FINS1612 Lecture Notes - Lecture 4: Financial Asset, Financial Instrument, Financial Transaction
FINS1612
Lecture 1
- Quiz 1: 20% (w4)
- Quiz 2: 30%
- Finance: art and science of managing scare resources of money
- Money: acts as a medium of exchange, represents a store of wealth, facilitates saving, solves
divisibility problem
- Household (surplus suppliers of funds Y>E and deficit demanders of funds E>Y), firms
(investment surplus, deficit), financial (surplus from household → interest income, deficit →
loans and interest payment AND firms AND banks are also deficit units borrow w/ one
another), gov (local or o/s financial sector), o/s
- Fiscal+ monetary policy on savings/investm decisions
Functions of a financial system
- Financial institutions, instruments, markets which interact to facilitate the flow of funds
between deficit and surplus units within the economy
- Financial institutions permit the flow of funds between borrowers and lenders by facilitating
financial transaction
o Provide investment products (surplus units)
o Provide alternative funding sources (deficit)
o Provide risk management products (insurance)
- Facilitate the flow of funds- primary financial market (creation of new financial assets) +
secondary market (provide arrangement for transfer of funds by arranging trades in existing
financial assets)
- Efficient financial system should ensure that savings will be directed to the most EFFICIENT
users (vs needy) of those funds
- Central bank + prudential supervisor
Financial Institutions
Istitutios’ sources and uses classification
- Depository financial institutions (DFIs)
- Investment banks and merchant banks
- Contractual savings institutions (CSI)
- Finance companies
- Unit trust
Financial Instruments
- Financial asset: entitlement to future CF (deposit, unit trust), attributes:
o Return/yield: total financial compensation received from an investment expressed as
a % of amount invested
o Risk: probability that actual return on an investment will vary from expected return
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o Liquidity: ability to sell asset w/in reasonable time at current market prices and for
reasonable transaction costs
o Time-pattern of the CF: when the expected CF from a financial asset at tb received
by the investor/lender
o Financial system (IIM) provides the potential suppliers of funds w the combos of risk,
return, liquidity, and cash flow patterns that est suit eah sae’s patiula eeds
o institutions utilise instruments to attract deficit and surplus units
o financial system facilitate flow of funds by utilising IIM
- Financial instrument: markets to describe financial assets and other instruments where there
is no organised secondary market where that instrument can be traded
▪ Types: Equity: ownership interest in an asset- ordinary, hybrid (quasi-equity)
security, preference, convertible notes
▪ Debt: contractual claim to periodic interest paym + repaym of principal
• ST M-LT
• Secured/unsecured
• Negotiable (ownership transferable commercial bills) or non (term
loan from bank)
▪ Derivatives
• Do provide actual funds for borrower, but rather facilitate the mgmt.
of certain related risk (price risk exposure + speculate)
• Futures, forward, option, swaps contracts
▪ hybrid
• incorporate both characteristics of debt + equity (pref share)
- Financial security: financial asset that can be traded in secondary market
- 1.27.00
Financial Markets
- Lending and borrowing of funds, creation and trading of financial asset (transactions)
- matching principle
o ST assets should be funded w ST liabilities + LT w LT (usually lend long and fund w ST)
- primary vs secondary market transactions
o primary: issue new financial instruments (funds obtained by the issuer) + 2ndary
existing instruments w trade (no new funds raised → no direct impact on original
issuer of security- transfer ownership from savers, provides liquidity which facilitates
restructuring of portfolios of security owners)
- direct vs intermediated financial flow markets (provider surplus, fin intermediary, user deficit)
o direct: users of funds obtain finance direct from savers- contractual agreement
between purchasers of funds and the users of funds)
o intermediated: 2 separate contractual arrangements, intermediary repackages funds
and funds are returned to intermediary before returning to supplier e.g DFI)
▪ ad: asset, atuity, edit isk diesifiatio sae’s edit isk is ltd to
intermediary) and transformation, liquidity transformation, eco of scale
- wholesale vs retail markets
- money vs capital markets
Flow of Funds and Market relationships
- financial system is composed of financial institutions, instruments and makes facilitating
transactions for goods and services and financial transactions
4 types of instruments (E,D,D,H)
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- debt instruments can be ST (money <1y) or LT (capital >1y)
- equity instruments can only be in capital markets (ownership in company)
Lecture 2
- authorised deposit-taking institutions (ADIs): financial intermediation
- Main activities of commercial banking
o Importance of banks (deregulation, largest share of assets of all institutions)
o Prior to dereg (asset management- loan portfolio tailored to match available deposit
base → liability mgmt. (deposit base and other funding sources are managed to fund
loan demand- borrow direct from cap market or OBS business)
- Sources of funds (L or SE on BS)
o Deposit and investm products w liquidity, return, maturity, risk, CF structure to
attract surplus units)
o Current deposit (liquid), call/demand deposits (savings account), term deposits
(lodged- term, liquidity, IR) [financial assets- not tradable vs CDs]
o (4) negotiable certificates of deposit (CDs)
o bill acceptance liabilities
o bill of exchange: a security issued into the money market at a discount to FV (repaid
at maturity)
▪ the business (deficit unit) that issues the bill will sell the bill to an investor w
bank guarantee to increase creditworthiness- bank as acceptor
▪ bank may agree to buy bill → bank sell bill into money market – bank as
discounter→ ROLE of bank is different
o debt liabilities (M-LT issued by bank)
o debenture: bond supported by a form of security, being a charge over the assets of
the issuer
o unsecured note: bond issued w no supporting security
o foreign currency liabilities
▪ debt instruments issued into the international capital markets that are
denominated in a foreign currency
• allows diversification of funding sources, facilitate matching of fx
denominated assets
o loan capital: sources of funds w characteristic of both debt + equity (hybrid) →
subordinated (holder of security has claim on interest paym/asset of issuer, after all
other creditors are paid
o SE: ordinary shares, retained funds
- Uses of funds (asset on BS)
o Loans that give rise to entitlement to fut CF (interest+repaym)
▪ personal (investm property, fixed term loan, credit card) and housing
(mortgage, amortised loan) finance
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Document Summary
Finance: art and science of managing scare resources of money. Money: acts as a medium of exchange, represents a store of wealth, facilitates saving, solves divisibility problem. Financial institutions, instruments, markets which interact to facilitate the flow of funds between deficit and surplus units within the economy. Financial institutions permit the flow of funds between borrowers and lenders by facilitating financial transaction: provide investment products (surplus units, provide alternative funding sources (deficit, provide risk management products (insurance) Facilitate the flow of funds- primary financial market (creation of new financial assets) + secondary market (provide arrangement for transfer of funds by arranging trades in existing financial assets) Efficient financial system should ensure that savings will be directed to the most efficient users (vs needy) of those funds. Financial security: financial asset that can be traded in secondary market. Lending and borrowing of funds, creation and trading of financial asset (transactions)
