Chapter 12 - Financial markets and the treasury function Flashcards
The financial system ecompasses what?
- financial markets
- financial institutions
- financial securities
What are some examples of financial markets?
stock exchanges, money markets
What are some examples of financial institutions?
banks, building societies, insurance companies and pension funds
What are some examples of financial securities?
mortgages, bonds, bills and equity shares
Why do we need the financial system?
- channels funds from lenders to borrowers
- provides a mechanism for payments
- creates liquidity and money
- provides financial services
- offers facilities to manage investment portfolios
What are financial markets?
mechanisms where those requiring finance (deficit units) can get in touch with those able to supply it (surplus units)
What are the 2 main types of financial markets?
capital markets
money markets
what are money markets?
short term (<1 year) debt financing and investment
What are capital markets?
stock markets for shares and bond markets
What are primary markets?
focal point for borrowers and lenders to meet. Market for issue of new finance
What are secondary markets?
- second hand trading in securities after having been issued on the primary market
What are the key roles of money markets?
- providing short-term liquidity to companies, banks and the public sector
- loans, factoring and commercial papers for companies
- inter-bank markets for banks and building societies
- loans to local government authorities
Capital markets deal in longer-term finance mainly via what?
stock exchange
capital markets deal mainly in what?
- public sector and foreign stocks
- company securities (shares and corporate bonds)
- eurobonds
What are eurobonds?
bonds issued in a currency other than that of the national currency of the issuing company
What are market makers?
help to keep the market moving. They have securities available to buy and sell and are continually quoting prices.
An international financial market exists where?
Where domestic funds are supplied to a foreign user or foreign funds are supplied to a domestic user
The role of the stock market is to what?
- facilitate trade in stocks (corporate bonds, government bonds etc)
- allocate capital to industry
- determine a fair price for the assets traded
Speculative trading on the market can assist by?
Smoothing price fluctuations
- ensuring shares are readily marketable
what are the 3 choices open to end-users of the financial system?
- lenders and borrowers contact each other directly
- lenders and borrowers use an organised financial market
- lenders and borrowers use financial institutions as intermediaries
What are some issues with lenders and borrowers contacting each other directly?
inefficient, risky and costly
Intermediation refers to what?
the process whereby potential borrowers are brought together with potential lender by a third party, the intermediary
What are the roles of a financial intermediary?
- risk reduction
- aggregation
- maturity transformation
- providing liquidity
- hedging
- financial intermediation
How does a financial intermediary reduce risk?
reducing the risk of a single default by lending to a wide variety of individuals and businesses
What is aggregation?
pooling small deposits to enable larger advances to be made
What is maturity transformation?
satisfying the different timescale needs of lenders (generally shorter) and borrowers (generally longer)
How do financial intermediaries provide liquidity?
through the processes of aggregation and maturity transformation, meaning that funds can be found/ invested somewhere quickly
What is fintech?
Financial technology - a term used to represent the technology and innovation that has allowed businesses that use such technology to modernise the provision of services
What is the aim of fintech?
aim to disrupt traditional markets through the use of technology that traditional institutions have been slow to adopt
What are the areas where Fintech businesses have an impact?
- Disintermediation
- Alternative credit source
- potential source of finance
- provision of financial services to those who are unbanked
What is distermediation?
removal of intermediary from transactions (online platforms, apps)
What are examples of alternative credit sources?
peer to peer lending platforms. Lender -> Borrower
What are examples of new sources of funding?
security token offering (STOs). instead of paying cash to but shares you could use cryptocurrency
Who are unbanked people?
those who are reluctant or unable to use conventional banks. Refers to adults who do not have a bank account or use banking institutions
What is a money market instrument?
any type of security that is traded in the money market?
What kind of maturities are money market instruments?
short maturities (less than 1 year)
Coupon bearing securities have what king of maturity and interest rate?
fixed maturity date and specified rate of interest
What are 2 coupon bearing securties?
certificates of deposit (CD)
Sale and repurchase agreement (repo)
What are certificates of deposit?
a certificate issued by a bank, stating that a set amount has been deposited
What is a sale and repurchase agreement?
selling a short-term security, and agreeing to buy it back later at a higher price
What are discount instruments?
issued at discount to their face value, and repaid later at a higher price. No interest is paid on them. However, the difference between the sale and repurchase price can be used to calculate an implicit interest rate.
What are some examples of discount instruments?
- Treasury bills
- commercial bills
- commercial paper
- banker’s acceptance
What are treasury bills?
short-term government debt (1 or 3 month maturity). The debt is issued by government at a discounted price, and repaid on maturity at a higher price
What are commercial bills?
Short-term large company debt, which operates in the same way as a treasury bill. Generally, sold at a greater discount than treasury bills
What are commercial paper?
very short-term company borrowing (7 to 45 days). Unsecured, so only companies with good credit ratings may use them successfully.
What are commercial papers equivalent of?
the money market equivalent to longer-term company debt such as a loan note
What is banker’s acceptance?
short-term debt that is guaranteed by a bank. effectively, a piece of paper that guarantees an amount will be paid out by a bank
What are derivatives?
financial instruments that derive their value from something else.
What are examples of derivatives?
FRAs
Caps and floors
Interest rate futures and options
interest rate swaps
swaptions
What are FRAs?
A forward rate agreement (FRA) is sued to fix, or lock in, a future interest rate
What are caps and floors?
guarantee a maximum or minimum interest rate that will be paid
What are interest rate futures and options?
tradeable securities that can be used to fix interest rates (future), or allow exposure to positive interest rate movements only (options).
What are interest rate swaps?
the option to swap interest rate payments with another party. This can be used to reduce overall interest costs, and to change interest type (fixed to variable or vice versa)
what are swaptions?
the option to swap interest rate payments. As with all options, this gives the holder the right but not the obligation to do something - leaving them exposed to positive interest rate movements only
What is the formula for rate for the time period requested?
(1 + rate for the given time period) ^ no. of periods - 1
What are the roles of the treasury function?
- short-term management of resources
- long-term maximisation of shareholder wealth
- risk management
What are some examples of short-term management of resources?
- short-term cash management - lending/borrowing funds as required
- currency management
What are some examples of long-term management of resources?
- raising long-term finance, including equity strategy, management of debt capacity and debt/equity structure
- investment decisions, including investment appraisal, the review of acquisitions and divestments and defence from takeover
- dividend policy
What are some examples of risk management of resources?
- assessing risk exposure
- interest rate risk management
- hedging of foreign exchange risk
What are the specific functions of the international treasury function?
- transfer prices
- currency exposure
- transferring cash
- investment strategies
- netting and matching
Why would a divisionalised business choose to have one centralised treasury function?
- avoids duplication of skills
- arrange funding in bulk
- more effective foreign currency management
- netting off surpluses and deficits in same currency means less need for overdraft and incidence of bank charges
What does a decentralised treasury function bring?
Autonomy and motivation
responsiveness
