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to the contract holders if a specified event occurs; e.g. life and general insurance
companies and superannuation funds. The large pool of funds is then used to purchase
both primary and secondary market securities. Payouts are made for insurance claims and
to retirees.
Unit trusts: not as important. Formed under a trust deed and controlled and managed by
a trustee. Funds raised by selling units to the public; investors purchase units in the trust.
Funds are pooled and invested by fund managers in a range of asset classes specified in
the trust deed. Types of unit trusts include equity, property, fixed interest and mortgage
trusts.
1.3
Define the main classes of financial instruments that are issued into the
financial system, that is, equity, debt, hybrids and derivatives.
Attributes of financial assets:
- Return/yield: total financial compensation received from an investment expressed as a
percentage of the amount invested.
- Risk: probability that the actual return on an investment will vary from the expected
return.
- Liquidity: ability to sell an asset within a reasonable time at current market prices and for
reasonable transaction costs. The higher the liquidity, the easier an asset will sell (i.e.
better it is as an investment).
- Time-pattern of cash flows: when the expected cash flows from a financial asset are to
be received by the investor or lender.
Financial instruments are financial assets that can be traded. They can also be seen as packages
of capital that may be traded. Most types of financial instruments provide an efficient flow and
transfer of capital all throughout the world's investors. These assets can be cash, a contractual
right to deliver or receive cash or another type of financial instrument, or evidence of one's
ownership of an entity.
Financial instruments are issued by a party raising funds, acknowledging a financial
commitment and entitling the holder to specified future cash flows. Double coincidence of
wants satisfied is a transaction between two parties that meets their mutual needs.
Equity and debt: two main sources of financial instruments an institution can use. Financial
instruments may be equity, debt or hybrid. Financial Instruments:
- Equity: Ownership interest in an asset, thus, have voting rights for the issues of an asset.
Residual claim on earnings and assets. E.g. Dividend, Liquidation. Types:
Ordinary share
Hybrid (or quasi-equity) security (e.g. Preference shares, Convertible notes)
- Debt: Ranks ahead of equity. Debt holders dont get to vote on issues, but otherwise have
more power. Contractual claim to: periodic interest payments, repayment of principal. Can
be:
short-term (money market instrument) or medium- to long-term (capital market
instrument)
secured or unsecured
negotiable (ownership transferable; e.g. commercial bills and promissory notes) or
non-negotiable (e.g. term loan obtained from a bank)
- Derivatives: Used mainly to manage price risk exposure and to speculate. A synthetic
security providing specific future rights that derives its price from:
a physical market commodity e.g. gold and oil
financial security e.g. Interest-rate-sensitive debt instruments, currencies and
equities
Three
1.
2.
3.
CLARIFY DERIVATIVES.
NEED TO TALK ABOUT HYBRIDS HERE.
1.4
Discuss the nature of the flow of funds between savers and borrowers, including
primary markets, secondary markets, direct finance and intermediated finance.
Flow of funds: the movement of funds through the financial system between savers and
borrowers giving rise to financial instruments.
Within Financial Markets:
- Primary and secondary market transactions:
Primary Market Transactions: The issue of a new financial instrument to raise
funds to purchase goods, services or assets by business/ governments/ individuals.
Funds are obtained by the issuer.
Secondary Market Transactions: The buying and selling of existing financial
securities. No new funds raised and therefore no direct impact on original issuer of
security. Transfer of ownership from one saver to another saver. Provides liquidity,
which facilitates the restructuring of portfolios of security owners
Direct finance: Users of funds obtain finance through primary market via direct relationship with
providers (savers).
Advantages:
Disadvantages:
- Avoids costs of intermediation
- Matching of preferences
- Increases access to diverse range of
- Liquidity and marketability of a
markets
security
- Greater flexibility in range of securities
- Search and transaction costs
- Assessment of risk, especially default
users can issue for different financing
risk
needs
Unrestricted movement of capital around the world. Theoretically, the global market will
encourage savings and allocate those savings efficiently to the most productive purposes
without regard to national boundaries.
Deregulation of nation-state financial systems, including the removal of significant
regulatory constraints that restrict financial markets, products, participants and pricing.
Financial innovation, to develop new systems, products and services.
The need of corporations and governments to diversify their funding sources on a global
scale.
Increased competition between financial markets and institutions for the provision of
financial products and services.
Exchange rate, interest rate and price volatility within the international markets and the
associated increase in demand for risk management products.
Changing demographic and savings patterns. For example, the ageing of populations of
many economies has resulted in the accumulation and mobilisation of greater levels of
savings.
The development of emerging markets, in particular, parts of Asia, South America and
Eastern Europe.
Rapid technological innovation and a more sophisticated business environment, together with
longer-term changes in the financial needs of market participants, are reshaping the financial
system. A progressively greater array of participants, products and distribution channels has
developed (and will continue to develop) the financial system. Competition is emerging from new
providers of financial services and through the increasing globalisation of financial markets.
Nation-states are striving to achieve improved market efficiency and performance.
To help understand the drivers for change in a modern financial system, it is beneficial to refer to
the interim report of an inquiry into the Australian financial system. The (interim) Murray
Report, released in 2014, considered the growing interconnectedness of the Australian financial
system with the rest of the world and identified a number of areas from which changes have
stemmed in the years since the previous financial system inquiry (Walliss 1997 Report). These
are:
- Growth and consolidation
- Post-GFC regulatory responses
- Technology
- Population dynamics.
Growth and Consolidation
A primary driver of change over time is the growth in size of the financial system. In Australia, the
financial system has grown considerably over the past two decades. This has been especially
evident in the superannuation sector. Interestingly, there has also been considerable
consolidation and an increase in concentration in Australias banking sector over the same period
of time. The key issues to emerge from these changes include:
- Competition
- Distortions in funding flows
- Efficiency of eh superannuation system
Although the interim Murray Report finds that c-------------------------------------1.8
Appreciate the efforts, consequences and relevance of the Asian financial crisis.
2.2 Identify the main sources of funds for commercial banks, including current
deposits, demand deposits, term deposits, negotiable certificates of deposit, bill
acceptance liabilities, debt liabilities, foreign currency liabilities and loan capital.
2.3 Identify the main uses of funds by commercial banks, including personal and
housing lending, commercial lending, lending to government, and other bank assets.
2.4 Outline the nature and importance of banks off-balance-sheet business, including
direct credit substitutes, trade- and performance-related items, commitments and
market-rate-related contracts.
2.6 Understand the background and application of Basel II and Basel III.
2.7 Examine liquidity management and other supervisory controls applied by APRA in
the context of Basel III.