FINS1612 Notes for Midsemester Exam

22 Pages • Topic Notes • Year: Pre-2021 • Previously uploaded under: FINS1612 - Capital Markets and Institutions

Chapter 1 Notes 1.0 Introduction A financial system encourages savings, provides funds for investment and facilitates transactions for G+S. Economic and financial transactions are valued in money terms. Money is a universally acceptable medium of exchange and a store of value. A financial instrument establishes an entitlement to future cash flows for example, the receipt of interest and return of principal on a bank term deposit. 1.1 Functions of a Financial System A financial system comprises financial institutions, instruments and markets. Overseeing a financial system are the central bank and prudential supervisor A financial asset incorporates four main attributes: Return, risk, liquidity and time-pattern of cash flows. The wide range of financial products available in a financial system facilitates portfolio structuring A financial system provides economic and financial information to the markets; that information should be timely and accurate 1.2 Financial Institutions Financial institutions may be classified into 5 categories based on their sources of funds and uses of funds. Depository financial institutions such as commercial banks gather savings from depositors and provide loans to customers. Investment banks and merchant banks do not have a depositor base; they specialise in the provision of advisory services to clients (eg merger and acquisition advice) Contractual savings institutions, such as insurance offices and superannuation funds, gather savings from the sale of insurance contracts and from superannuation contributions respectively, and make payouts on the occurrence of specified events (eg car accident or retirement from the workforce) Finance companies raise funds directly from the money markets and capital markets and provide loans and lease finance to customers Unit trusts sell units in a trust and invest those funds in assets specified in the trust deed for example an equity trust would invest in certain types of shares. 1.3 Financial instruments The principal form of equity issued by a publicly listed corporation is the ordinary share of common stock Ordinary shares entitle the shareholder to share in the profits of the company, either through the receipt of dividends or through capital gains and provide certain voting rights A hybrid security such as a preference share incorporates the characteristics of both debt and equity. The basic characteristic of debt is that it must be repaid. The debt holder is entitled to receive cash flows specified in the debt instrument (eg interest payments and principal repayment.) Debt may be secured or unsecured. A derivate contract is designed to facilitate the management of risk (eg interest rate risk). Types of derivative products are futures, forwards, options and swaps. 1.4 Financial Markets The matching principle contends that short-term assets should be financed by short-term liabilities, and logner-term assets financed with longer-term liabilities and shareholder funds. Within the context of financial markets, primary markets are those markets where new financial instruments are issued.

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