01 Overview of the Financial System
Transcript of 01 Overview of the Financial System
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Banking and Finance
An Overviewof the Financial System
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Course Requirements
Course material:
everything presented during the classes
all slides on CooSpace
additional readings
Textbook: Mishkin, F.C.: The Economics of Money, Banking
and Financial Markets, Addison-Wesley 2010 (9thedition)
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Grading Policy
Class Participation (quiz)/ Midterm: 30%
maximum of 25% absence is allowed; otherwise the semester can
not be approved. midterm test contains some multiple-choice and true-false
questions also simple problems to solve and short essays for a totalof 100 points,
Final exam: 45%
the final contains short and long essays, small calculations for atotal of 100 points
a student is required to achieve at least 50%+ (pass) of each partof the assessment in order to receive a pass in aggregate
Semester paper 15%
topics on CooSpace, other topics are to be agreed on
Professors evaluation of class performance 10%
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Function of Financial Markets
Perform the essential function ofchanneling funds from economic
players that have saved surplus funds to those that have a shortage of
funds
Direct finance: borrowers borrow funds directly from lenders in
financial markets by selling them securities.
Promotes economic efficiency by producing an efficient allocation
of capital, which increases production Directly improve the well-being of consumers by allowing them to
time purchases better
Technical intermediaries help in the mutual search process
(broker, dealer, dual trader, underwriter)
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Flows of Funds trough the Financial Markets
Borrowers(spenders, deficit)
Savers
(lenders, sufficit)
Funds
SecuritiesHouseholds
Firms
Government
Foreigners
Households
Firms
GovernmentForeigners
Direct finance,
technical intermediaries
Indirect finance, financial intermediaries
Financial markets
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Direct finance
Borrowers turn directly to lenders offeringdifferent securities, i.e.: IOUs (bonds, stocks, etc.)
Technical intermediaries help in the mutualsearch process broker, dealer, dual trader, underwriter
Three major conflicts: nominal value
maturity
risk, etc.
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Financial Intermediaries
They solve the conflicts of: nominal value, maturity,
risk, etc.
increase the saving and borrowing capacity of the
economy Institutions:
banks,
mutual funds,
pension funds, insurance companies, etc.
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Market types
Trade
Primary markets new issues are traded
Secondary markets previously issued securities aretraded
Institutional structure
Exchanges (concentrated markets)
OTC (over the counter) dealers at different locationstrade for or from their inventories
ATS (alternative trading systems)
Maturity Money market (less than 1 year to maturity)
Capital market (more than 1 year to maturity)
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Types of Money Market Instruments
Treasury bills
Negotiable bank CDs
Commercial papers
Bankers acceptances
Repurchase agreements
Eurodollars
Fed funds
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Principal Money Market Instruments
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Types of Capital Market Instruments
Corporate stocks
Mortgages
Corporate bonds
Government securities (notes, bonds) State/Region/Local government
securities
Consumer and bank commercial loans
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Principal Capital Market Instruments
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The Present Model of Securities Trade
Institutionalinvestor
Private
investorBrokerage
company
Institutionalinvestor
Private
investor
Brokerage
company
InternalizationInternalization
CrossingNetwork
OTC
MultilateralTrading Facility
Dark Pool
Exchange
ATS
Internalization:the client makes an order to his/her brokerage to buy or sell a security which fills the order from
its own inventory of the security. Some exchanges prohibit these trades, and brokerages are required
to report internalization on exchanges that permit it.
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Alternative Trading Systems
Multilateral Trading Facility (or MTF) a multilateral system, operated by an investment firm or a market operator, which
brings together multiple third-party buying and selling interests in financialinstruments in a way that results in a contract in accordance with the provisions of
Title II ofMiFID They can be assimilated to alternative trading exchanges providing
additional pool of liquidity to their members (banks, major mutual funds and large
insurance companies).
Crossing network
matches buy and sell orders electronically for execution without first routing theorder to an exchange or other displayed market, Instead the order is either
anonymously placed into a black box or flagged to other participants of the crossing
network. The advantage of the crossing network is the ability to execute a large
block order without impacting the public quote.
Dark pools of liquidity
are crossing networks that provide liquidity that is not displayed on order books.This is useful for traders who wish to move large numbers of shares without
revealing themselves to the open market.
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2004:145:0001:0044:EN:PDFhttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2004:145:0001:0044:EN:PDF -
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Market Share of MTFs in Stock Trade
0,00%
5,00%
10,00%
15,00%
20,00%
25,00%
2008.
jan.
febr.
r.
pr.
mj.
jn.
jl.
aug.
szept.
okt.
nov.
dec.
2009.
jan.
febr.
r.
pr.
j.
jn.
jl.
aug.
szept.
okt.
nov.
dec.
2010.
jan
feb.
Forrs: FESE
Chi-X(2007. March)
Turquoise(2008. Aug)
BATS
(2008. Oct)
NASDAQ OMX Europe(2008. Sept.)
Burgundy
(2009. May)
QUOTE MTF(2009. Sept)
Equiduct-Berliner (2009.
March)
NYSE ArcaEurope
(2009. mrc.)
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The Structure of Capital Market (January 2010)
Deutsche Boerse
10%
Markit BOAT21%
LSE Group
18%
Euronext
17%
CHI-X9%
Spanish
Exchanges
7%
SIX Swiss
5%
Nasdaq OMX
Nordic
4%
BATS Europe
2%
Turquoise
2%
Other
5%
Forrs: Reuters
M i G f Fi i l I t t 1
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Main Groups of Financial Instruments 1.
Right
Debt - temporary, should be repaid (bond) Equity - permanent, not refunded (stock)
Right limiting the trade of a product (bill of lading, warehouse
warrant, etc)
Right or obligation to buy or sell (option, future)
Reparation certificate (a special Hungarian instrument)
Transferability
Registered: given owner, endorsement on the back or on anattached form
Bearer entitled: simple sale Negotiable: endorsed drafts, universal obligation
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Main Groups of Financial Instruments 2.
Physical character Materialized: printed, preserved by the owners, physically
transferred when traded Immobilized: printed, deposited at a central place, deposit
certificates
Immaterialized: not printed; bookkeeping entry or electronic sign;transfer between security accounts
Maturity Varies country by country, no consent
Short term: less than 1 year to maturity (consensus),
Medium term: 1-10 years to maturity
Long term: 5 - 30 years
Conditional (console): matures with an event (life insurance) Without maturity: provides the service till the issuer exists
(stock)
i G f i i l 3
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Main Groups of Financial Instruments 3.
Returns Interest bearing securities
permanent: fix interest from the issue to the maturity flexible
changing by a given schedule (increases 1 % yearly)
pegged to a well measurable economic phenomenon (inflation, prime rate, exchangerate, etc.)
convertible bond (a bond convertible to stock)
Discount papers: issued under and redeemed at the face value
Dividend bearing securities: shares Issuer
Government: federal, state, regional, municipal (local)
Special institutions issue special securities: banks - CDs,
mutual funds - mutual fund shares
warehouses - warehouse warrants mortgage institutions - mortgage bonds
Companies: bonds, stocks,commercial papers...
Anyone: check, drafts...
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Main International Instruments of Financial Markets
Foreign Bonds:
sold in a foreign country and denominated in that country
scurrency
Eurobond:
bond denominated in a currency other than that of the country
in which it is sold
Eurocurrencies:
foreign currencies deposited in banks outside the home country
Eurodollars: U.S. dollars deposited in foreign banks outside the
U.S. or in foreign branches of U.S. banks
World Stock Markets
Help finance governments also
F i f Fi i l I di I i i
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Function of Financial Intermediary Institutions
Institutions:
banks, mutual funds, pension funds, insurance companies,
Reduce the exposure of investors to risk Risk Sharing (Asset Transformation)
Diversification
Deal with asymmetric information problems
(before the transaction) Adverse Selection: try to avoid selectingthe risky borrower.
Gather information about potential borrower.
(after the transaction) Moral Hazard: ensure borrower will notengage in activities that will prevent him/her to repay the loan.
Sign a contract with restrictive covenants.
Conclusion:
Financial intermediaries allow small savers and borrowers tobenefit from the existence of financial markets.
T A d Li bili i f Fi I di i
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Types, Assets and Liabilities of Fin. Intermediaries
Fi i l I t di i d V l f Th i A t
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Financial Intermediaries and Value of Their Assets
R l ti f th Fi i l S t
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Regulation of the Financial System
To increase the information available to investors:
Reduce adverse selection and moral hazard problems
Reduce insider trading (SEC)
To ensure the soundness of financial intermediaries:
Restrictions on entry (chartering process).
Disclosure of information. Restrictions on Assets and Activities (control holding of
risky assets).
Deposit Insurance (avoid bank runs).
Limits on Competition (mostly in the past):
Branching
Restrictions on Interest Rates
P i i l R l t A i f th U S S t
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Principal Regulatory Agencies of the U.S. System