Lecture 1 Flashcards
What are the six functions of the financial system?
1) The settlement of commercial transactions
2) Promote the flow of funds
3) Provide opportunities for participants to manage the risks they face
4) Overcome information asymmetry
5) To resolve incentive problems
6) Promote the pooling of funds
What is the purpose of the settlement function?
Involves the settlement of commercial transactions- that is the payment of actual money once something is purchased
What is the difference between consumer and financial market transactions?
Consumer transactions are settled immediately- where financial market transactions have the agreement (between the buyer and seller detailing the terms of trade) and settlement (specified number of days later when payment is actually made) stages
What is a payment order? What types of transactions are they used for?
Payment orders are instructions to an ADS to pay the stated amount to the nominated party. They are used for payments between households and businesses, therefore retail payments within the net deferred settlement system
What are the two stages in interbank payment orders?
1) Clearing- where ADIs agree on their net obligations to one another
2) Settlement- the actual transfer of ES funds form the paying to the receiving ADI
How does the settlement function occur? One what platform?
REITS system- that is, the RB Australia’s Information and Transfer System
What are exchange settlement accounts and what are their main features?
ESA are held by ADIs to settle funds using payment orders. They:
- Enable ADIs to provide payment services to customers
- Are safe
- RBA pays interest on the end of day balance
- Cannot be overdrawn
What are the two settlement systems used?
1) Wholesale system- RTGS
2) Retail system- Net deferred settlement
What types of transactions is the wholesale system used for? How does settlement occur?
Used for settlement of transactions in the finaical market and involves the individual settlement of payments immediately upon clearing
Who instructs wholesale transactions?
Austraclear (or other clearing houses for debt security transactions) or SWIFT- for FX market transactions
How does the retail system settle transactions
Uses net deferred settlement:
- at the end of each day, ADIS will agree on their payment obligations (clearing)
- then at 9am next day the funds are cleared
In what ways are funds raised directly and indirectly from surplus to deficit units
Directly- through financial markets or the issue of securities
Indirectly- where funds are supplied as deposits to financial institutions, which in turn supply funds as loans to deficit units
Risk transfer function- what are the two types of risk and how does the financial market address these risks?
Two types of risks: default risk and market risk:
- Default risk: chance that financial obligations will not be met
- Market risk: the possibility of a loss arising from movement in market variables (FX rates, interest rates ect)
Address through trading in derivatives
When does information asymmetry occur and what are the two ways of overcoming it?
Information asymmetry: when one party to a potential contract has an information advantage over the other party. Methods include:
- Restricting participation to professional traders who understand risks
- Through financial regulations that require the more informed party to provide certain information to less informed party
What is a moral hazard? What are the ways of addressing moral hazards?
Moral hazard- where the ‘self interest’ of a party in a financial arrangement is in conflict with moral or ethical values. Two methods of overcoming include
- Requiring financial institutions to have a fiduciary duty
- require ethical behaviour
