Quiz 1 Flashcards
(37 cards)
What is the financial system
A financial system consists of financial institutions, markets and instruments that together provide financial services for the economy
What is the settlement function
What are the two payment systems
the arrangements that can be used to settle commercial transactions. Check price and item… exchange money for item
Retail payment system and wholesale (high-value) payment system
What is the flow of funds function
Outline two methods of financing
The supply of funds for a period usually on the basis the users compensate the suppliers for the use of their funds.
direct financing = Transactions in financial markets = Deficit units raise funds directly from surplus units by way of securities
indirect financing = Transactions with financial institutions = The flow of funds between surplus and deficit units travels through deposit-taking institutions = two sets of contracts
What is the risk transfer function
what are two types of relevant risk
What do we use for transfering risk
Provide instruments for managing risk. Because risk cannot be eliminated, only traded for a different type of risk we call it ‘risk transfer’
default risk: The chance of loss resulting from financial obligations not being met
market risk: The chance of loss arising from an unexpected movement in a market variable (exchange rates, value of traded assets, interest rates)
derivatives
What do we mean by overcoming information assymetry
Two ways of overcoming information assymetry
overcoming a situation where one party to a potential contract has an information advantage over the other party.
use of professional traders + financial regulation
What do we mean by overcoming incentive problems
one way of overcoming incentive problems
Where parties to a transaction serve to gain through faulty or less than ideal transactions there exists moral hazard, as one of the contracting partners has an incentive to not act appropriately.
fiduciary duty
What is the pooling of funds function
Consequence?
An arrangement that consolidates small amounts of funds to satisfy the demand for large amounts. Because usually deficit units seek large amounts repaid over a long time and surplus units seek to supply small amounts over short periods.
Consequence = improves flow of funds function too
Define finance
Principal sources of finance
secondary principal source of finance
return formula?
The funds that are made available for use under agreed terms and conditions
principal = savings and income not spent
secondary principal = earnings retained by firms.
return formula = return = risk free rate + risk premium
Which is cheaper debt or equity?
Define leverage?
capital structure?
rule of one price?
Debt is cheaper due partly to tax deductions
Leverage = ratio of debt to assets
Capital structure = equity to debt
One price = financial instruments should have one price where they can be traded in different markets
What are ADIs
What authority do ADI’s require
what do they provide
ADI = authorised deposit taking institution = banks whether or not the ADI calls itself a bank
Require authority of APRA
provide indirect financing services and provide depositors with payment services = traditional banking services = retail customers, households, small businesses, organisation, wholesale customers (large businesses and organisations)
What are non-banks
Merchant banks or shadow banks (non-bank lenders) = non-ADI financial institutions
Merchant banks = provide direct financing services to wholesale customers
shadow banks = arrange loans usually for prime borrowers, receive funding primarily through MBS which have been issued by an investment bank
Three types of insurance companies?
what are fund managers?
life, general, medical
fund managers = financial institutions that contribute to direct financing by arranging the collective investment of investors’ funds in return for fees
The money market?
(engaged in flow of funds): The market for short-term debt securities (discount securities) = discount because issued at discount to their face (future) value.
The bond market
(engaged in flow of funds): contributes to the flow of funds through the issue of long-term securities, known as bonds.
The share market
(engaged in flow of funds):: arranges trading in shares and other corporate securities
The foreign exchange market
enables transactions to be made in different currencies because it arranges trading in foreign currencies.
The market for derivatives
operate either in a similar fashion to the share market (where the derivative contracts are traded) or the contracts are arranged by wholesale customers with dealers who mainly work for banks
APRA?
ASIC?
RBA?
Australian treasury?
APRA = an organisation to supervise financial institutions = ensure institution is able to meet obligations to customers ASIC = an organisation to regulate markets and to protect retail investors RBA = an organisation responsible for implementing monetary policy, the issue of notes and to act as the banker to the Australian Government.
Australian treasury = not a regulator, however it influences the framework for regulation
Five main functions of RBA?
- The implementation of monetary policy (the use of monetary variables, principally short-term interest rates, to help manage the economy.
- The stability of the financial system
- The regulation of the payment system
- The issue of notes to the community (through the banks)
- Banker to the commonwealth government
What is a loan originator?
How were the original loans funded by banks prior to GFC?
Elaborate on the effect of sub-prime housing loans and rising interest rates?
securitisation + effect?
flaws of US process of securitisation?
credit default swap + effect?
moral hazard of bailouts?
Loan originator = The person in charge of whether an applicant will receive a loan and on what terms.
Funding = by establishing a MBS and selling it off to an investor
sub prime and interest rates = lend to sub prime borrowers to expand market and make more money = include rising interest rates at a later date = everyone starts to default around same time = house prices fall = MBS loose value
securitisation = is the process through which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors.
effect = This process can encompass any type of financial asset and promotes liquidity in the marketplace.
flaws = information asymmetry = sub prime lenders + high interest rates
flaws = incentive problems = sell more mortgages = make more money
CDS = derivative for transferring risk of default on MBS to banks = done because banks did not predict all the defaults and thought this extra “unnecessary” insurance would just make them more money = effect of banks becoming bankrupt and so unable to payout for all of the CDS and so the CDS all became worthless and meaningless.
moral hazard of bailouts = leads top management to think they are immune and so they take riskier and riskier actions
Exchange settlement account + main condition + main advantage?
Two steps for processing interbank payment orders?
Two sources responsible for settlement of trades in wholesale financial market?
ESA = account financial institutions have with the RBA to settle the payments they make to each other and with the RBA = condition of not being able to overdraw = main benefit is RBA pays interest on account balance + allows ADIS to provide payment services to customers + are a safe place for funds
interbank payment order process = 1)clearing = both parties agree to terms of transaction = 2) settlement = exchange of value
two sources = clearing house (logs issued securities and owners and clears trades) + SWIFT (operates network for exchange of payment and other financial messages between financial institutions)
Elaborate on the purpose and instruments used for the retail payment system vs wholesale payment system
Retail = individual and normal business payments = more transactions = however, lower net value wholesale = financial market transactions and transfers between ADIs and the RBA = less transactions = however, overall higher value
Retail = cash, cheques, credit/debit cards, etc. wholesale = real-time gross settlement
in the case of the retail payment system, when is immediate and when is deferred settlement used? Also what are merchants fees?
Retail = two steps to DNS?
Retail = Advantage and disadvantage of DNS?
Payment orders + 4 types?
immediate settlement = cash and same-ADI payment orders
Deferred settlement = drawer and recipient use different ADI
merchants fees = fees for use of EFTPOS terminals and ADIs processing of payment orders ,etc.
DNS = net clearing (deducting payments from receipts when settling obligations between two parties) = settlement (transfer of net amounts at 9am next business day.
DNS advantage = uses net clearing to reduce number of overall transactions and to offset amounts owing and amounts owed (this reduces the amount of ES funds required as a bank which owes another bank $10 at 1pm and then is owed $5 by this same bank will then only have to pay $5 and so never required the full $10 in their ES account).
DNS disadvantage = settlement is not immediate
payment orders = instructions to ADi to pay stated amount to nominated party
- direct credits (+) and direct debits (-) = allows organisations to make payments to, and receive payments from, large groups
- cheques
- debit, credit and charge cards
- online payment orders
Types of transactions in the wholesale payments system (3)?
Real-time gross settlement: Use and 4 steps?
- wholesale financial market transactions from the FX, bond and money markets = two steps = 1) trade is made between the buyer and the seller that specifies the terms of the trade = 2) settlement occurs a specified number of days later then payment is made and ownership of the asset is transferred
- Transfers between ADIs (including DNS transfers)
- Payments are made with ES funds between ADIs and the RBA
Real-time gross settlement = Used by the wholesale system for clearing and settling
- Instructions regarding the payments to be settled each day are received mostly from the clearinghouses in the debt markets (Austraclear) and FX market (SWIFT)
- These payments are placed in a queue within the Reserve Bank Information and Transfer System (RITS) where they are processed individually throughout the day
- Processing involves firstly the clearing of the payment – which is checking that the paying ADI has sufficient ES funds to enable payment
- Once a payment is cleared it is immediately settled through a transfer of ES funds
