Preliminary Exam Topic 5 Flashcards
Define ‘FINANCIAL MARKETS’
Systems that facilitate the buying and selling of financial instruments (stocks, bonds, currencies, etc) enabling resource, allocation, and the risk transfer amoungst investors and entities.
What are some things financial markets are able to do?
Provide returns for households and businesses that have excess funds.
Make funds available to those who need additional money for consumption or investment.
Utilise income that is not immediately spent by allowing others to borrow the surplus for immediate consumption and investment.
Financial Markets are also the factor markets for capital.
Who are the net-savers and net-borrowers in an economy
Individuals are classified as net-savers
Businesses are classified as net-borrowers
Define ‘FINANCIAL INTERMEDIARIES’
Create a bridge between savers and borrowers - hold savings of individuals or firms as deposits, and then make loans to other firms or individuals who can make use of them.
Where do savings come from for individuals, businesses and governments (sources of savings)
Individuals - any surplus income that is not spent goes into savings (usually stored in a bank or financial institution, however can be kept liquid)
Businesses - can save by not distributing all of their profits to their owners. The funds that are not distributed can be supplied to financial markets until needed.
When the government budgets for a surplus (that is, current revenue is greater than its expenditure), it accumulates savings.
There are also foreign pools of savings supplied by individuals, firms and governments from other countries that Australians can borrow from.
Reasons for borrowing
Consumers borrow when their demand for G&S exceeds their current capacity to pay for them.
Entrepreneurs/business managers borrow to fund the operation or expansion of their businesses.
The government becomes a borrower of funds when it budgets for a deficit (when its current expenditure is greater than its current revenue).
Australian financial institutions can lend money overseas to borrowers. (While this does occur, in overall terms Australia borrows far more from overseas countries than it lends - Australia is a net borrower)
Define ‘SECURITIES’
Any form of financial instrument, including shares and bonds, that provides the holder of that instrument with a claim over real assets or a future income stream.
Financial markets are commonly divided into two main types: what are they?
Primary
Secondary
Define ‘PRIMARY FINANCIAL MARKETS’
Financial markets that facilitate the creation of financial assets, known as securities, that can be sold into the economy.
If a business wants to raise funds, it can either borrow money by issuing debt securities or expand the ownership of the company by selling new shares.
In a primary market, the money received from investors goes directly to the company.
Define ‘SECONDARY FINANCIAL MARKETS’
Give an example
Financial markets that involve transactions with financial assets that have already been issued on a primary market some time in the past.
No new financial asset is created; instead the ownership of an existing financial asset is transferred from one individual or business to another.
Most financial market transactions are conducted on secondary markets.
Companies whose securities are traded on the secondary markets do not receive any money from these transactions.
Using a trading app to buy and sell shares is an example of secondary markets.
Define the ‘SHARE/EQUITY MARKET’
Where ownership shares in companies are issued or exchanged.
what are the the main financial markets that exist across the world? (4)
The Share or Equity Market
The Debt Market
The Derivatives
The Foreign Exchange Market
In various ways, all financial intermediaries perform the same basic function – channel the excess savings (from net savers) in the economy to those who wish to borrow funds ( net borrowers).
Define the ‘DEBT MARKET’
Where debt securities (e.g bonds) are exchanged, or cash is lent or borrowed.
Define ‘DERIVATIVES’
Where people buy and sell financial assets that are based on the value of other financial assets.
Define the ‘FOREIGN EXCHANGE MARKET’
Where financial assets defined in one country’s currency are exchanged for assets defined in another countries currency.
Financial markets don’t need a location - give an example of this
Majority of Australian trades occur on the ASX (Australian Securities Exchange), the largest primary and secondary financial market in Australia
ASX: major share market in AUS, where the purchase/sale of most shares in public companies occurs. The share market brings together people wishing to buy and sell shares to allow transactions to occur.
Define ‘the ASX’
ASX: major share market in AUS, where the purchase/sale of most shares in public companies occurs. The share market brings together people wishing to buy and sell shares to allow transactions to occur.
Define ‘FINANCE COMPANIES’
Define ‘FINANCE COMPANIES’
Finance Companies: institutions that obtain funds primarily by borrowing from the public or banks through debt securities, and then lend those funds to individuals or businesses at higher interest rates.
Define ‘FINTECHs’
Fintechs: is a type of financial services business that uses technologies such as artificial intelligence or blockchain to increase efficiency or deliver new services.
Define ‘INVESTMENT BANKS’
Investment Banks: borrow short-term funds from companies with excess capital to lend to large corporations/government agencies for expansion - offer financial advice for mergers, and trading securities for profit.
Define ‘CREDIT UNIONS’
Credit Unions: non-profit, cooperative organisations whose members belong to a particular trade, industry or live in a particular area. People can deposit or borrow money, with any profits returned to members.
Define ‘SUPERANNUATION FUNDS’
Superannuation Funds: receive the contributions of employees/employers and invest them in financial assets in order to provide retirement income for the contributors.
Since the introduction of compulsory superannuation in the early 1990s, the superannuation sector has grown to become a major part of the financial sector.
List 6 financial market products
- Housing Loans
- Business Loans
- Short-term money market
- Bonds
- Financial Futures
- Foreign Exchange
Give Details about ‘HOUSING LOANS’
HOUSING LOANS: It is a secured loan.
Offered by banks, as well as mortgage originators such as Aussie and RAMS.
Long-term loan used to purchase property.
Not competitive since 2008, when banks took over many non-bank lenders
Housing loan rates are typically 2% - 3% higher than the Reserve cash rate.
Give details about ‘BUSINESS LOANS’
Business loans are a form of debt that allows businesses to invest in their business operations, such as with new technology or expanded office space
Business loan rates are typically higher than housing rates, due to a larger amount of risk being involved (which cannot be offset with a mortgage).
Small businesses will pay higher rates than large businesses
Give details about ‘FINANCIAL FUTURES’
Contracts to trade in financial instruments (such as shares or bonds) at a later date for a certain price.
Futures markets allow investors to protect themselves against adverse movements in interest rates, currency fluctuations or share prices by agreeing on a price and currency at which to buy or sell the financial product now, even though they do not have to make the transaction until a later date.
Holder can make the transaction or can choose not to and let the option expire.
Give details about ‘SHORT-TERM MONEY MARKET’
Brings together people and businesses who lack funds or have extra funds
Those with surplus funds issue various forms of debt securities (such as bank bills or promissory notes) to those in need of funds.
These debt securities all have a maturity date of less than one year.
Give details about ‘BONDS’
Longer-term securities for which lenders receive regular fixed payments (known as coupon payments) from the issuing institution, and receive the principal value of the debt (known as the face value
of the bond) at the end of the bond period (known as the date of maturity).
Bonds are issued by the government and a small number of large companies and banks.
Give details about ‘FOREIGN EXCHANGE’
The market for buying and selling of foreign currencies. Just as individuals require foreign currencies on holiday, investors and businesses require foreign currencies when they do business with people overseas.
The forex market provides a market for people to buy and sell currencies, and it operates 24 hours a day.
What type of business does a business have to be to sell shares?
An incorporated company
Define ‘INCORPORATED COMPANY’
Separate legal entity from the individuals who own/manage it.
Thus, it has limited liability so that the individuals who manage it are protected from bankruptsy.
Incorporate businesses can be either public or private - define BOTH of these terms.
Public Companies: an entity whose shares are traded freely on the share market and are not subject to any restrictions on being transferred to other parties.
Private Companies: restricts ownership of shares to only a few individuals and places restrictions on share transfers so that ownership cannot be freely bought or sold between individuals
The sharemarket only deals in shares of —— companies
Public
Define a ‘SHARE’
a type of financial asset that provides an indidividual with ownership over part of a business or company
Define ‘THE SHARE-MARKET’
Why is it important for businesses and individuals?
A financial market in which investors buy and sell shares, which are financial assets that give part ownership of their company.
The share market plays an important role in an economy because businesses can sell shares in their companies to raise funds needed for growth, and individuals can gain returns on their surplus funds.
What is the share-market in australia?
The ASX (The Australian SECURITIES exchange) - brings together buyers and sellers in the exchange of shares.
Both primary and secondary market - mainly secondary tho
What are buyers in terms of the sharemarket
Investors
What are lenders in terms of the sharemarket (2)
Companies (primary)
Previous investors wishing to sell (Secondary)
What are the main role/functions of the sharemarket for investors?
The main role/function of share markets for INVESTORS are:
To gain a stake in any company profits and to make capital gains from increases in share prices.
Owning shares also gives investors the right to vote for a company’s board of directors, who decide how the company will act to maximise the wealth of shareholders.
Entitled to a proportion of the profits (dividends).
Risks are limited to investors as they have ‘limited liability.’ If a company loses money or closes due to business failure, shareholders only stand to lose the amount they initially invested in the shares.
Define ‘CAPITAL GAIN’
Capital Gains: are the profits made by investors who sell their shares or assets at a price above the level that they originally paid for them.
Define ‘DIVIDENDS’
Dividends are the profit returns received by the shareholders (owners) of a business.
What are the main role/functions of the sharemarket for companies?
The share market provides an opportunity to raise new funds for investment and business growth.
A company can sell new shares to generate funds at any time in the primary market by issuing a prospectus.
The sale of new shares is a primary financial market transaction.
Issuing new shares reduces the control existing shareholders have over the company, as they will own a smaller proportion of the company.
