ZeePedia buy college essays online


Money and Banking

<<< Previous FINANCIAL INTERMEDIARIES:Indirect Finance, Financial and Economic Development Next >>>
 
img
Money & Banking ­ MGT411
VU
Lesson 5
FINANCIAL INTERMEDIARIES
Financial Intermediaries
Financial Instruments
Uses
Characteristics
Value
Examples
Financial Intermediaries
The informal arrangements that were the mainstay of the financial system centuries ago have
since given way to the formal financial instruments of the modern world
Today, the international financial system exists to facilitate the design, sale, and exchange of a
broad set of contracts with a very specific set of characteristics.
We obtain the financial resources we need from this system in two ways:
Directly from lenders and
Indirectly from financial institutions called financial intermediaries.
Indirect Finance
A financial institution (like a bank) borrows from the lender and then provides funds to the
borrower.
If someone borrows money to buy a car, the car becomes his or her asset and the loan a liability.
Direct Finance
Borrowers sell securities directly to lenders in the financial markets.
Governments and corporations finance their activities this way
The securities become assets to the lenders who buy them and liabilities to the borrower who
sells them
Financial and Economic Development
Financial development is inextricably linked to economic growth
There aren't any rich countries that have very low levels of financial development.
Figure: Financial and Economic Development
Correlation=0.62
25000
Financial  Development  is
20000
Hong Kong
measured by the commonly
used ratio of broadly defined
15000
money to GDP. Economic
Korea
10000
development is measured by
Malaysia
the real GDP per capita.
5000
China
50
100
150
200
250
0
Financial Market Development
14
img
Money & Banking ­ MGT411
VU
Financial Instruments
A financial instrument is the written legal obligation of one party to transfer something of value
­ usually money ­ to another party at some future date, under certain conditions, such as stocks,
loans, or insurance.
Written legal obligation means that it is subject to government enforcement;
The enforceability of the obligation is an important feature of a financial instrument.
The "party" referred to can be a person, company, or government
The future date can be specified or can be when some event occurs
Financial instruments generally specify a number of possible contingencies under which one
party is required to make a payment to another
Stocks, loans, and insurance are all examples of financial instruments
Uses of Financial Instruments
1. Means of Payment
Purchase of Goods or Services
2. Store of Value
Transfer of Purchasing Power into the future
3. Transfer of Risk
Transfer of risk from one person or company to another
Characteristics of Financial Instruments
Standardization
Standardized agreements are used in order to overcome the potential costs of complexity
Because of standardization, most of the financial instruments that we encounter on a day-to-day
basis are very homogeneous
Communicate Information
Summarize certain essential information about the issuer
Designed to handle the problem of "asymmetric information",
Borrowers have some information that they don't disclose to lenders
Classes of Financial Instruments
Underlying Instruments (Primary or Primitive Securities)
E.g. Stocks and bonds
Derivative Instruments
Value and payoffs are "derived from" the behavior of the underlying instruments
Futures and options
Value of Financial Instruments
Size of the promised payment
People will pay more for an instrument that obligates the issuer to pay the holder a greater sum.
The bigger the size of the promised payment, the more valuable the financial instrument
When the payment will be received
The sooner the payment is made the more valuable is the promise to make it
The likelihood the payment will be made (risk).
The more likely it is that the payment will be made, the more valuable the financial instrument
The conditions under which the payment will be made
Payments that are made when we need them most are more valuable than other payments
15
img
Money & Banking ­ MGT411
VU
Value of Financial Instruments
1. Size
Payments that are larger are more valuable
2. Timing
Payments that are made sooner are more valuable
3. Likelihood
Payments that are more likely to be made are more valuable
4. Circumstances Payments that are made when we need them most are more
valuable
16
img
Money & Banking ­ MGT411
VU
Lesson 6
FINANCIAL INSTRUMENTS & FINANCIAL MARKETS
Financial Instruments
Examples
Financial Markets
Roles
Structure
Financial Institutions
Examples of Financial Instruments
Primarily Stores of Value
Bank Loans
A borrower obtains resources from a lender immediately in exchange for a promised set of
payments in the future
Bonds
A form of a loan, whereby in exchange for obtaining funds today a government or corporation
promises to make payments in the future
Home Mortgages
A loan that is used to purchase real estate
The real estate is collateral for the loan,
It is a specific asset pledged by the borrower in order to protect the interests of the lender in the
event of nonpayment.
If payment is not made the lender can foreclose on the property.
Stocks
An owner of a share owns a piece of the firm and is entitled to part of its profits.
Primarily to transfer risk
Insurance Contracts
The primary purpose is to assure that payments will be made under particular (and often rare)
circumstances
Futures Contracts
An agreement to exchange a fixed quantity of a commodity, such as wheat or corn, or an asset,
such as a bond, at a fixed price on a set future date
It is a derivative instrument since its value is based on the price of some other asset.
It is used to transfer the risk of price fluctuations from one party to another
Options
Derivative instruments whose prices are based on the value of some underlying asset;
They give the holder the right (but not the obligation) to purchase a fixed quantity of the
underlying asset at a predetermined price at any time during a specified period.
Financial Markets
Financial Markets are the places where financial instruments are bought and sold.
Enable both firms and individuals to find financing for their activities.
Promote economic efficiency by ensuring that resources are placed at the disposal of those who
can put them to best use.
When they fail to function properly, resources are no longer channeled to their best possible use
and the society suffers at large
17
img
Money & Banking ­ MGT411
VU
Role of Financial Markets
Liquidity
Ensure that owners of financial instruments can buy and sell them cheaply and easily
Information Pool and communicate information about the issuer of a financial instrument
Risk Sharing Provide individuals with a place to buy and sell risk, sharing them with individuals
Financial markets need to be designed in a way that keeps transactions costs low
Structure of Financial Markets
Primary vs. Secondary Markets
In a primary market a borrower obtains funds from a lender by selling newly issued securities.
Most companies use an investment bank, which will determine a price and then purchase the
company's securities in preparation for resale to clients; this is called underwriting.
In the secondary markets people can buy and sell existing securities
Centralized Exchanges vs. Over-the-counter Markets
In the centralized exchange (e.g. Karachi Stock Exchange www.kse.com.pk ), the trading is
done "on the floor"
Over-the-counter (or OTC)
OTC market are electronic networks of dealers who trade with one another from wherever they
are located
Debt and Equity vs. Derivative Markets
Equity markets are the markets for stocks, which are usually traded in the countries where the
companies are based.
Debt instruments can be categorized as
Money market (maturity of less than one year) or Bond markets (maturity of more than one
year)
Characteristics of a well-run financial market
Low transaction costs.
Information communicated must be accurate and widely available
If not, the prices will not be correct
Prices are the link between the financial markets and the real economy
Investors must be protected.
A lack of proper safeguards dampens people's willingness to invest
18
Table of Contents:
  1. TEXT AND REFERENCE MATERIAL & FIVE PARTS OF THE FINANCIAL SYSTEM
  2. FIVE CORE PRINCIPLES OF MONEY AND BANKING:Time has Value
  3. MONEY & THE PAYMENT SYSTEM:Distinctions among Money, Wealth, and Income
  4. OTHER FORMS OF PAYMENTS:Electronic Funds Transfer, E-money
  5. FINANCIAL INTERMEDIARIES:Indirect Finance, Financial and Economic Development
  6. FINANCIAL INSTRUMENTS & FINANCIAL MARKETS:Primarily Stores of Value
  7. FINANCIAL INSTITUTIONS:The structure of the financial industry
  8. TIME VALUE OF MONEY:Future Value, Present Value
  9. APPLICATION OF PRESENT VALUE CONCEPTS:Compound Annual Rates
  10. BOND PRICING & RISK:Valuing the Principal Payment, Risk
  11. MEASURING RISK:Variance, Standard Deviation, Value at Risk, Risk Aversion
  12. EVALUATING RISK:Deciding if a risk is worth taking, Sources of Risk
  13. BONDS & BONDS PRICING:Zero-Coupon Bonds, Fixed Payment Loans
  14. YIELD TO MATURIRY:Current Yield, Holding Period Returns
  15. SHIFTS IN EQUILIBRIUM IN THE BOND MARKET & RISK
  16. BONDS & SOURCES OF BOND RISK:Inflation Risk, Bond Ratings
  17. TAX EFFECT & TERM STRUCTURE OF INTEREST RATE:Expectations Hypothesis
  18. THE LIQUIDITY PREMIUM THEORY:Essential Characteristics of Common Stock
  19. VALUING STOCKS:Fundamental Value and the Dividend-Discount Model
  20. RISK AND VALUE OF STOCKS:The Theory of Efficient Markets
  21. ROLE OF FINANCIAL INTERMEDIARIES:Pooling Savings
  22. ROLE OF FINANCIAL INTERMEDIARIES (CONTINUED):Providing Liquidity
  23. BANKING:The Balance Sheet of Commercial Banks, Assets: Uses of Funds
  24. BALANCE SHEET OF COMMERCIAL BANKS:Bank Capital and Profitability
  25. BANK RISK:Liquidity Risk, Credit Risk, Interest-Rate Risk
  26. INTEREST RATE RISK:Trading Risk, Other Risks, The Globalization of Banking
  27. NON- DEPOSITORY INSTITUTIONS:Insurance Companies, Securities Firms
  28. SECURITIES FIRMS (Continued):Finance Companies, Banking Crisis
  29. THE GOVERNMENT SAFETY NET:Supervision and Examination
  30. THE GOVERNMENT'S BANK:The Bankers' Bank, Low, Stable Inflation
  31. LOW, STABLE INFLATION:High, Stable Real Growth
  32. MEETING THE CHALLENGE: CREATING A SUCCESSFUL CENTRAL BANK
  33. THE MONETARY BASE:Changing the Size and Composition of the Balance Sheet
  34. DEPOSIT CREATION IN A SINGLE BANK:Types of Reserves
  35. MONEY MULTIPLIER:The Quantity of Money (M) Depends on
  36. TARGET FEDERAL FUNDS RATE AND OPEN MARKET OPERATION
  37. WHY DO WE CARE ABOUT MONETARY AGGREGATES?The Facts about Velocity
  38. THE FACTS ABOUT VELOCITY:Money Growth + Velocity Growth = Inflation + Real Growth
  39. THE PORTFOLIO DEMAND FOR MONEY:Output and Inflation in the Long Run
  40. MONEY GROWTH, INFLATION, AND AGGREGATE DEMAND
  41. DERIVING THE MONETARY POLICY REACTION CURVE
  42. THE AGGREGATE DEMAND CURVE:Shifting the Aggregate Demand Curve
  43. THE AGGREGATE SUPPLY CURVE:Inflation Shocks
  44. EQUILIBRIUM AND THE DETERMINATION OF OUTPUT AND INFLATION
  45. SHIFTS IN POTENTIAL OUTPUT AND REAL BUSINESS CYCLE THEORY