

traded with original term-to-maturity in excess of one
year
– Equity market
– Corporate debt market
– Government debt market
• Also incorporate use of foreign exchange markets and
derivatives markets
• Participants include individuals, business, government
and overseas sectors


1.6 Summary

1.5 Flow of funds and market relationships
• Sectorial flow of funds
– The flow of funds between business, financial institutions,
government and household sectors and the rest of the world
– Net borrowing and net lending of these sectors of an
economy vary between countries
– Influenced by:
▪ the impact of fiscal and monetary policy on savings and
investment decisions
▪ policy decisions like compulsory superannuation
– The GFC has significantly impacted on flow of funds
(cont.)
1.5 Flow of funds and market relationships
(cont.)
• The flow of funds between deficit and surplus units is
an important contributor to economic growth
• For these benefits to be fully realised, the flow of funds
must be characterised by relative stability
• The GFC interrupted the functioning of the financial
system and inflicted serious damage on the ‘real’
economy in many countries
• The role of regulators is to balance the benefits of a
free financial system against the costs of instability


1.6 Summary

1.6 Summary
• The financial system is composed of financial
institutions, instruments and markets facilitating
transactions for goods and services and financial
transactions
• Financial instruments may be equity, debt or hybrid
• Financial markets may be classified according to:

– primary and secondary transactions
– direct and intermediated flows
– wholesale and retail markets
– money markets and capital markets
– financial institutions


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Chapter 1

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Double coincidence of wants satisfied

– Time-pattern of cash flows

• Implementation of monetary policy

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Institutions may be categorised by differences in the

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Depository financial institutions

• Mainly attract the savings of depositors through on-

• Mainly provide loans to borrowers in household and

Investment banks and merchant banks

• Mainly provide off-balance-sheet (OBS) advisory services to

Contractual savings institutions

• The liabilities of these institutions are contracts that require,

• The large pool of funds is then used to purchase both

• Payouts are made for insurance claims and to retirees

• Funds are raised by issuing financial securities, such as

• Funds are used to make loans and provide lease finance to

• Funds raised by selling units to the public; investors

• Funds are pooled and invested by fund managers in a range

• Types of unit trusts include equity, property, fixed interest

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

1.1 Functions of a financial system

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Short-term assets should be funded with short-term

• Longer term assets should be funded with equity or

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Primary market transaction

• Secondary market transaction

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Intermediated financial flow markets

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Wholesale markets in which short-term securities are

• Money market submarkets exist for:

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Markets in which longer term securities are issued and

Copyright  2012 McGraw-Hill Australia Pty Ltd

1.1 Functions of a financial system

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

1.1 Functions of a financial system

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Financial instruments may be equity, debt or hybrid

• Financial markets may be classified according to:

Copyright  2012 McGraw-Hill Australia Pty Ltd

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