TOPIC 5 ECO (chapter 12 - 13) Flashcards

1
Q

financial markets

A

provide products that provide returns for HH & businesses w/ excess funds & make funds available to those needing additional money for consumption or investment (C&I)

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2
Q

financial intermediaries (banks)

A

firms hold savings (accumulated funds) of individuals/firms as DEPOSITS, make LOANS to other FIRMS/IND who can make USE of them

bridge between savers & borrowers in economy

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3
Q

4 sources of savings

A
  1. proportion of household income not spent on consumer goods
  2. business who dont distribute all profits to owners
    -funds not distributed can be supplied to financial markets until needed
  3. GVT budgets for SURPLUS
    -revenue > expenditure
  4. FOREIGN pools of savings supplied by individuals, firms & GVTs from overseas AUS can borrow from
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4
Q

4 reasons for borrowing for each person

A
  1. consumers borrow when demand for g&s EXCEEDS current capacity to pay
    -borrow to purchase houses
  2. entrepreneurs/bus managers borrow to FUND OPERATION/EXPANSION of businesses
  3. GVT borrows funds when it BUDGETS for DEFECIT
    -expenditure > revenue
  4. AUS financial institutions (banks) LEND money OVERSEAS to borrowers
    -AUS NET borrower in GLOBAL financial system, borrows more than lends overseas
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5
Q

financial markets are the ___ markets for ___ in an economy

A

factor markets for capital

income isn’t expended immediately & still constributes to present aggregate demand by allowing others to borrow surplus for immediate C&I

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6
Q

since when were financial markets more important for the economy?

A

since the financial sector was deregulated in early 1980s

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7
Q

financial instruments

A

shares, investment funds, superannuation, bonds

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8
Q

what financial services does AUS fianncial sector provide

A

home mortgages, credit cards, personal loans, super management, insurance

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9
Q

securities

A

any form of financial instrument that provides holder of instrument with claim over real assets/future income stream

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10
Q

2 types of financial markets

A
  1. primary financial markets
  2. secondary financial markets
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11
Q

primary financial markets

A

facilitate CREATION of financial ASSETS (SECURITIES) can sold into economy
-bus wants raise funds, borrow money by issuing debt securities/expand ownership of company by selling new shares
-money received from investors directly to company

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12
Q

secondary financial markets

A

transactions w/ financial assets ALREADY ISSUED on primary market in PAST
-no NEW financial ASSET is CREATED, but OWNERSHIP of existing financial asset TRANSFERRED from 1 individual/bus to another
-companies whose securites TRADED here DONT receive MONEY from TRANSACTIONS

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13
Q

ASX

A

australian securities exchange
-PRIMARY and SECONDARY financial market

major share market in AUS, purchase & sale of most shares in PUBLIC companies
-share market brings together ppl wishing to buy & sell shares to allow TRANSACTIONS occur

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14
Q

4 main financial markets across the WORLD
SDDF

A

SHARE/equity market
ownership shares in companies issued/exchanged

DEBT market
-debt securities (eg. bonds) exchanged/cash lent & borrowed

DERIVATIVES market
-ppl buy & sell financial assets based on VALUE of OTHER financial ASSETS

FOREIGN EXCHANGE market
-financial assets defined in 1 country’s currency exchanged for assets defined in another country’s currency

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15
Q

all financial intermediaries perform the same basic function:

A

channel excess savings from NET SAVERS in economy to those wishing to borrow frunds (NET BORROWERS)

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16
Q

non-financial intermediaries

A

legally cannot hold deposity

banks (financial) hold deposits on behalf of savers

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17
Q

banks comprehensive offer of financial services

A

-accepting deposits (savings)
-making advances (loans)
-issuing credit cards
-arrange overseas payments & collect funds

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18
Q

fintech

A

type of financial services business using tech eg. AI to increase efficiency/deliver new services

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19
Q

other financial institutions FICPS

A

Finance companies
investment banks
credit unions
permanent building societies
superannuation funds

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20
Q

finance companies

A

obtain most their funds by borrowing from general PUBLIC, issuing DEBT SECURITIES/from banks (non-financial businesses)
-funds loaned out to households/businessese at HIGHER rates of INTEREST to make profit
-fintechs

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21
Q

investment banks

A

borrow on short-term basis from companies with SURPLUS FUNDS
-lend funds to other large companies (expand business) & GVT agencies
-provide financial advisory services to large companies eg. takeovers, trade securities for profit

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22
Q

credit unions

A

non profit cooperative organisations
-members belong to certain trade, industry, profession, live certain area
-ppl deposit/borrow money with profits returned to members

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23
Q

permanent building societies

A

accept deposits from PUBLIC & provide FUNDS mainly for HOME LOANS
-also offer business loans but interest rate structure controlled lil by STATE GVTs

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24
Q

superannuation funds

A

long term contribution of employees & ers and invest in financial assets to provide retirement income for contributors

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25
credit
**loans** extended to individuals, businesses & GVTs for spending on **C&I** -constitutes **assets for financial intermediaries** that derive income from & **liabilities** for individuals & bus that **borrow funds**
26
consumer credit
allows consumers to **purchase** consumer g&s in **advance of actual payment** -enables individuals to tap into **future streams of income** likely to receive to **fund consumption in present**
27
msot common type of consumer credit & function
**credit cards** allow consumers to purchase goods & **repay borrowings with INTEREST** at **later** date
28
credit cards are offered by
**banks** **credit unions** **non-financial** corps eg. woolies in conjunction with credit card companies eg. **mastercard**
29
another major form of consumer credit
**personal loans** offered by **banks & credit unions** eg. **afterpay** -charged at **higher rate of interest > housing** loans -diff in interest rates charged on diff financial products reflect **diff in RISK to LENDER** borrower wont be able to pay back
30
why do successful economies depend on a competitive financial system?
transform **savings **--> productive **investment** --> higher **SOL** and eco **growth** increased **comp** improves **ALLOCATION of resources** in eco --> easier for **firms** to **raise funds**
31
are australia's financial markets successful?
yeah they large and sophisticated
32
australia's banking sector is not that/highly concentrated in the developed world
**ANZ, Commonwealth, NAB, Westpac** dominate markets for deposits, home loans, other **lending** large **market shares,** major banks wield sig **market & pricing power**, enabling to **raise retail deposit rates slower than borrowing rates**, :(
33
why do GVTs face pressure to increase competition in the banking sector?
assume banks make **excessive profits**, 'ripping off' **households & small bus** w i**nterest rate margins,** other fees
34
how do GVTs try increase competition
**policies** for **easier switching between banks** -**ban mortgage exit fees** -impose duty on **dinancial advisers** to put interests of **clients** first
35
housing loans
offered by **banks & non-bank financial institutions** (building societies) **long term** loans to purchase **property**, requiring **periodic repayments with interest**
36
financial futures & options
**contracts** to **trade** in **financial instruments** at **later** date for certain **price** -futures markets allow **investors protect themselves against** adverse movements in **interest rates, currency fluctuations/share prices** by **agreeing** on **price & currency to buy/sell financial product** in **present**, dont make transaction until later date -**options** give investors' **holder** **RIGHT** to make transaction but **NOT OBLIGATION** to complete transaction, can NOT let option expire (less risk)
37
foreign exchange
market for **buying & selling foreign currencies** -investors & bus need foreign currencies when doing **business** with ppl **overseas**
38
7 financial market products (to meet needs of lenders & borrowers varying risk, return & liquidity) CHB**SB**FF
1. consumer credit 2. housing loans 3. business loans 4. **short term money markets** 5. **bonds** 6. financial futures & options 7. foreign exchange
39
BUSINESS LOANS | SMR rates, where they borrow from
form of **debt** allows bus to **invest in operations & expansion** -**rates** on loans to **SMEs > housing** loan rates (**mortages** typically '**secured' by property** to purchase) -**lenders can sell** their **property** in situations when **borrowers default on** their **debt** to **offset losses** on loan, so loans arent as risky to provide -**greater risks** lending to small businesses (most likely to default on their loan obligations) -**small** bus typically borrow funds from **finance companies & banks** -**large** companies borrow from **investment banks** too
40
short-term money markets
bring **bus & ind together** with **temporary shortages/surpluses** of **funds** -those with **surplus** funds (eg. banks) **issue** various forms of **debt securities** (eg. bank bills) to those in need of funds -debt securites have **maturity date <1yr**
41
# gvt/company borrows money from investors bonds aka long-term debt security | less risky than stocks
written **record of debt** -**borrower sells bond** in return **for LOAN** -**holder**/lender of bond receives **INTEREST(coupon) payments and final(principal, face value of debt)** repayment from issuing institution at **end of bond period (maturity date)** -rate of financial return/risk on bond ***(yield)*** calculated by **dividing coupon payment by bond price** -if **interest rates ^**, **yield** on bond **^** but **coupon payment**ws are **fixed** so its reflected in **lower price for bond** (price of bond fluctuates according to changes in lvl of interest rates) -**can** be ***sold*** in **SECONDARY** financial markets -issued by **GVT** and few large companies & banks
42
superannuation
AUS employers **obliged to pay contributions to employees** superannuation **acc**ounts **(early 90s**) -superfunds **invest into financial products** (shares, bonds) in AUS & **overseas** -employees retire, **funds available as retirement income** (regular payments/single sum)
43
superannuation roles for AUS economy
-source of retirement income -system allows more ppl to **indirectly own shares** & participate in sophisticated parts of finance sector with **higher returns, than simply depositing money in savings bank** -growth of super reduces **pressure on gvt** to provide income for retired aussies -gradually increasing large pool of finance created **promotes growth** in eco -money in super funds can be **loaned to financial institutions to provide loans to housholds** (eg. mortgages) & businesses -also can be directly invested in **new share issuances** by businesses to purchase more **capital**
44
how do changes in superannuation have significant impactso n the rest of the economy?
large amt super invested in shares = changes to **share market main driver of superannuation balances** -super industry regulated by GVT through **APRA**
45
share
type of financial asset provides individual with ownership over part of business/company
46
share market
financial market where investors buy & sell shares only deals with trade in shares of **PUBLIC companies**
47
why does the share market play an important role in the AUS eocnomy
businesses can sell shares in their companies to raide funds for growth individuals/other businesses can gain returns on their og bus' surplus funds
48
how can a firm issue shares?
-must be COMPANY, (INCORPORATED!!) -LIMITED LIABILITY
49
incorporated business
legal process recognised as separate legal entity from owners/managers of business (no matter what happens to shareholder, business continues operating) * **assets** and **cash flows** of the **business entity** are **kept separate** from those of the **owners and investors** (limited liability) -*easier* for a business to **sells shares**, raise capital -fails, indivudals who **operate** business **protected from** risk of **bankruptcy**
50
incorporated businesses can be either ____ or ____
public or privatep
51
public company shares
**no** **transfer restrictions (beyond** those established by **GVT regulation)** -company's shares can be **traded freely on share market**
52
private ocmpany
**restricts ownership of shares** to only few (<50) individuals & places restrictions on **share transfers** so **ownership cannot be freely bought/sold** betw individuals -**Pty Ltd** propriety limited
53
how does the ASX provide a regulated environment for investors to buy & sell shares?
matching sellers who have desired selling price with buyers willing to pay that price investor can **buy/sell sahres through BROKER registered with ASX** -broker can be specialist online trading agency/finance company/stockbroker (person) -online brokerages popular recently cause **low cost & accessible** way of **trading shares**
54
reasons for investors to purchase shares
gain **stake** in **company profits** make **capital gains** from **increases in share prices** owning shares = **right to vote for company's board of directors** who appoint company's senior managers -**decide how company** will act to **maximise wealth of shareholders** -shareholders meet **once a year to vote** matters & voice opinion -mangers have **FIDUCIARY (legal) duty** to **manage company** in way serves **interests of shareholders**
55
shareholders as owners of company
entitled to share successes of company -company refutnrs **profit, prop** returned to **shareholders** **(DIVIDENDS) awareded per share** -most companies autonomy to decide what **fraction of profits** returned to shareholders -**company grows, value share price increases,** shareholders can sell shares for more than paid them **(CAPITAL GAINS)**
56
possible gains for shareholders
value of shares increasing, may sell any time to make gain
57
risks for shareholders
company **loses money**/closes due to failure, only stand to lose amt initially invested in shares (limited) -not responsible for further debts of company
58
dividends
profit returns received by shareholders (owners) of business
59
capital gains
profits made by investors who sell their shares/assets at price ABOVE level originally paid for them
60
float
company lists itself on stock exchange & offers its shares to public first time DEBUT
61
share market benefits for company
opportunity to **raise new funds for investment & growth** -once listed, **access further equity funds** any time by issuing approved prospectus for release of new shares -issuing new shares **REDUCE CONTROL existing shareholders** have over company, **(own smaller prop** of company)
62
sale of new shares is a _____ financial market transaction
primary
63
when EXISTING shareholder sells shares to another investor, what financial market transaction is this? (most trades in australia) primary/secondary
secondary
64
a company's share price is SET by the market forces of ___ and ___
supply and demand
65
what factors does a company's share price reflect
-**confidence in management -previous & expected earnings** -general **eco conditions**
66
if company's share price loses value for shareholders, what do shareholders do and what happens to the company
put **pressure** on management to improve performance & even **vote new management** threat of possible **takeover**
67
relationship between general eco conditions & share values
fluctuations in **share market** mirror changes in **eco growth** -down/upturns in share market **measured by ALL ORDINARIES INDEX** -share market much **LESS STABLE** than real eco (small change in eco growth --> enormour change in share values)
68
all ordinaries index
stock market index measuring changes in overall value of companies listed on ASX
69
how do share markets act to allocate resources to diff types of production?
companies & sectors with **best growht prospects** able to use additional **investment funds** most effectively -**raise msot funds when floated** -raise **medium-term** growht prospects of economy -**share prices higher** for firms in **industries shareholders expect high growht**
70
major problem using share market as guide to health or eco/indicator of industry growth
**assume** all **share purchases** based on **rational**, confident beliefs of shareholders -share purchases **SPECULATIVE**, **bought** with intention of being **resold within short period** -investors **dont** buy to gain **long term income stream from shares but hope for short-term capital gains** -speculators base investment decision on 'HYPE' in market, **not real profitability of firms** --> shares/industries may **overvalue prices**, draw further investment & **misallocate resources**
71
speculation
investors buy assets with intention of reselling for higher price in short period
72
recent decades seen dramatic **increase in participation of foreign investors** in AUS markets. why? (2)
1. both through **increased lending to AUS** 2. increased **foreign ownership of AUS companies**
73
AUS financial markets become closely INTEGRATED with global markets last 3 decades. what does this reflect? (3)
**falling communications costs** increased **reliability & speef of electronic transfer of funds** **deregulation** of AUS financial markets since 80s encouraged **foreign participation in domestic markets**
74
when has AUS been more open to FEM?
1983
75
why are global debt markets important for AUS eco development?
reliance on foreign borrowing -AUS net borrower, borrows funds overseas > lends foreigners
76
what facilitates AUS foreign movement of funds?
AUS 4 major banks source finance for domestic loans from overseas foreign banks established stronger presence since AUS operations established 1985
77
equity markets
**regulated by NATIONAL GVTs**, exist primarily within individual countries -companies raise capital to startup or expand their enterprises -meet **issuers and buyers of stocks** in a **market eco**nomy. **international movement of funds** betw equity markets dominated by **financial institutions (banks)**
78
domestic & global markets FGE
foreign exchange markets global debt markets equity markets
79
Australia is primarily a ___ market with foreign participation than ___ market, regulated by the ___
domestic global ASIC
80
2 + 2 international organisations limited functions of regulation in GFM
1. **Bank for International Settlements BIS** -international org helps central banks promote financial stability through market regulations -Basel Committee sets standards for banking regulations to promote uniform financial regulatory systems globally 2. International Monetary Fund IMF -general stability of international financial system -monitors ecos & markets -provides financial assistance to countries diff meeting IF obligations 3. International Organisation of Securities Commission (IOSC) -share markets 4. iNTERNATIONAL association of insurance supervisors (IAIS) -insurance markets
81
main benefit of GFM
allow aussies **access foreign capital** for individual & business **investment** enable aussies **invest & earn returns from overseas bus** without access to inter finance, face **higher borrowing costs/unable access** finance easily
82
main disadvantage of integration with GFM
regular **disturbances** in **market overseas** quickly **transmitted** to AUS esp through **financial market SPECULATION**
83
results of financial market disturbances 4
1. savings lost 2. **companies bankrupt** 3. **undermine confidence** across eco 4. reduce eco growth
84
4 GVT bodies AUS responsible for regulation & supervision of financial system
1. RBA -responsible for **monetary policy**, payments system regulation, banking services to GVT, supply of banknotes, stability of financial system (5) 2. Aus Prudential Regulation Authority (APRA) -prudential supervision & regulation of all **deposit-taking institutions** -life & general **insurance** -**super** funds 3. ASIC -**corp** regulation -**consumer protection** -oversight of **financial service products** 4. AUS Treasury -advises GVT on **macroeco & financial stability** issues -advice for **legislative & regulatory framework for financial system**
85
Council of Financial Regulators CFR
coordinates collaboration among 4 members (RBA, APRA, ASIC, Treasury) **informal** body allows info sharing & coordinating advice -**no collective powers separate from powers of individual members** **late 1990s**
86
RBA
AUS central bank, main role to ocnduct monetary policy & oversee stability of financial system now, prioritieses **sustaining low & stable inflation (og goal maintain stability of currency)** created **1959**
87
central bank role 3
executing monetary policy on **behalf of GVT** **print banknote**s regulate country's banking system according to **eco objectives of Commonwealth GVT**
88
how are central banks diff to other banks?
not set as **financial bus**iness w/ desire to **make profit** **legal monopoly privilege to issue banknotes ** doesnt provide **accounts for general public**
89
7 functions of RBA
1. conducting MONETARY policy on behalf of GVT -influence **cost & availability of money** in eco by influencing **general lvl interest rates** -achieve sustained low inflation rate while encourage **eco growth** 2. financial system **stability** -monitors risks & developments in AUS financial system -conducts research & provides **guidance to APRA to enforce regulations** -maintain long term stability of financial system by **AVOIDING/reduce risk financial crises**
90
other 5 functions of RBA
3. control of note issue -AUS currency manufacturer -volume of notes & coins vary according to demand for cash 4. regulation of payments system -payment methods (credit cards, electronic cash) -promote stability in settling large transactions in financial markets 5. **banker to the banks -hold ES accounts with banks** -accs allo****w banks to **settle debts between themselves** & RBA at **end of day's trading** -banks can use to **buy & sell GVT securities from RBA** 6. responsibility for holding AUS reserves of gold & foreign currency dealings -provide funds used to make international payments/RBA operations in FEM -oversees dealers in FEM 7. banker & source of financial & eco advice to GVTs -banking & financial agency services to Commonwealth GVT & soem state GVTs -can lodge excess funds w/ RBA & complete transactions on behalf of gvt (welfare, pensions) to citizens -publishes** regular assessments of eco's state & financial markets (sig influence policy making)**
91
ADI
authorised deposit-taking institutions from **APRA** -**banks, superfunds,** insurance companies, credit unions, building societies
92
2 main regulatory roles of APRA
1. ensures **institutions** **meet obligatiosn** to **ppl placing money w/ em** -ensure **deposit-holders can take** back deposit ***money*** when wanted -**superfunds perform well **& can pay ppl **withdraw savings** 2. sort out institutions financial position & ensure **policy/deposit holders receive as much of their funds possible**
93
ASIC has power to
**monitor, investigate & act** in situations where integrity of financial system undermined by **illegal acts/unethical investment products** **protect consumers against misleading/deceptive conduct** affecting **financial products & services**
94
ASIC aims
****maintain high standards of **corp behaviour & confidence in financial markets** **offence regulate**d by ASIC: ***insider trading (company directors use non-public info abt company to buy & sell shares on market to make profit)***
95
AUS Treasury role in functioning of AUS financial markets
main source of **eco policy advice to GVT** -how they **devise budgets, colelct taxes, allocate expenditure, implement policies** (monetary, labour, market regulations) for **FINANCIAL MARKET** -**advice** to GVTs on **regulatory** settings for financial markets, **corporate practices & consumer protection**
96
price of money in the financial/money market
**rate of interest borrowers pay** -**not** achieved through **equilibrium of market forces alone but RBA influencing interest rates**
97
mortgage
**most common** form of b**orrowing by households** to **purchase house** -lending **bank gives house as security on loan** -if borrower **defaults making repayments** on loan, bank right to **sell house to regain debt before giving leftover money to borrower**
98
indivudal borrowing for short term borrowing
**buying car,** travel internationally, **credit cards** -**loans mostly unsecured, no asset financial institution can claim if borrower defaults** on loan -**higher interest rate** relative to those for **mortgages**
99
why does the business sector access msot funds of any sector in the economy? how do they borrow funds?
need access to **funds** to **expand production, invest in R&D** -**directly** by **issuing shares to raise equity/issue bonds to raise debt** -**indirectly borrow** money from **financial isntitutions** -overcome **downturns in its cash flow**
100
how do GVTS participate in financial markets as borrowers
**raise lvl eco activity** -**slow growth** rate --> funds readily vailable from financial markets --> **borrow to increase spending/give tax cuts to stimulate eco** GVT **spending grows faster than revenue (unintentional)**/fund major **infrastructure projects** (decades so future returns from assets cover costs of investment)
101
liquidity
***ease*** which financial **asset** can **convert into cash** so it can be used as **medium of exchange** benefit of holding money, **easy use of funds when necessary**
102
when individuals have **surplus funds** what **form** can they decide to keep those funds?
hold **money ( currency & bank deposits)** **purchase financial assets (bonds/shares)**
103
benefit of purchasing financial assets
**return** can earn by holding -owners of **shares** in **company** can receive **prop of profits** made by company in **dividends** -no return when holding cash **(cash value erodes over time, money holds value)** **RISKY** THO **value can change depending on market conditions**
104
3 reasons why some **prefer** holding **money/highly liquid assets > invest surplus funds** in financial **assets** offering **return** TPS
1. **transactions motive** -**regular payments for g&s** -need **certain quantity of currency** for these transactions -**most financial assets cant be used to pay** these 2. **precautionary** motive -unpredictable circumstances, **emergencies for liquid funds** 3. **speculative** motive -**buying financial assets** possibility making **capital gains/losses** -**value shares/bonds falls, capital loss** -avoid capital loss **expect value fall, sell assets and convert to money)**
105
how does lvl **demand for liquid funds (money) depend** on sophistication of financial system & **ease** one can **convert non-liquid assets into money?**
**simple** system, wanna **hold more cash for transactions & precautionary** purchases to **easily access funds** -**banks only** operate brances & **savings accs** require ***holders to physically make transactions at bank***, a**dvanced** -**easier to convert financial assets into liquid funds** -ind&bus **confidently hold more savings in less liquid assets**when **markets for assets have lots of buyers & sellers**, function more efficiently - affects demand, **ease of electric transactions**
106
main opportunity cost of holding liquid funds
**interest** wouldve been **earned by holding financial assets** -benefit holding liquidity (**lower costs for transactions, no risk of capital losses) > costs (interest)**, individuals wanna hold money than financial assets
107
demand for funds (during surplus) by businesses affected by factors
**cash flow generated by business operations** whether cash flow sufficient to **cover expenses** general **eco conditions** -good --> more **comfortable taking debt to fund major investments & expansion** **low interest rates** borrow more
108
payment method trends
**electronic payment methods** increasingly **substitute for cash** -driven by **^availability & convenience** (contactless card, mobile phone payments) more **time efficient**
109
why is AUS household debt increasing (mortgages)
1. **long period of low interest rates** esp 2000-10s -when **borrowing**, main **concern** is **how MUCH to pay back in monthly repayments** -afford to borrow more 2. **financial deregulation -increased competition --> lowered borrowing costs & increased debt options** to homebuyers 3. **rising income** levels -afford to buy **bigger loans in dollar terms & as % of income** 4. **low inflation** (avg)
110
6 financial innovation affecting consumer demand for liquidity (new tech)
1. ATM, EFTPOS 2. growth of **internet based discount stockbrokers** -**cheaper & easier** for small ind **investors** participate in financial markets 3. rise of **BUY NOW PAY LATER** products offered by **companies** -pay for goods in **instalments w/o credit card/traditional loan** 4. **MORTGAGE BROKERS** -help individuals find most suitable loan products -**replace banks** as conduit to housing loan for large % borrowers 5. **CONTACTLESS PAYMENT** systems -pay without signing/providing PIN -**reduce transaction time > debit & credit cards** 6. CRYPTO/digital currnecies -future, transfer funds internationally quicker -lower transaction fees < traditional methods -transact directly w/o intermediaries (banks)
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how are individuals lenders in financial markets
place **deposits in financial institutions** **lend** money to institution **for return** -but hold wealth, not spend range options -**invest in assets/buy shares/avoid risk place money into interest-bearing deposit in bank**
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how can businesses be lenders in financial markets
successful business strong **cash flow & profits** but may **not** have wanna **immediately expand/buy out another** -**deposit funds** in bank (FI) -**interest rates** lvl where **maintaining deposit funds** likely more **lucrative > investing in expansion,** firm more likely deposit funds
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how can GVTs be lenders in financial market
mostly borrowers, but surplus on budge, allows **pay past debts/maintain positive financial balance** (loan(borrow) money through financial sector)
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why is the INTERNATIONAL SECOTR an importnat source of funds for domestic borrowers?
AUS historically **low savings rates**, relying overseas svings to **finance domestic C&I** -**borrow** money from **overseas foreign LIABILITY**, must be **repaid future**
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4 characteristics why money is important component of modern ecos
1. **MEDIUM of EXCHANGE** -g&s, resources exchange for money 2. measure of VALUE -compare relative value of g&s, resources 3. **STORE of value** -can be held over time & used predictably for **future exchanges** 4. **method of DEFERRED PAYMENT** -allows development of system of **lending & borrowing**
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why is a stable monetary system important for the successful performance of an economy?
affect ability of **markets to function properly** & allow **economy grow** over time * full employment * eco prosperity & welfare * stability of currency (more inflation now)
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4 main ways money supply measured
1. **CURRENCY** -held by **households & businesses** 2. **M1 = currecny + transactional bank deposits** - transactional **bank accounts** -measure most **liquid financial assets**, used **instantly** to complete **transactions** 3. M3 -M1 + all **non-transaction deposits** -consists of all **currency** in circulation & all **private sector deposits in banks** -**not as liquid** as M1 4. **BROAD money** -M3 + **deposits in NBFI - NBFI in banks** (credit unions, building societies) - holdings of bank deposits
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M1 =?
M1 = Currency + transactional bank deposits
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M3 = ?
M1 + NON-transactional bank deposits
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BROAD MONEY = ?
M3 + NBFI deposits - NBFI deposits in banks
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how is CREDIT an important ***FINANCIAL AGGREGATE (publishes*** &**monitors data** on the **stock of money** and **credit)** measured by thr **RBA**?
**borrowers receive money** upfront while **lenders receive credit asset** (have right to **receive interest payments from borrower & amt moeny initially borrowed at end of loan period)** -credit itself loan asset banks & lenders hold -**not money** but close credit = **value of total borrowing in AUS eco by HH & businesses**
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interest rates/borrowing rate
**cost of borrowing money as % of total amount borrowed** -price brings **equilibrium** in financial market **(quantity of funds supplied by lenders = demanded by borrowers)** ***rate of return(yield) on financial assets/instruments***
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supply of funds is in/elastic to changes in interest rate
inelastic
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why do banks act as borrowers of funds when they accept savings deposits? ## Footnote make profit
use funds to **make profit by lending funds to other borrowers, charge interest** on funds when **make loans** to customers -profit by charging **LENDING rate > BORROWING rate**
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borrowing rate & lending rate difference between these rates
borrowing : rate of interest **offered** borrowed lending rate: **charge** rate of interest by lenders diff: interest rate differential
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how do we distinguish betw short & long term interest rates?
based on **length to maturity of financial assets/ securities** -eg. Comm GVT borrows funds using short term (
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short term interest rates
interest rates on loans with maturity <1 yr
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why interest rates diff betw long & short term securities
**long term: riskier** (can **charge** much **more over time**), **less liquid** (more **diff to convert into cash**) -**return** required for assets usually higher , **lenders receive higher interest rate**
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factors that influence general lvl **interest rates** (factors affects **supply/demand funds** in financial markets lead to **change in equilibrium** lvl **interest rates**) ISLIGIM
1. **demand for capital** goods **(investment)** -stronger investment demand --> higher demand for borrowing by firms to **finance capital expansion**, **upward** pressure on IR -**^ real wage rate** (capital cheaper < labour)/**^ lvl eco activity** (firms need expand capcity to **satisfy stronger demand)** 2. lvl **SAVINGS** in eco higher, **^ supply of loanable funds, downward** pressure on IR 3. **demand** for **LIQUID FUNDS** -stronger pref, **willing forgo returns from buying securities** & choose **hold** funds in **bank deposits/currency** -**supply of loanable funds lower**, put **upward** pressure on rate of interest 4. **INFLATION**ARY **EXPECT**ATIONS 5. GVT **BUDGET** 6. **INTERNATIONAL** interest rates 7. **MONETARY** POLICY
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how do inflationary expectations affect interest rates
inflation reduces value of money & financial assets -inflation **expected to rise, lenders** require **higher IR paid** as compensation for **loss of value of financial assets** -if **real** rate of return**(yield)** on **securities** stays **same, higher expected inflation --> higher nominal IRs** in eco
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how does GVT Budget affect interest rates
GVT budget **deficit** & **borrower** in FM --> **higher IRs** -if GVT **net lender** in financial markets, **DOWNward** pressure on IRs
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how do international interest rates affect AUS interest rates
**capital markets open & funds move across national borders easily,** lvl world interest rates impact **domestic interest rates** -**domestic IR < overseas** IR, domestic lenders seek **invest** funds **overseas** to advantage **higher** rates of return **yield** -**reduce supply of loanable funds domestic**ally, **UPWARD** pressure on domestic IRs
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what type of influence monetary policy (RBA) on interest rates
manages **cash rate** -**DIRECT** influences **returns** for **SHORT-term** **loans** & **INDIRECT** influence on **interest rates on LONGER term loans**
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cash rate
**interest rate** in **overnight money market** (market for **very SHORT term loans betw banks**, loans made for overnight use many cases)
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mechanics of cash rate & overnight money market is explained by 3 things
1. exchange settlement accounts 2. **policy interest rate corridor** 3. open market operations
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exchange settlement accounts
banks **need** to **hold certain prop of their funds with RBA in ES accs** to settle **payments with other banks & RBA** -eg. consumer ANZ uses debit card to buy g/s from bus from westpac, funds need flow from ANZ to westapc for transaction through **transferring funds bwtween banks ES accs** -banks end up having **surplus/shortage funds in ES at end of day** -banks can **hold ES balances in accs at RBA to store value** **overnight money market** banks have **shortage of ES funds** **borrow** money from banks with **surplus**, enables banks to **settle interbank payment obligations each other** -like other FM, demand by borrowers & supply from lenders interact to set **IR (equilibrium)** -**supply of funds** from lenders w/ excess ES **increases**, **price borrowing** this **(cash rate) falls** -BUT **RBA** intervenes to enure **cash rate** sets **targets** using **policy (IR) rate corridor & open market operations**
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policy rate corridor
RBA can ensure **cash rat**e doesnt stray far from **target **w/ **ES funds** outside **overnight money market** 1. RBA **pays IR to banks** on funds in ES accs **0.25 <** target -banks with **excess ES** balances **dont** have **incentivce to lend** funds to other banks as they could earn **greater returns by leaving** extra funds in **ES account** -hence RBA's deposit rate creates **min value** for cash rate 2. RBA always willing lend ES balances to banks outside overnight market -sets **IR on loans 0.25% above** cash rate target -**banks** need **borrow ES** balances **not incentivised to pay rate HIGHER than RBA's lending rate** -**borrow ES funds directly from RBA** outside overnight market -creates **MAX** value for cash rate together,** floor (RBA deposit rate)** & **ceiling (RBA lending rate)** form policy rate corridor for cash rate **-no banks (surplus/shortage of ES funds) have incentive** to complete transactions in **OMM outside of corridor** -actual cash rate always closely follows RBAS target
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what is the policy rate corridor responsible for
implementing changes to **RBA's cash rate target bc ceiling & floor automatically** set so cash rate **target MIDDLE** -if RBA **decrease target, floor & ceiling shift DOWNWARDS**, banks borrow & lend from eahc other consistently with new target ***as soon as RBA announces changed target***
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borrowers & lenders always execute trades using the cash rate target. why?
**cash rate target & actual almost same** -no reason why cash rate cant move within corridor
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domestic market operations
**demand for ES** balances **by banks** **fluctuate** daily -esp when **large transactions**/payments in eco (eg gvt pays **social security** benefits)
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why does RBA manage lvl suppply of ES funds
it **meets demand at price** = target daily without, **cash rate bounces inside corridor whenever demand fluctuates** -but **massive increase in ES balances no need** for as many interventions
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how does the RBA manage the supply of ES funds
conducting domestic market operations (**DMO), RBA buy& sell financial securities in exchange for ES balances** -affect supply of ES funds used to complete transactions -if **demand for ES funds ^, RBA** need to **increase supply** of ES funds to keep **cash rate at target**
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domestic market operations
purchase & sale of financial securities by RBA in exchange for ES balances
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HOW DOES THE rba INCREASE SUPPLY OF ES funds to keep cash rate at target
i**buy** financial **securities** accounts -increases supply of ES funds to **meet additional demand** if **DECREASE supply RBA sell financial securities to banks, exchange** by **withdrawing funds** sitting in their exchange settlement **accounts** -**decrease supply** of ES funds down to lower lvl of demand
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**DMO** involves outright purchases/sales of securities (eg secondhand Comm GVT bonds) or **repurchase agreements**. what are repurchase agreements?
'seller' of bond/security agrees to buy bond/security back from 'buyer' at later date
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SUMMARY of cash rate policy corridor
uses CRPC to **change cash rate target** DOMESTIC market operations **DMO to ensure CR stays target EVERYDAY when demand for ES funds change** **both** feature of OMM allow **RBA control cash rate**
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what happens when the cash rate increases?
more **expensive financial institutions to obtain funds in SHORT term money market** -**increases** overall **cost** structure of ***borrowing***, flowing through **LONGER term & mortgage IR**s as *banks* try **maintain profit margins**
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why is the cash rate important?
provides foundation of interest rate structure in economy
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what happens during a reduction in cash rate
lowers cost of borrowing for banks in **SHORT term money market** -financial institutions **pass cost saving to customers** in lower lending IRs
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how do changes in general level of interest rates (caused by changes in cash rate) impact lvl of eco activity?
interest rates fall -encourages C&I spending --> ^ lvl eco activity interest rates rise -deters C&I spending, reducing overall eco activity
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what is the RBA's influence on IRs to affect lvl of eco activity?
**monetary** policy **tighten** by RAISING IRs or **loosen** by LOWERING IRs