Financial Markets Financial Markets

Financial Markets

Financial Markets

Borrowers

SpendersHouseholdsBusiness firmsGovernmentsForeigners

FinancialMarkets

Indirect Finance

Direct Finance

Funds

Funds

Funds

Financial Intermediaries

Lenders

Savers

HouseholdsBusinessGovernmentsForeigners

Funds

Funds

Interactive guide to capital markets

http://www.goldmansachs.com/s/interactive-guide-to-capital-markets/

Investment Opportunities

What Do Financial Markets Provide?

Funds to Borrow

Means to Reduce Risk (E.g. Insurance)

Payment Mechanisms

How the Economic Machine Works:

https://www.youtube.com/watch?v=PHe0bXAIuk0

Key Role of Financial Intermediaries

Address the ‘

conflict of preferences

’ between borrowers and lenders.

Liquidity/

Maturity

Volume/

Size

Risk

FINANCIAL INTERMEDIARIES CONSIDER PREFERENCES FOR

How do Financial Intermediaries Gain Benefits?

Pooled Resources

Expertise

Reputation and Trust

Economies of Scale

Gain Benefits

Banking

Sectorretail, corporate, investmentfinance houses, savings and loans, credit unionsLong Term SavingsPension and insurance fundsRisk Spreaders

Mutual funds, investment trustsRisk TakersPrivate equity, hedge fundsBrokerActs as a agent on behalf of a clientAssists in buying/selling securities

Can provide (indirect) access to marketsBroker‐Dealer

can also trade for their own accountmay be a market maker

Inter‐Dealer BrokerFacilitates trades between broker‐dealers and other financial institutions rather than individuals

Types of Financial Institutions

Key Features About Equity

If it’s the first time the company has done this, we call it a ‘new issue’If the company already has shareholders, it may approach them with the opportunity to buy more shares in the company, called a rights issueThe reward for the shareholders by way of income is the dividend

Raising Capital

Bank loans

Bonds

Equity

Classification of Capital Markets

Debt

Capital Markets

Equity

Short Term (Money Markets)

Long Term Bonds

Shares

Capital Markets is not the same as Financial Markets

Capital Markets

Classification of Financial Markets

Debt

Foreign Exchange

Equity

Commodity

Derivatives

Financial Markets

Agriculture, Metals, Energy

Shares

Short term (Money Markets)

Long term Bonds

Throughout

the life of the instrument there is the possibility of buying and sellingThis is the secondary marketNo new funds are raised through secondary market

deals but profits (and losses!) can be generated

Primary and Secondary Markets

Primary Markets

Secondary Markets

When

a

financial instrument

is

first

issued and

offered for

sale this is

known

as the primary

market

The

market

in which funds

are

first

raised

The existence of a secondary market encourages investment in the primary market

Exchange Traded and OTC Markets

Physical

or

virtual

Products are

standardized (e.g. stocks, bonds,

futures)Heavily regulated

Transaction costs tend to

be low

Over‐the‐counter (OTC)

Exchange Traded

Trades

between

two

parties on a

private

basis

Custom

products

Lacks

transparency

The Role of the Central Bank

Central Bank Activities

Issue of Banknotes

Raising Money for the Government

Liaison with International Bodies

Controlling the Nation’s Currency Reserves

Acting as ‘Lender of Last Resort’

Supervision of the Banking System

Advising the Government on Monetary Policy

Acting as Banker to the Other Banks

Acting as Banker to the Government

Monetary Policy

Relates to government tax and spending

Monetary Policy

Fiscal Policy

Relates to the supply of money

KEY PECULIARITIES OF MONETARY POLICIES

MANAGED

ROLE OF CENTRAL BANKS

KEY CONSIDERATIONS

CONTROL MECHANISMS

In

developed nations

this is normally

managed by

an

independent

central

bank.

Set the monetary policy

or

Implement

a

government

set

policy

Price S

tability –

controlling

inflation

Economic growth

Employment

Exchange R

ates

Interest

rates

are

a

major mechanism

for

control

Banknotes

Let us consider the European Central Bank

Key Functioncontrols the issue of

Banknotes

Coins

MODERN PAYMENT MODES

Cash Cheques

Standing Orders

Direct Debits

Mobile Payments

Cash

is

important as banks’ cash holdings

are a constraint on the

creation of credit.

why is controlling issue of cash important?

Bankers to the Other Banks

For whom does the central bank acts as a banker?

Other Banks in the Economy

Holding Accounts with International Bodies

World

Bank

“

Other

banks

hold

non‐interest‐bearing

reserves

with it in

proportion to their

deposits”

Central Bank

WHAT PURPOSE DOES THIS SERVE?

Helps the bank make a profit

Serves as an instrument of control over the money supply

1

2

Bankers to the Government

Acts as the government’s banker

Receives

Pays Out

Revenues for taxes or other

income. Money for the

government’s expenditure.

Government

Lenders

Funds

Funds

Bills and Bonds

Bills and Bonds

Central Bank

Over

time, the debt grows and is not, in any real sense, ever ‘paid off’. Does this matter?The first point is that,

for any individual, how serious debt is depends on their income.Inflation is also a key

factorFinally, to

whom is the money owed?

Raising Money for the Government

While the Treasury or Ministry of Finance sometimes handles government issues, it is much more common for the central bank to control this and to settle payments through the accounts that banks and financial institutions have with it

Acting as lender of

last resort not only refers to the role of the bank as a periodic rescuer of banks in trouble, it also refers to the fact that

the central bank will help the other banks temporarily when they meet problems with their liquidityDuring 2008, the US, the UK and all European central

banks and governments engaged in widespread liquidity

support schemes in order to support their banking

systems

Acting As Lender of Last Resort

Central

banks will liaise with other international financial bodies like the IMF and the International Bank for Reconstruction and Development (IBRD), usually called the World Bank.

They also liaise with and take part in discussions at the Bank for International Settlements (BIS) in Basel

Regular meetings between G7, G10 and

G20

Liaison with International Bodies

Position of Central Bank Today

Inflation is the key target for central banks.

Accountability is Another Current Issue.

Do We

Need a Central Bank?

How do we

Measure Inflation?

Thank you

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