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Financial Markets 2014 > Focus > Flashcards

Focus Flashcards

1
Q
  1. Describe the flow of funds
A

Savers have surplus units (could be Govt, Corps, household or Rest of world) they supply funds into financial markets, these are received by borrowers who have deficit funds. Borrowers sell financial instruments and savers buy them.

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2
Q
  1. What is an efficient flow of funds?
A
  • Directs funds to those who need it
  • Encourages saving
  • Implements monetary policy
  • Has a combination of assets and liabilities of varying attributes
  • Facilitates transactions for goods and services
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3
Q
  1. What can flow of funds data analysis provide?
A
  • Comprensive and consistent set of macro-financial information for all sectors of the economy.
  • Information about the type and owner of financial transactions which allow conclusions about economic growth, monetary success, financial position and stability
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4
Q
  1. What is the impact of the GFC on financial flows
A
  • Discouraged purchase of financial assets
  • Government required to sell CGS which crowded out market
  • Less borrowing
  • Impacts to the economy
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5
Q
  1. What is the manufacturing industry governed by?
A

Profits, liquidity and transaction requirements

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6
Q
  1. How would a change in the manufacturing sector impact the flow of funds?
A
  • Loss of jobs - less savers
  • Loss of investment in Australia - less borrowers
  • Loss of jobs in other areas - raw materials & contracting - slowing of economy
  • prices of goods may rise as lower supply
  • more funds required to buy goods, less saving
  • Government intervention may be required - could crowd market
  • Economic growth stifled
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7
Q
  1. How is a financial asset created?
A

By savers using their surplus units in order to generate a return on those. By investing funds into the financial markets it enables those with deficit units to access funds.

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8
Q
  1. What are the attributes of a financial asset?
A

Risk
Return (yield)
Liquidity
Timing of cash flow

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9
Q
  1. Why does an efficient system (flow of funds) require a combination of assets and liabilities of varying attributes?
A

To enable the saver and borrower to find assets/liabilities which are compatible with their requirements.

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10
Q
  1. How may assets be offered?
A

Intermediated vs Direct
Primary vs Secondary
Retail vs Wholesale

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11
Q
  1. Who determines the interest rates and how does this occur?
A

Govt set monetary policy, RBA implements the policy through changes to the interest rates by changing the cash rate.

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12
Q
  1. What is the RBA’s objectives in implementing monetary policy?
A
  • stability of currency
  • maintenance of full employment
  • economic prosperity of Australia (inflation between 2-3%)
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13
Q
  1. Why may the RBA increase rates?
A
  • Inflation above target range
  • Excessive growth in GDP
  • Large deficit in balance of payments
  • Rapid growth of credit & debt levels
  • Excessive downward pressure in FX markets
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14
Q
  1. Why may the RBA decrease rates?
A
  • Inflation below target range
  • Excessive decline in GDP
  • Large surplus in balance of payments
  • Rapid decline of credit & debt levels
  • Excessive upward pressure in FX markets
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15
Q
  1. What are the three stages of a tightening or contracting monetary process?
A
  1. Liquidity effect - rates rise money supply decreases
  2. Income effect - money supply decreases economic growth decreases
  3. Inflation effect - economic growth decreases, inflation decreases.
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16
Q
  1. What are the factors of the Australian economy now?
A
  • Interest rates 2.5%
  • Inflation 2.9%
  • AUD/USD 0.927
  • CGS on issue $327B
  • Economic growth above expectations
  • Steady unemployment
  • Business outlook down due to budget etc
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17
Q
  1. What does the law of one price suggest?
A

That the Purchasing Power Parity will apply and therefore that prices of identical commodities will sell for the same price in different countries after adjustment for exchange rates (Big Mac).

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18
Q
  1. Why may the Purchasing Power Parity be incorrect?
A
  • Theory may be wrong
  • Statistical differences in weight
  • Goods are not homogenous
  • Different consumer behaviours & income
  • Monopoly or monopsony
  • Transport costs / trade barriers
  • Sticky prices
  • Uncertainty & home bias
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19
Q
  1. Why may PPP not hold true in the short run?
A

Because some goods are not traded, but it should hold true in the long run.

20
Q
  1. What are short term debt instruments?
A

A financing arrangement for less than one year to help companies manage short term cash flow deficits.

21
Q
  1. What are examples of short term debt instruments (6)
A
  • Trade credit
  • Bank overdrafts
  • Bills of exchange (Commercial bills)
  • Promissory notes (Commercial paper)
  • Negotiable certificates of deposits
  • Cash products
22
Q
  1. What is trade credit?
A

A supplier provides goods to a purchaser with an arrangement for payment at a later date. eg. 2/10 (2% discount if paid within 10 days) or n/30 (full payment due in 30 days.

23
Q
  1. What is a bank overdraft?
A

A facility set up with a fluctuating credit facility provided by a bank which allows a businesses operating account to go into debit by an agreed amount

24
Q
  1. What is a commercial bill / bill of exchange?
A

It is a discount security issued with a face value payable at a future date, terms of 7-180 days, traded on yields, 2 way pricing, $5-$10M parcels.

25
Q
  1. What is a bank accepted bill?
A

A bill of exchange that is issued by a corporation and incorporates the name of a bank as acceptor.

26
Q
  1. What is a promissory note?
A

Is a discounted security similar to a bill of exchange but that there is no acceptor involved, they use the same formula, min of $100K, 7-180 days, and only available to companies with exceptional credit ratings.

27
Q
  1. What is a NCD?
A

A Negotiable Certificate of Deposit is a short term discount security issued by a bank with an initial maturity up to 180 days. These are used by banks to manage their liabilities and liquidity. They use the same disc. sec. formula and have an active secondary market.

28
Q
  1. What is securitisation?
A

Non-liquid assets are sold into a trust, the trustee issues new securities. Cash flows from the original securities are used to repay the new securities.

29
Q
  1. What is a special purpose vehicle?
A

It is a trust established to hold securitised assets and issue asset-backed securities.

30
Q
  1. What was the impact of the GFC on the securitisation market?
A

Suffered a large contraction mortgaged backed loans fell from $215B to $112B in 2010. These falls were recorded in Australia despite the much lower default rates experienced on mortgages compared to other parts of the world.
The RBA continues to focus on these introducing new eligibility criteria which includes transparency of underlying assets and risk.

31
Q
  1. What are the causes to the change of assets held by corporations since 1990?
A
  • Global financial crisis
  • Increased regulatory change (higher capital ratios for banks)
  • Internationalisation of the financial markets
  • Application of technology to development of new financial products and systems
32
Q
  1. Between 1990 and 2010 how have the assets of the banks changed?
A

Increased due to higher capital ratios required and have 57.7%

33
Q
  1. Which financial institutions have decreased the % of financial assets held since 1990?
A
  • Building societies declined as changes in regulation allowed most larger societies to become banks
  • Finance companies contracted as a result of financial deregulation, greater competition and absorption into parent company.
  • Life insurance offices.
34
Q
  1. Which financial institutions other than banks have increased asset holdings?
A

Superannuation funds have significantly increased as have public unit trusts

35
Q
  1. How has the GFC affected the efficiency of the financial system?
A

1) Savings patterns have changed
2) Monetary policies have impacted interest rates
3) Risk, return & liquidity factors for investors have changed
4) International lending more scrutiny (PIGS)
5) Higher levels of debt because bail out - tight budgets, higher taxes
6) Reduction of securitisation in Aus
7) Low business confidence and investment due to outlook and govt crowding out.

36
Q
  1. What are the international debt markets?
A

They are a significant source of short term and long term funding for governments financial institutions and corporations. They are deep and liquid and can offer higher returns and provide diversification.

37
Q
  1. Why do banks issue debt securities into the international debt markets?
A
  • Average cost of borrowing is slightly less than borrowing domestically
  • Ability to manage foreign exchange risk
38
Q
  1. What is the euro-sovereign debt crisis?
A

This relates to the extension of the GFC on particular countries - PIIGS (Portugal, Ireland, Italy, Greece and Spain). These countries have significant debt and some have been down graded in terms of credit rating. As there is higher risk with these countries, they need to offer higher rates in order to entice investment.

39
Q
  1. What is the problem with higher bond yields in the international debt market?
A

Higher bond yields make it more expensive for governments to borrow and their debt harder to bear. A 10 year yield above 7% has triggered bailouts for Greece, Portugal, and Ireland.

40
Q
  1. Why has the euro-sovereign debt crisis raised scrutiny of credit ratings?
A

Credit ratings reflect the country risk (law changes), sovereign risk (govt default) and foreign exchange risk of a country. It took a long time for the agencies to downgrade these countries, including Portugal in 2011, where it was reduced by four notches pushing it into junk territory.

41
Q
  1. What are the factors that impact on exchange rates?
A
  • relative inflation rates
  • relative national income growth
  • relative interest rates
  • exchange rate expectations
  • government intervention.
42
Q
  1. Explain the impact of relative inflation rates on exchange rates?
A

High inflation in Australia will reduce demand for goods in Australia, and will increase Aust demand for overseas goods, increasing the amount of AUD in the market. Supply increases, move along demand curve and price falls.

43
Q
  1. Explain the impact of relative national income growth on exchange rates?
A

An increase in national income growth for Australia usually will increase Australian’s demand for imports, this will increase the AUD in the market. Supply increases, move along demand curve and price falls.

44
Q
  1. Explain the impact of relative interest rates on exchange rates?
A

If interest rates rise, there may be an increase in foreign investment into australia, this will cause a reduction of AUD in the market. Supply decreases, move along demand curve and price rises.

45
Q
  1. Explain the impact of exchange rate expectations on exchange rates?
A

Belief AUD will rise, will generate investment into AUD, increasing the demand and the price will rise.

46
Q
  1. Explain the different types of government intervention on exchange rates?
A
  • trade flows - banning, quotas, tariffs etc
  • foreign investment restrictions
  • direct FX market intervention

Financial Markets 2014 (8 decks)

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