Chapter 13 - functions of financial system Flashcards
what is short term finance
sometimes called working capital finance, refers to short term assets such as inventory or receivables
what is long term finance
firm needs funds to finance property, machinery
what is the matching concept
normal for a company to try to match the time period of the finance to the life of the assets they finance
what are financial intermediaries
institutions, like banks/building societies, which channel funds from savers to borrowers
provides link between savers and borrowers
examples of financial intermediaries
- investment banks = provide large corporation loans
- pension funds = invest to meet future pension liabilities
- insurance companies = invest to meet future liabilities
- venture capital companies = invest in risky ventures eg start ups
functions of financial intermediaries
- maturity transformation = long term lending while allowing depositors to take out money to maintain liquidity. {short term deposits transformed into long term loans}
- aggregation of funds = bank can aggregate lots of {small amounts of money into a large loan}
- pooling losses = {losses from a single bad debt will not directly impact savers} because the bank has earned enough interest from other loans to cover the loss (risk transformation)
impact of financial intermediaries on savers
encourages savings because they provide a convenient and secure mechanism for a saver to save and gain a return
sources of short term finance from financial intermediaries
- overdraft = allows borrowing up to a limit, bank only charges interest when its used. possible to set up a revolving credit facility where bank agrees overdraft for period of time
- short term loan = more secure way of finance than an overdraft
- short term lease = some assets have short term rental agreements to remove risk of owning asset
sources of long term finance from intermediaries
- long term loans = companies may make promises about future behaviour eg equity ratio
- long term leases = long term rental transferring risks and rewards of ownership of an asset. easier to organise than a bank loan because provider of lease retains legal ownership
functions of financial markets
- borrowers can raise finance = primary market
- savers can sell assets to other investors = secondary market
what are the financing products for short term finance
- BILLS OF EXCHANGE = legal document can be signed by the customer confirming their obligation to pay in near future
- COMMERCIAL PAPER = like bill of exchange but signed by the company confirming its obligation to pay the buyers of the ‘bill’. is unsecured and only issued by companies with good credit rating
- BANK BILLS = bill signed by company’s bank guaranteeing payment to buyers of the bill, can be sold to banks at higher price (acceptance credit)
financing products on capital market
- SHARES = in form of ordinary shares or preference shares
- BONDS = fixed interest securities issued by companies listed on stock market
other types of bonds
- eurobonds = bonds sold outside jurisdiction of country the who currency the bond is denominated
- convertible bonds = bond holder has right to convert bond into shares in the future (mezzanine finance)
- gilts = bonds issued by government, very low risk.
short term and long term finance
SHORT TERM:
- commercial paper
- bills of exchange
- overdraft
LONG TERM:
- convertible bonds
- shares
- debentures (capital market)
which assets are available in the capital market
- debentures
- mezzanine finance
- shares
- bonds
- gilts
