CH1- An Overview of the Changing Financial-Services Sector(Reader) Flashcards
What is a Financial System?
Set of arrangements or conventions embracing the lending and borrowing of funds by non-financial economic units and the intermediation of this function by financial institutions in order to facilitate the transfer of funds, to create additional money when required, and to create markets in debt instruments so that the price and allocation of funds are determined efficiently
What are the 5 essential elements of a financial system?
- Lenders and Borrowers
- Financial Intermediaries
- Financial Instruments
4.The creation of money - Financial markets
Lenders and Borrowers
the non-functional economic units that undertake the lending and borrowing process
Financial Intermediaries
which intermediary the lending and borrowing process, meaning that they interpose themselves between the lenders and borrowers
Financial Instruments
are created to satisfy the needs of the various participants
The creation of money
the unique money creating ability of banks
Financial Markets
the institutional arrangements and conventions that exist for the issue and trading of financial instruments
Financial Intermediaries
There are lenders and borrowers (or surplus and deficit economic units)
It is unlikely that Savings = Investment
Surplus Units : Savings > Investments = Lenders are non-financial economic units that generate funds that are available for investment
Deficit Units : Investments > Savings = borrowers
Pipeline is necessary to channel funds from surplus units to deficit units
Intermediate offer claims against themselves, tailored for
the needs of the lenders, in turn acquiring claims on the
borrowers
Intermediaries receive a fee (represented by the difference between cost of their indirect securities issued and the revenue earned from the primary securities purchased and they also levy other fees
What are the ultimate lenders when it comes to financial intermediaries?
Household Sector
Corporate Sector
Government Sector
Foreign Sector
Household Sector
consists of individuals and families, but also includes private charitable, religious and non-profit bodies serving household. It includes unincorporated businesses such as farmers, retailers and professional partnerships, as the transactions of these businesses cannot be separated from the personal transactions of their owners
Corporate Sector
The corporate sector comprises all companies not classified as financial institutions and therefore covers business enterprises directly or indirectly engaged in the production and distribution of goods and services
Government Sector
the general government sector consists of the central government, provincial governments and local authorities
What are the two types of financing on intermediaries?
Direct Financing
Indirect Financing
Direct Financing
involves the bringing together of lenders and borrowers(and often entails the interposition of a broker who acts as a go-between in return for a commission, i.e he distributes the claims on borrowers among the lenders
Indirect Financing
assist in resolving the conflict between lenders and borrowers by creating markets in two types of financial instruments. They offer claims against themselves, tailored to the needs of lenders, in turn acquiring claims on the borrowers
Function of Financial Intermediaries
Facilitate the flow of funds from surplus economic units to deficit economic units
Benefits of Financial Intermediaries?
Creates liquidity to the lender through aggregating small amounts for on-lending in larger packages
More effective diversification of risk than an individual lender through investing in a diverse portfolio of primary securities
Tap savings that would otherwise not have been available by providing liquidity and reducing risk
Decreases the constraints of income on expenditure, thereby enabling the consumer to spend in anticipation of income on expenditure and the entrepreneur to acquire physical capital by facilitating the availability of finance
The flow of funds is allocated in the most efficient way
Why do Financial Institutions exist?
because of the conflict between lenders and borrowers requirements in terms of size, term to maturity, quality and liquidity. They issue financial liabilities that are acceptable as investments to the ultimate lenders, and use the funds obtained to acquire the claims that reflect the requirements of the borrowers
What does Banks do?
Facilitate the flow of funds from surplus to deficit economic units
Have the unique ability to acquire financial claims first and thereby increase the financial liabilities in the system
Make markets in financial instruments. They assist in the adjustment of the price of funds in response to changing supply and demand conditions
Why is the little distinction between institutions that perform the intermediation function?
There is little distinction between banks, financial houses, insurance companies, unit trusts and many other type of intermediary
The distinguishing characteristics lie in the nature of the claims (indirect securities) and services offered to lenders and in the nature of the claims on services offered to borrowers
Financial Institutions are more specialized on which side?
They tend to be more specialized on the liability side on their balance sheets
What are the two financial intermediaries that exists in South Africa?
Mainstream
Quasi-financial intermediaries
What are the two broad categories under Mainstream financial intermediaries?
Deposit intermediaries
Non-deposit intermediaries
What are deposit intermediaries in SA?
South African Reserve Bank (SARB)
Corporate for Public Deposits (CPD)
Land and Agricultural Bank
Private Banks
Mutual Banks
Postbank
What are Non-deposit intermediaries in SA?
Contractual Intermediaries (CIs)
Collective Investment Schemes (CISs) / Portfolio Intermediaries
Development finance Intermediaries (DFIs)
Examples of Contractual Intermediaries (CIs)
Long-term Insurers
Pension and Provident funds
Public Investment Commissioners (PIC)
Examples of Collective Investment Schemes (CISs) / Portfolio Intermediaries
Collective Investment Schemes (CISs) in securities / Unit trusts
Collective Investment Schemes (CISs) in property / Property unit trust
Collective Investment Schemes (CISs) in participation bonds / participation Mortgage Bonds Schemes (PMBS)
Examples of Development finance Intermediaries
Development Bank of Southern Africa (DBSA)
Industrial Development Corporation (IDC)
National Housing Financial Corporation (NHFC)
Khula Enterprise Finance (KEF)
Infrastructure Finance Corporation (INCA)
Explain what Quasi-financial intermediaries are
Are number of institutions and funds that boarder on being classified as financial intermediaries
They do not borrow and lend to the same as extent as deposit intermediaries and non-deposit intermediaries
Examples of Quasi-financial intermediaries in SA
Investment trusts
Hedge funds
Micro-lenders
Stockvels
Finance companies
Securitisation vehicles
Private equity funds
What role does the Monetary banking sector play in the financial system?
As the custodians of the money stock of the country e.g private sector deposits
As the keeper of government’s surplus balances
In providing loans to the public and corporate sectors
In purchasing the debt of the private sector
In the creation of money
What are the Intermediation functions in South Africa?
South African Reserve Bank (SARB)
Corporation for Public Deposits (CPD)
Private Sector Banks
Mutual Banks and Postbank
Land Bank
Insurers
Pension funds
Public Investment Commissioners
Portfolio Intermediaries
Development finance intermediaries
What role does the SARB play as a function of intermediation?
The SARB intermediates between ultimate lenders and the banks on the one hand, and ultimate borrowers and private banking sector on the other hand
What role does the Corporation of Public Deposit (CPD) play as a function of intermediation?
The CPD intermediates mainly between the government, other financial institutions, and the foreign sector on one hand, and public sector ultimate borrowers on the other hand
What role does the Private Sector Banks play as a function of intermediation?
The private sector banks intermediate between all sectors that make up the ultimate lenders and virtually all other financial institutions on the one hand, and all ultimate borrowers on the other hand including the foreign sector
What role does the Mutual bank and Postbank play as a function of intermediation?
Mutual banks intermediate almost exclusively between surplus and deficit domestic households
Postbank is mainly a deposit receiving institution
What role does the Land Bank play as a function of intermediation?
The Land and Agricultural Bank of South Africa (Land Bank) intermediates exclusively domestically and essentially between other financial intermediaries on the one hand and corporate sector on the other hand
What are the 3 groups that Insurers can be split into?
Short-term insurers
Long -term insurers
Reinsurers
What role does Short-term Insurers play as a function of intermediation?
They intermediate between the corporate and household sectors on liabilities side of their collective balance sheet and the corporate and government sectors on the asset side of their collective balance sheet
They also have financial intermediary securities and other assets on the asset side of their balance sheet
What role does Long-term Insurers play as a function of intermediation?
Have similar intermediary function as short-term Insurers. Their liabilities are comprised of varies long-term policies which are held mainly by the corporate and household sectors, while on the asset side of their balance sheet they hold the securities of all sectors with the exception of the household and foreign sectors
What role does Reinsurers play as a function of intermediation?
They intermediate between other insurance companies and the corporate and government sectors
What role does the Public Investment Commissioners (PIC) play as a function of intermediation?
The PIC intermediates mainly between the household sector on the one hand and the corporate and government sector on the other hand
What role does the Collective Investment schemes (CISs) in Securities play as a function of intermediation?
CISs in securities intermediate almost solely between the household sector on the one hand and ultimate borrowers and the financial intermediaries on the other
What role does the Collective Investment schemes (CISs) in Property play as a function of intermediation?
CISs in property intermediate mainly between the household sector and pension funds on the one hand, and the corporate sector on the other hand
What role does the Collective Investment schemes (CISs) in Participation bonds play as a function of intermediation?
CISs in participation bonds have on the liability side of their balance sheets funds received from individuals, while the asset side is comprised mainly of funds loaned to the corporate sector
What role does the Development finance intermediaries (DFIs) play as a function of intermediation?
Development Bank of Southern Africa (DBSA), Industrial Development Corporation (IDC), National Housing Financial Corporation (NHFC), Khula Enterprise Finance (KEF), Infrastructure Finance Corporation (INCA) intermediate between ultimate lenders and financial institutions on the one hand and mainly domestic ultimate borrowers on the other
What distinguishes financial intermediaries from other financial entities?
Other financial entities do not have a large balance sheet reflecting the lending and borrowing process which financial intermediaries have
What other financial entities are in the financial system?
Financial exchange (The Johannesburg Stock Exchange(JSE), Bond Exchange of South Africa(BESA), SAFEX)
Members of the above exchanges (banks, companies)
Financial regulators (SARB, Financial Services Bond(FSB))
Fund managers (OMAM, Gensec)
What are the two-broad categories of financial instruments?
Shares
Debt instruments
Reasons why shares are classified as financial instruments
Companies may repurchase their own shares
It is conventional
Companies have two kind of finance available – equity and debt thus they are substitutes of each other
Certain types of share (preference shares) are closer to debt instruments than to ordinary shares
What are the various kinds of shares?
Ordinary shares
Preference shares
What are ordinary shares?
ordinary shares impart to the holder the right to vote on issues that affect the company. However, the shareholder does not have a right to the profits until the board of directors declares a dividend
What are preference shares?
Preference shares impart to the holder the prior right over ordinary shareholders to the distribution of dividends and capital in the event of the company winding up
Define financial instrument (Debt structures)
A financial instrument is a claim against a person or institution for the payment of a future sum of money and/or a periodic payment of money
What are debt structures?
There is no periodic payment in the case of treasure bills but long term debt usually pays interest 6 months in arrears
What is the most important characteristics of financial claims?
Reversibility and marketability
This refers to the ease with which the holders of securities can recover their investments
What are derivative instruments?
The value of the instrument are derived from the value of shares or debt structures and can be categorized into Money market and Bond market
Define Financial Markets
are simply the mechanisms and conventions that exist for the transfer of funds and the counterparts
What is the economic function of financial markets?
is to provide channels for transferring the excess funds of surplus units to deficit units
Do financial markets link surplus and deficit units, and if so, how?
Financial markets constitutes of the mechanism that links surplus and deficit units, providing the means for surplus units to finance deficit units either directly or indirectly through financial intermediaries
Which securities can surplus units buy?
Surplus units can purchase primary or indirect securities or reduce their debt by purchasing their own outstanding securities
What kinds of securities can deficit entities issue?
Deficit units may issue securities or dispose of some financial assets previously acquired
Who are the participants in the financial markets?
Borrowers, lenders, financial intermediaries and the brokers, fund managers, speculators, exchanges and regulators
What does the term financial market encompass?
Financial markets encompasses the participants and their dealings in particular financial claims, groups of claims and equities, and the manner in which their demands and requirements interact to set prices for such claims and prices of equities
What are the two types of financial markets?
Primary markets
Secondary markets
Define Primary market
issue of new securities to borrow money for consumption or investment purposes
What type of instruments are traded in the primary markets?
Non-negotiable instruments like mortgage, loans, savings deposits and life policies
Define Second markets
markets in which previously issued financial claims are traded
When it comes to secondary markets, what two distinguishes do you need to make?
When discussing secondary it is important to distinguish between Brokers and Market makers
What do Brokers do?
Brokers act on behalf of other financial market
participants in return for a commission.
Explain Market makers
are financial intermediaries, mainly the banks, who have assumed or are appointed by the issuers to perform this function
are prepared to quote buying and selling prices simultaneously for certain securities – the spreads quoted by them are
very small. The small spread in prices are market
makers’ profit
Why are market makers large domestic and international banks?
These institutions are prepared to hold portfolios of securities and they need to be adequately capitalized
List reasons why an active secondary market is important
assists the primary market by providing investors with the assurance that they will b able to dispose of securities if they so desire
provides the basis for the determination of rates to be offered on new issues (primary instruments)
registers changing market conditions rapidly indicating the receptiveness of the market for new primary issues
enables investors to rapidly adjust their portfolios in terms of size, risk, return, liquidity and maturity.
enables Central bank to buy and sell securities in order to influence liquidity in the financial markets
What is the debt market’s other name, and why is it called that?
It is called the Fixed-Interest Markets because the majority of instruments carry fixed rates of interest
what is the financial market usually split into?
The financial market is usually split into the money and bond market
What distinguishes the bond market from the money market?
“Term to maturity” distinguishes the bond market to the money market
Define the bond market
the market for the issue and trading of long term securities
Longer than 1 year
Explain the money market
the market for the issue and trading of short-term securities
Shorter than 1 year
How does the money market encompass the Interbank market?
SARB operates in the money market in the form of open
market operations.
This is done to establish a certain desired “money market
shortage” (borrowed reserves) and this it provides via the
interbank market at the repo rate
The repo rate influence short-term interest rates (money
market rates
What are allied markets?
Markets that are closely related to the equity and debt markets
Two types of allied markets?
Foreign exchange markets
Commodities markets
Is the Foreign exchange market a financial market? Why?
No it is not a financial market but a conduit into foreign debt and equity markets
In South Africa, what type of market is the foreign exchange market?
Over-the-counter (OTC) / non-regulated market and is closely monitored by the SARB
What type of market is the commodities market?
Over-the-counter (OTC) market and is used in the exchange of big-volume items like maize and wheat
What is the capital market made up of?
equity and bond market
What is the interest-bearing market made of?
money market and bond market
Define: Spot rate
When a financial instrument is traded and settled on
the same or on the following day or even five days hence
Define: Forward rate
The instrument is traded today for settlement in, say two weeks. Price of the forward transaction = spot price
+ price of money for the two-week term. Forward rate
derived from spot rate
Define: Option
holder has the right to buy or sell
Define: Future
agreement to buy from or sell to an exchange established for this purpose, a standard quantity and quality of an asset on a specific date and a price to be determined at the time of negotiation of the contract
Why are options and futures termed as derivatives?
because they are derived from specified underlying assets or notional assets
Define: Repo
the sale of a previously issued security at an agreed rate of interest for a specified period of time
Define: Interest rate swaps (IRS)
swapping of interest obligations between two parties via a facilitator i.e agreement to exchange a fixed interest rate for a floating interest rate
Define: Forward Rate Agreement (FRA)
An agreement that enables users to hedge themselves against the unfavorable movements in the interest rates by fixing a rate on deposit or a notional loan that starts some time in the future
What does a Cap do?
A cap purchased makes it possible for a company with the borrowing requirement to hedge itself against rising interest rates
What does a floor do?
Allows a company with surplus funds to shied itself against declining interest rates by determining a specified floor rate upfront while it remains the right to profit from rising interest rates
What is the difference between OTC market and Formalized market?
OTC refers to the meeting of buyers and sellers “over-the-counter”
Formalized markets are governed by statute, rules and regulations
List the OTC markets that are in South Africa?
Money market
Foreign exchange (and their derivatives)
Spot commodities
