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Title: FINANCIAL INSTITUTION AND MONETARY THEORY
Description: Demonstrate the importance of the circular flow of income to the national economy
Description: Demonstrate the importance of the circular flow of income to the national economy
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LECTURE 01
With respect to learning outcomes, you should be able to:
a
...
Demonstrate the important role of the financial system for an efficient flow of funds; What are the key activities
c
...
Distinguish between various types of financial markets according to function
...
•
(e
...
) savings, net tax payments, and imports
...
•
(e
...
) investment, government spending and exports
...
•
Financial system endeavours to transfer funds from savers to borrowers
...
Both are employed to achieve policy goals
...
e
...
e
...
•
Monetary Policy
•
Primary objective is ‘inflation targeting’
...
•
Central Banks tend to implement monetary policy via:
i
...
discount rate; and
iii
...
•
Role of the Financial System
The role of the financial system is:
i
...
To provide ways of dealing with incentive problems
iii
...
To provide the means to transfer and manage risk
v
...
e
...
To facilitate the flow of funds (direct financing and indirect financing)
•
Financial market (direct financing)
•
Financial institutions (indirect financing)
•
i
...
g
...
pay a specific sum of money (the principal)
ii
...
over a period of time (maturity of the loan)
...
These are considered liabilities
...
These are considered
assets
...
Managing Incentive Problems
The three main incentive problems are:
•
Information asymmetry
i
...
•
occurs before a financial transaction takes place which can result in undesirable
(i
...
, adverse) outcomes
...
•
occurs when buyers and sellers do not have access to the same information
...
Engagement of behaviour different to what
was agreed to
...
Financial Market Efficiency
•
The three main financial market efficiency areas are:
i
...
funds are allocated to their highest value use
...
Informational Efficiency:
a
...
iii
...
the cost of conducting transactions are as low as possible
...
Transfer and Manage Risk
•
Making financial claims is not risk free
...
Securitisation: Packaging up homogenous assets and selling them to a third party
...
Derivative products: Futures, Forwards, Options and Swaps
...
v
...
•
High-value payments
•
•
(e
...
) property, wholesale market equity, debt securities and FX transactions
...
v
...
•
•
•
(e
...
) Australian Payments Clearing Association (APCA)
...
v
...
g
...
e
...
•
DSUs issue financial claims on themselves and sell them directly to SSUs for money (i
...
, private
placement)
...
The SSUs hold the financial claims in their portfolios as interest-bearing assets
...
e
...
Indirect Financing
•
A financing arrangement involving two separate contractual agreements
...
FIs issue indirect claims to SSUs in exchange for funds;
ii
...
iii
...
Indirect Financing
Main Benefits of Financial Intermediation
•
Financial intermediaries perform a range of functions as they transform claims, such as:
i
...
Denomination divisibility
•
iii
...
g
...
Currency transformation
•
•
Ability to transform liabilities (e
...
deposits) into assets (e
...
loans)
...
Main Benefits of Financial Intermediation
i
...
Intermediaries can offer different ranges of maturities to both SSUs and DSUs (e
...
from 1 day to more than 30 years)
...
•
Financial Markets
•
Each financial market is created to satisfy particular preferences of market participants (e
...
):
•
Time period: Short-term period or long-term period
•
Risk level: High level of risk or avoid risk
...
•
Financial Markets
Matching principle
•
Short-term assets should be funded with short-term (money market) liabilities
...
•
Lack of adherence to this principle accentuated effects of the ‘sub-prime’ market collapse
...
•
Businesses (via company shares or debentures)
•
Governments (via Treasury notes or bonds)
•
Individuals (via mortgage)
Secondary markets are where previously issued financial claims are exchanged among investors
...
•
Transfer of ownership
...
•
Money Markets
Short-term securities are issued (primary market) and traded (secondary market)
•
•
Securities are highly liquid:
•
Term to maturity of one year or less (usually 90 days or less)
•
Highly standardised form
•
Deep secondary market
•
Low expected return but also low degree of risk
•
Large denominations (over $1 million)
•
Most important function is it allows FIs to undertake liquidity management
...
•
Capital Markets
•
Longer term securities are issued and traded with original term-to-maturity in excess of one year
...
•
Offer higher returns than money markets
...
•
Government bond markets are very important due to their size and liquidity
...
•
Investment banking firm typically acts as the underwriter
...
•
Issuing currency
...
•
Overseeing the operations of the financial system
...
•
Essential to support the day-to-day business of an economy
...
•
Key aspect of the financial system is to gather money from SSUs and transfer it to DSUs in an efficient
manner
...
•
Indirect finance operates in the retail markets, where financial institutions intermediate transactions
between DSUs and SSUs
...
•
Financial markets are created to satisfy particular preferences of market participants
...
Title: FINANCIAL INSTITUTION AND MONETARY THEORY
Description: Demonstrate the importance of the circular flow of income to the national economy
Description: Demonstrate the importance of the circular flow of income to the national economy