Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

MMUST notes 3rd year 2015

1
...
1
...
This is
achieved by financial infrastructure, in which entities with funds allocate those funds to
those who have potentially more productive ways to invest those funds
...
As one party of the transaction may
possess superior information than the other party, it can lead to the information asymmetry
problem and inefficient allocation of financial resources
...


According to the structural approach, the financial system of an economy consists of
three main components:
1) financial markets;
2) financial intermediaries (institutions);
3) financial regulators
...


According to the functional approach, financial markets facilitate the flow of funds in
order to finance investments by corporations, governments and individuals
...
The financial regulators perform the
role of monitoring and regulating the participants in the financial system
...

An asset is any resource that is expected to provide future benefits, and thus possesses
economic value
...
An intangible asset represents a legal claim to some future
economic benefits
...


Financial assets, often called financial instruments, are intangible assets, which are
expected to provide future benefits in the form of a claim to future cash
...


Any transaction related to financial instrument includes at least two parties:
1) the party that has agreed to make future cash payments and is called the issuer;
2) the party that owns the financial instrument, and therefore the right to receive the
payments made by the issuer, is called the investor
...

they allow the transfer of funds from those entities, who have surplus funds to invest to those
who need funds to invest in tangible assets;

they redistribute the unavoidable risk related to cash generation among deficit and surplus
economic units
...
They role is performed by the specific entities
operating in financial systems, called financial intermediaries
...


1
...
Financial markets and their economic functions
A financial market is a market where financial instruments are exchanged or traded
...
At the
same time the required return from the investment of funds is determined by the
participants in a financial market
...
It is these functions of financial
markets that signal how the funds available from those who want to lend or invest funds
will be allocated among those needing funds and raise those funds by issuing financial
instruments
...
Without liquidity, an investor would be forced to hold a financial instrument
until conditions arise to sell it or the issuer is contractually obligated to pay it off
...
All financial markets provide some form of

liquidity
...


3) The function of reduction of transaction costs is performed, when financial market
participants are charged and/or bear the costs of trading a financial instrument
...


The key attributes determining transaction costs are
asset specificity,
uncertainty,
frequency of occurrence
...
It is lower
when an asset can be easily put to alternative use, can be deployed for different tasks
without significant costs
...
If changes in external events are readily verifiable, then
it is possible to make adaptations to original contracts, taking into account problems
caused by external uncertainty
...
However, when circumstances are not easily observable, opportunism creates
incentives for contracting parties to review the initial contract and creates moral hazard
problems
...


Frequency of occurrence plays an important role in determining if a transaction should
take place within the market or within the firm
...
Conversely, frequent transactions require detailed

contracting and should take place within a firm in order to reduce the costs
...
And, vice versa, if assets are non-specific,
transactions are infrequent, and there are no significant uncertainties least costly may be
market transactions
...
The economists (Coase (1932,
1960, 1988), Williamson (1975, 1985), Akerlof (1971) and others) have contributed to
transactions costs economics by analyzing behaviour of the human beings, assumed
generally self-serving and rational in their conduct, and also behaving opportunistically
...
This type of behavior
requires efforts of ex ante screening of transaction parties, and ex post safeguards as well
as mutual restraint among the parties, which leads to specific transaction costs

Transaction costs are classified into:
1) costs of search and information,
2) costs of contracting and monitoring,
3) costs of incentive problems between buyers and sellers of financial assets
...

Explicit costs include expenses that may be needed to advertise one’s intention to sell
or purchase a financial instrument
...
The presence of an organized financial market
reduces search costs
...
In a price efficient market, prices reflect the aggregate information
collected by all market participants
...

3) Costs of incentive problems between buyers and sellers arise, when there are conflicts
of interest between the two parties, having different incentives for the transactions
involving financial assets
...
The participants in
financial markets can be also classified into various groups, according to their motive for
trading:
Public investors, who ultimately own the securities and who are motivated by the
returns from holding the securities
...

Brokers, who act as agents for public investors and who are motivated by the
remuneration received (typically in the form of commission fees) for the services
they provide
...

Dealers, who do trade on their own account but whose primary motive is to profit from
trading rather than from holding securities
...

Credit rating agencies (CRAs) that assess the credit risk of borrowers
...
Some public investors may occasionally
act on behalf of others; brokers may act as dealers and hold securities on their own, while
dealers often hold securities in excess of the inventories needed to facilitate their trading
activities
...


1
...
Financial intermediaries and their functions
Financial intermediary is a special financial entity, which performs the role of efficient
allocation of funds, when there are conditions that make it difficult for lenders or investors
of funds to deal directly with borrowers of funds in financial markets
...

The role of financial intermediaries is to create more favourable transaction terms than
could be realized by lenders/investors and borrowers dealing directly with each other in
the financial market
...
The funds that a financial intermediary lends or invests become the asset of
the financial intermediary
...


Asset transformation provides at least one of three economic functions:
Maturity intermediation
Risk reduction via diversification
...


These economic functions are performed by financial market participants while providing

the special financial services (e
...
the first and second functions can be performed by brokers,
dealers and market makers
...

Other services that can be provided by financial intermediaries include:
Facilitating the trading of financial assets for the financial intermediary’s customers through
brokering arrangements
...

Assisting in the creation of financial assets for its customers and then either
distributing those financial assets to other market participants
...

Manage the financial assets of customers
...
4
...
4
...
Financial instruments
There is a great variety of financial instrument in the financial marketplace
...


A financial instrument can be classified by the type of claims that the investor has on the
issuer
...
A debt instrument also referred to as an
instrument of indebtedness, can be in the form of a note, bond, or loan
...
For example, in the case
of a debt instrument that is required to make payments in Euros, the amount can be a fixed

Euro amount or it can vary depending upon some benchmark
...
For this reason, debt
instruments are often called fixed income instruments
...
MONEY MARKETS
Mini contents

The purpose of money markets

Money markets segments and participants
Money market instruments
Money market rates and yields

3
...
Money market purpose and structure

3
...
1
...

They play central role in the country’s financial system, by influencing it through the
country’s monetary authority
...

Money markets are wholesale markets with very large amounts of transactions, e
...
with
transactions from 500 million Euro to 1 billion Euro or even larger ones
...


From the start of emergence the traditional money markets performed the role of
monetary policy
...
However due to fast technological advances,
internationalization and liberalization of financial markets, possibilities to carry out policy
objectives through such measures have diminished
...
Thus money markets serve the
interface between execution of monetary policy and the national economies
Another role of domestic money markets is to serve public policy objectives, i
...

financing public sector deficits and managing the accumulated government deficits
...
The scope and measures of monetary policy are also
linked to the government’s budget and fiscal policies
...


Changes in the role and structure of money markets were also influenced by
financial deregulation, which evolved as a result of recognition that excessive controls are
not compatible with efficient resource allocation, with solid and balanced growth of
economies
...

Finally, money markets were influenced by such international dimensions as
increasing capital mobility, changing exchange rate arrangements, diminishing monetary
policy autonomy
...


3
...
2
...
It can be divided into several major segments:
Interbank market, where banks and non-deposit financial institutions settle
contracts with each other and with central bank, involving temporary liquidity surpluses
and deficits
...

Secondary market for different short-term securities, which redistributes the
ownership, ensures liquidity, and as a result, increases the supply of lending and reduces
its price
...


Interbank market is defined mainly in terms of participants, while other markets are
defined in terms of instruments issued and traded
...
Interbank market is referred mainly as the market for
very short deposits and loans, e
...
overnight or up to two weeks
...


The money-market instruments are often grouped in the following way:
Treasury bills and other short-term government securities (up to one year);
Interbank loans, deposits and other bank liabilities;

Repurchase agreements and similar collateralized short-term loans;
Commercial papers, issued by non-deposit entities (non-finance companies, finance
companies, local government, etc
...

Many investors regard individual money market instruments as close substitutes, thus
changes in all money market interest rates are highly correlated
...

Money markets consist of tradable instruments as well as non-tradable instruments
...
The arguments
behind the trend are the following:
1
...

2
...

In terms of risk two specific money-market segments are:
unsecured debt instruments markets (e
...
deposits with various maturities, ranging
from overnight to one year);
secured debt instruments markets (e
...
REPOs) with maturities also ranging from
overnight to one year
...
Credit risk is minimized by limiting access to high-quality
counter-parties
...
In the secured REPO markets, this counterparty credit risk is mitigated as the bank
that provides liquidity receives collateral (e
...
, bonds) in return
...
The influence of business culture and traditions, industrial structures
have played an important role also
...
Growth of government securities issues, their
costs considerations, favourable taxation policies have become additional factors boosting
some of the country’s money markets
...
1
...
Money market participants
Money market participants include mainly credit institutions and other financial
intermediaries, governments, as well as individuals (households)
...
Ultimate lenders and borrowers usually do
not participate directly in the markets
...

Important role is played by government, which issue money market securities and use the
proceeds to finance state budget deficits
...
Thus it manages to finance longterm
needs through money market securities with short-term maturities
...
Through monetary
intervention means and by fixing the terms at which banks are provided with money,
central banks ensure economy’s supply with liquidity
...
e
...
They
issue money market securities to finance loans to households and corporations, thus
supporting household purchases and investments of corporations
...

Other important market participants are other financial intermediaries, such as money
market funds, investment funds other than money-market funds, insurance companies and
pension funds
...

In general issuance of money market securities allow market participants to increase their
expenditures and finance economic growth
...
Individuals (or
households) play a limited role in the market by investing indirectly through money
market funds
...
), to hedge
their longer-term positions with short-term contracts, and to reduce individual liquidity

imbalances37
3
...
Money market instruments
3
...
1
...
Therefore market participant view these government securities as having little or
even no risk
...
A typical life to maturity of the securities is from four weeks to 12 months
...
Any
new issue with the same maturity date as an existing issue is regarded as a new tranche of
the existing security
...
Budget deficits create a challenge for
the government
...
The
mix of Treasury offerings determines the maturity structure of the government’s debt
...
The securities are issued via a regularly scheduled auction process
...

Concept
A tender is a sealed bid
...
A competitive
bidder specifies both the amount of the security that the bidder wants to buy, as well as
the price that the bidder wants to pay
...
The price of the
securities in the auction is set based on the prices offered in competitive bids, taking the
average of all accepted competitive prices
...
Typically the longer the maturity, the greater would be the percentage of

accepted bids
...
Competitive bidders are the largest financial
institutions that generally purchase largest amounts of Treasury securities
...

A non- competitive bidder specifies only the amount of the security that the bidder wants
to buy, without providing the price, and automatically pay the defined price
...
Limits on each non-competitive bid can be
set
...
In
such cases they use the services of dealers
...
The Treasury will accept
the competitive bids with the highest price and lowest interest rates, and will reject other
bids
...

There are two auction forms:
Uniform price auction, when all bidders pay the same price;



---