Module 1: Intro to Money markets

Question 1

What is the primary role of financial market?

Answer 1

To provide a medium of exchange where funds transfers can take place between individuals, firms and governments.

Question 2

Money markets are markets for

Answer 2

• Trading short term financial instruments
  -Short term lending and borrowing

Question 3

Money markets are markets for

Answer 3

Short term capital

Question 4

Capital markets are markets for

Answer 4

Long term capital

Question 5

A financial intermediary is

Answer 5

An institution which links lenders with borrowers, by obtaining deposits from lenders and then re-lending them to borrowers

Question 6

What is a primary market?

Answer 6

A market where securities (debt and equity) are issued for the first time. Primary markets enable organizations to raise new finance by issuing new shares or new bonds

Question 7

What is a secondary market?

Answer 7

A market where securities which have been issued in the primary market are traded, enabling existing investors to sell their investments, should they wish to do so. The marketability of securities is a very important feature of the capital markets, because investors are more willing to buy stocks and shares if they know that they could sell them easily. The secondary market does not raise new finance for companies.

Question 8

Foreign exchange rates are influenced by

Answer 8

-the comparative rates of inflation in different countries (purchasing power parity)
-the comparative interest rates in different countries (interest rate parity)
-the underlying balance of payments
-sentiment, for example whether investors feel that a country’s economy, and thus its currency is healthy or not
-currency speculation
-government policy on managing or fixing exchange rates

Question 9

The main capital market in Australia is

Answer 9

The Australian Securities Exchange (ASX)

Question 10

What are Equity securities?

Answer 10

Equity securities consist primarily of ordinary shares which entitle the owner to a share of the company’s profits and give them voting rights

Question 11

What are Debt securities?

Answer 11

Debt securities are typically fixed interest borrowings with a set repayment date, often secured on the assets of the company.

Question 12

Examples of Financial Intermediaries

Answer 12

-Commercial banks are the major holders of public savings and the providers of loans to individuals and companies
-Building societies and credit unions are savings from individuals (members) to provide mortgages and consumer credit
-Institutional investors include pension funds, insurance companies and investment trusts
-Finance houses raise funds through borrowing and debentures and provide short-term and long-term finance to firms and individuals (e.g major providers of lease finance)
-Merchant and investment banks mobilize and allocate funds of large denominations for major projects or investments

Question 13

Benefits of Financial intermediation

Answer 13

-They provide obvious and convenient ways in which a lender can save money. Instead of having to find suitable borrowers for their money, lenders can deposit their money with a financial intermediary. All the lender has to do is decide how long to lend the money for, and what sort of
return is required. They can then choose a financial intermediary that offers a financial instrument
to suit their requirements.
-Financial intermediaries also provide a ready source of funds for borrowers. Even when money is in
short supply, a borrower will usually find a financial intermediary prepared to lend some.
- They can aggregate or ‘package’ the amounts lent by savers and lend on to borrowers in different
amounts.
- Risk for individual lenders is reduced by pooling. Since financial intermediaries lend to a large
number of individuals and organizations, any losses suffered through default by borrowers or
capital losses are effectively pooled and borne as costs by the intermediary. Such losses are shared among lenders in general.
- By pooling the funds of a large number of people, some financial institutions are able to give
investors access to diversified portfolios covering a varied range of different securities, such as unit
trusts and investment trusts.
- Financial intermediaries, most importantly, provide maturity transformation; they bridge the gap
between the wish of most lenders for liquidity and the desire of most borrowers for loans over
longer periods.

Question 14

What is Eurocurrency?

Answer 14

Eurocurrency is currency which is held by individuals and institutions outside the country of issue of
that currency.

Question 15

What is a Eurobond?

Answer 15

A eurobond is an international bond that is denominated in a currency not native to the country
where it is issued.
Eurobonds are long-term loans raised by international companies or other institutions and sold to
investors in several countries at the same time. The term of a eurobond issue is typically 10 to 15 years
and the issue is usually underwritten by a multinational syndicate of banks. Such bonds can be sold by
one holder to another.
Eurobonds may be traded throughout the world, such as Tokyo and Singapore (not a specific national
bond market), and are named after the currency they are denominated in. For example, Euroyen and
Eurodollar bonds are denominated in Japanese yen and American dollars respectively.
Eurobonds may be the most suitable source of finance for a large organisation with an excellent credit
rating, such as a large successful multinational company, which:
 requires a long-term loan to finance a big capital expansion programme; the loan may be for at
least five and up to 20 years
 requires borrowing which is not subject to the national exchange controls of any government.

Question 16

What is an Over-the-counter (OTC) Market?

Answer 16

Over-the-counter (OTC) trading refers to financial instruments such as stocks, bonds,
commodities or derivatives which are traded directly between two parties, as opposed to via an
exchange. Major products traded on OTC markets in Australia include government debt securities,
corporate debt securities, currency and derivative instruments.

Question 17

What is an Equity Market?

Answer 17

The Equity market is where companies raise finance by issuing shares
for investors to purchase and where investors buy and sell shares which have already been issued.

Question 18

What is the Bond Market?

Answer 18

The Australian bond market has, until relatively recently, been dominated by the borrowing
requirements of the Federal Government. Banks, life insurance companies and superannuation funds,
who until the 1980s, were required to hold prescribed percentages of their assets in public sector
securities, absorbed most of the debt issued by governments. In more recent times the bond market
has grown in importance as a source of finance for the private sector.

Question 19

What is the Foreign Exchange Markets?

Answer 19

Foreign exchange is a major sector in the Australian financial markets. The Australian dollar is one of
the most actively traded currencies in the world (after the US dollar, yen, euro and Swiss franc).

Question 20

What is the derivatives market?

Answer 20

Derivatives markets allow market participants to fix today the price at which trades will be made in the
future. Efficient derivatives markets allow financial market participants to manage risk. The Sydney
Futures Exchange (SFE), which is now part of the ASX, provides derivatives in interest rates, equities,
currencies and commodities.

Question 21

What are institutional investors?

Answer 21

Institutional investors are institutions which have large amounts of funds which they want to invest. They will invest in stocks and shares or any other assets which offer satisfactory returns and security. They may also lend money to companies directly. The major institutional investors in Australia are superannuation funds and insurance companies and they are the biggest investors on the stock
market.

Question 22

Key financial instruments traded are

Answer 22

 Cash deposits – money in the bank accounts of banks and other financial intermediaries, offering a
range of different investment periods and rates of return.
 Negotiable instruments – a piece of paper representing ownership of debts and obligations. The
ownership is passed on with the delivery of the piece of paper. Negotiable instruments traded in
the money market include 90- and 180-day bills of exchange, promissory notes and certificates
of deposit, which are written orders promising to pay a specified sum of money at a predetermined
time to the order of a specified person or bearer.
 Treasury notes – a short-term debt instrument issued through the Reserve Bank of Australia (RBA),
by the Australian Government. Treasury notes are issued on a tender basis for periods of 5, 13 and
26 weeks, at a discount from face value. The notes are highly negotiable and are aimed at
professional short-term money market investors rather than the ordinary individual.
 Commercial bills – IOUs issued by large companies which can be held to maturity or sold to third
parties before maturity.
 Fixed interest short term bonds.

Question 23

What is a stock market?

Answer 23

A stock market acts as a primary market (i.e. where securities (debt and equities) are issued
for the first time) and as a secondary market for the trading of existing securities (i.e. shares
and bonds).