Chapter 1- A general overview Flashcards
What is financial markets?
Financial markets facilitate the exchange of financial securities, commodities, currencies and other tradable items
Relationship between lenders and borrowers
- Lenders
- Financial intermediaries
- Financial markets
- Borrowers
Lenders
- individuals
- companies
Financial intermediaries
- banks
- insurance companies
- pension funds
- mutual funds
Financial markets
- interbank
- stock exchange
- money market
- bond market
- foreign exchange
Borrowers
- individuals
- companies
- central government
- municipalities
- public corporations
Financial intermediaries vs financial markets
Big differences in size and scale of operations
What is a bank?
A financial institution licensed as a receiver of deposit
In most countries, banks are regulated by the national government and/or central bank
In general, there are two types of banks
- commercial/retail banks
- investment banks
Examples of investment banking expertise
- mergers & acquisitions
- equity underwriting
- private placements
- valuation & fairness opinions
- corporate restructuring
- management buyouts
- cross-border transactions
- structured finance
Retail Banking
- the street banks we are all familiar with
- take deposits from individuals, provide saving facilities and pay interest on these accounts
- also lend money to individuals in form of loans and overdrafts (charge interest on the money they lend)
- also provide a range of other financial services
Commercial Banking
- provide banking services to businesses –> from small companies to corporate banking directed at large corporations
- help raise finance to expand their businesses and to maintain their cashflow by lending them money
- provide a large range of other financial services (leasing, straight loans,…)
Investment Banks
- distribute and guarantee the sale (=underwrite) of share and bond issues
- trade securities on the financial markets and advise corporations on capital market activities such as mergers and acquisitions
- are extremely specialized banks
Examples:
- Merrill Lynch
- Goldman Sachs
Central Banking
- not a traditional bank
“The lender of last resort”
- is responsible for providing its economy with funds when commercial banks can’t cove a supply shortage
- prevent the country’s banking system from failing
- acts as a regulatory authority of a country’s monetary policy and is the sole provider and printer of notes and coins in circulation
- time has proved that the central bank can best function in these capacities by remaining independent from government fiscal policy and therefore uninfluenced by the political concerns of any regime
- should also be completely divested of any commercial banking interests
- each country has a central bank that sets its own goals
The primary goal for central banks
Provide their countries´currencies with price stability and controlling inflation
Primary functions of banks
1- Accepting deposits
2- Granting loans
The difference in interest rate is an important source of income
Institutional investors
- insurance companies
- pension funds
- mutual funds
Insurance companies
- offers insurance policies to the public, either by selling directly to individuals or companies
- can specialize in one type of insurance, such as life insurance, or car insurance or offer multiple types of insurance
- provides coverage in the form of compensation resulting from loss, damages, injury, treatment or hardship in exchange for fee payments
Pension funds
- a fund established by an employer to facilitate and organize the investment of employees´retirement funds contributed by the employer and employees
- a common asset pool meant to generate stable growth over the long term, and provide pensions for employees when they reach the end of their working years and commence retirement
- control relatively large amounts of money and represent the largest institutional investors in many nations
- Advantage (in comparison with insurance)- can hold money until you turn 65, they know exactly (almost, it depends) when u will take out your money
Mutual funds
- an investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in many different securities such as stocks, bonds, money market instruments and similar assets
- managed by specialists who invest the fund´s capital and attempt to produce capital gains and income for the fund´s investors
- a mutual fund´s portfolio is structured and maintained to match the investment objectives stated in its prospectus
- focus on global “blue chips”
What is a prospectus?
A formal legal document that provides details about an investment offering for sale to the public. It should contain the facts that an investor needs to make a good investment decision.
Advantages of mutual funds
- gives small investors access to professionally managed, diversified portfolios of equities, bonds and other securities which would be quite difficult (if not impossible) to create with a small amount of capital
- each shareholders participates proportionally in the gain or loss of the fund
- mutual fund units, or shares, are issued and can typically be purchased or sold as needed at the fund´s current net asset value (NAV) per share
Disadvantages of mutual funds
- high expense ratios and sales charges (fees and commissions)
- management abuses
- tax inefficiency
- poor trade execution (prices are only visible once a day- NAV)
When demand meets supply in the market..
a price for “capital is born”
The most important functions:
- borrowing and lending
- risk sharing
- price determination
- information aggregation and coordination
- liquidity
- efficiency
Borrowing and lending
permit the transfer of funds (purchasing power) from one agent to another for either investment or consumption purposes
Risk sharing
allow a transfer of risk from those who are willing to invest to those who provide funds for those investments
Price determination
Prices are set both for newly issued financial assets and for the existing stock of financial assets
Information aggregation and coordination
act as collectors and aggregators of information about financial asset values and the flow of funds from lenders to borrowers
Liquidity
provide the holders of financial assets with a chance to resell or liquidate these assets
Efficiency
reduce transaction costs and informations costs
Classification of financial markets by:
Nature of claim: Debt market, stock market, forex market
Maturity: Money market, capital market
Market: Primary market, secondary market
Time of delivery: Cash or spot market, futures market
The debt market
It is where fixed income securities of various types are issued and traded
- a predictable stream of payments by way of interest and repayment of principal at the maturity of the instrument
Example: Bonds, treasury bills
The stock market
- the market in which shares are issued and traded
- one of the most vital areas of market economy because it gives companies access to capital and investors a slice of ownership in a company with the potential to realize gains based on its future performance
Why invest in shares (equity securities)?
- possible positive change of the stock price
+
- dividend payments (not sure)
Primary market
- market in which new capital is raised
- the first issue
Secondary market
- where existing securities are traded
Short vs long term
Money market–> ST finance < 1 year
- to cover liquidity problems
Capital market –> LT finance > 1 year
Buying shares, loans > 1 year
Forex market- regulations (normal markets)
Normal (reglementet) markets:
- strong reglementation (Mifid, Basel,…)
- open access
- very heavy and frequent trending
- falls under financial supervision
- transparent prices
Example: Stock exchanges (NYSE, Nasdaq,…)
Forex market- regulations (OTC)
Over-the-counter market:
- less reglementation
- almost no financial supervision
- prices not publicly known (negotiation)
Example: The inter banking market
