FINS1612 Lecture Notes - Lecture 1: Capital Market, Financial Instrument, Financial Market

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22 Oct 2018

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You can also get help from your tutor. It(cid:859)s a(cid:271)out (cid:373)o(cid:374)ey, funds, banks, trading, interest, payments and returns and so on. What is money: acts as medium of exchange, represents a store of wealth, facilitates saving, solves the divisibility problem labour. They are also surplus and deficit unit, being involved in both return and payment. This is the heart of the whole economy. They are both surplus and deficit unit again. Sectorial flow of funds: the flow of funds between business, financial institutions, government and household sectors and the rest of the world, net borrowing and net lending of these sectors of an economy vary between countries. The impact of fiscal and monetary policy on savings and investment decisions. Chapter organisation: 1. 1 functions of a financial system, 1. 2 financial institutions, 1. 3 financial instruments, 1. 4 financial markets, 1. 5 flow of funds and market relationships, 1. 6 summary. What is financial system? (it is not a charity organisation, it generates profits.

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Position A: Financial Institutions' role as specialists in risk measurement and management is reduced.

Position B: Financial Institutions' role as specialists in risk measurement and management is increased.

Required:

Read the âbackgroundâ below. After reading, select the position you agree with and write a position paragraph supporting either Position A or Position B.

Background: A major event that changed and reshaped the financial services industry was the financial crisis of the late 2000s. As Financial Institutions adjusted to regulatory changes brought about in the 1980s and 1990s, one result was a dramatic increase in systemic risk of the financial system, caused in large part by a shift in the banking model from that of âoriginate and holdâ to âoriginate to distribute.â In the traditional model, banks take short-term deposits and other sources of funds and use them to fund longer term loans to businesses and consumers. Banks typically hold these loans to maturity, and thus have an incentive to screen and monitor borrower activities even after a loan is made. However, the traditional banking model exposes the institution to potential liquidity, interest rate, and credit risk. In attempts to avoid these risk exposures and generate improved return-risk trade-offs, banks shifted to an underwriting model in which they originated or warehoused loans, and then quickly sold them. Indeed, most large banks organized as financial services holding companies to facilitate these new activities. More recently activities of shadow banks, nonfinancial service firms that perform banking services, have facilitated the change from the originate-and-hold model of commercial banking to the originate-and-distribute banking model. In the shadow banking system, savers place their funds with money market mutuals and similar funds, which invest these funds in the liabilities of other shadow banks. Like the traditional banking system, the shadow banking system intermediates the flow of funds between net savers and borrowers. However, instead of the bank serving as the middleman, it is the non-bank financial service firm, or shadow bank, that intermediates. Further, unlike the traditional banking system where the complete credit intermediation is performed by a single bank, in the shadow banking system, it is performed through a series of steps involving many non-bank financial service firms. These innovations remove risk from the balance sheet of financial institutions and shift risk off the balance sheet and to other parts of the financial system. Thus, the financial institutions, acting as underwriters, are not exposed to the credit, liquidity, and interest rate risks of traditional banking.

In your own words, explain what is meant by business and financial risk. Suppose Firm A has greater business risk than Firm B. Is it true that Firm A also has a higher cost of equity capital? Why or Why not? Explain.

FINS1612 Lecture Notes - Lecture 1: Capital Market, Financial Instrument, Financial Market

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