BANKING

Methods of funds transfer

1. Direct financing Borrowers borrow directly from lenders in financial markets by selling financial instruments which are claims on the borrower's future income or assets Securities are assets for the person who buys them They are liabilities for the individual or firm that issues them 2. Indirect financing Borrowers borrow indirectly from lenders via financial intermediaries by issuing financial instruments which are claims on the borrower's future income or assets

five core principles of banking and money

1. Time has value 2. Risk requires compensation 3. Information is the basis for decisions 4. Markets determine prices and allocation resources 5. Stability improves welfare

lenders/savers

1. households - mainly lenders/savers - households get income from their working activities or pensions. Saving is disposable income that is not spent. —> Savings are transformed in wealth which can be used when times are adverse or to allow a good standard of living during retirement —> Typically inflation adjusted household income increases substantially with age until about age 50 and then decrease slightly until retirement. —> Households save a higher percentage of income when income is high. —> Government and Business Firms can use household saving as their sources of fund without having to seek external fund outside the country even during the economic slowdown 2.Business firms 3.Government 4.Foreigners

Types of brokerage services

Brokers work exclusively for third parties by facilitating the search for trade partners and making it possible to cross between supply and demand. They can offer information services ● Dealers operate on its own account and perform the function of making liquid the market of particular financial assets, ensuring the continuity of trades. They hold their own portfolio of financial assets they use to respond promptly to the trading needs of other operators, expressing the purchase price (bid) and selling prices (ask) ● Market makers are operators acting on their own account and who are committed to make public pricing conditions at which they are willing to negotiate: quoting prices at which they wish to purchase (bid) and sell (ask) minimum lots of financial assets. They are committed to "make a market"

Borrower-spenders

Business firms —> mainly borrowers Government —> mainly borrowers Households Foreigners

Six parts of the financial systems: central banks

Central Banks —> To monitor financial Institutions and stabilise the economy. (ex. FED (federal reserve) is responsible for influencing liquidity and overall credit condition , its primary monetary policy tool is open market operations and control the buying and selling US trading and federal agencies securities, such purchase and sells determine the federal funds rate and alter the resource available level. Also the federal reserve board is responsible for regulating and supervising the US banking system which is intended to provide overall economic and financial stability in US) Central banks began as large private banks to finance wars. Central banks control the availability of money and credit to ensure low inflation, high growth and stability of financial system. Today's policymakers strive for transparency in their operations.

Market efficiency: different meanings: Completeness efficiency

Completeness efficiency (Arrow - Debreu, 1954) ensures complete contracts for all operators across the different maturities for all possible states of nature

derivative security markets

Derivative security • a financial security whose payoff is linked to (i.e., "derived" from) another security or commodity, • generally an agreement to exchange a standard quantity of assets at a set price on a specific date in the future, • the main purpose of the derivatives markets is to transfer risk between market participants. Selected examples of derivative securities • Exchange listed derivatives ● Many options, futures contracts ● https://www.borsaitaliana.it/derivati/derivati/derivati.en.htm • Over the counter derivatives ● FX Forward contracts ● Forward rate agreements (FRAs) ● Swaps (often used by banks to hedge interest rate risks)

Why do FIs exist?

Economies of scale on transaction costs Search costs Screening costs Costs to produce financial contracts Monitoring costs Provision of liquidity services Risk sharing provision Asset transformation Portfolio diversification Asymmetric information Screening and monitoring aimed to minimize informational asymmetries

Foreign Exchange (FX) Markets

FX markets Trading one currency for another (e.g., euro for US dollar) Spot FX ● The immediate exchange of currencies at current exchange rates (settlement usually two business days after the trade) Forward FX ● The exchange of currencies in the future on a specific date and at a pre-specified exchange rate

Six parts of the financial systems: Financial institutions

Financial Institutions —> To provide access to financial markets, collect information & provide services. Corporations that provide services as intermediaries of financial markets. —> there are 3 major types of financial institutions: depository institutions (manage deposits and make loans), contractual institutions and investments institutions. Banks began as vaults, developed into institutions, to today's financial supermarket. Offer a huge assortment of financial products and services.

Six parts of the financial systems: Financial instruments

Financial Instruments —> To transfer RESOURCES from savers to investors and to transfer risk to those best equipped to bear it. Buying and selling individual stocks used to be only for the wealthy. Today we have mutual funds and other stocks available through banks or online. Putting together a portfolio is open to everyone.

Six parts of the financial systems: Financial markets

Financial Markets —> To buy and sell financial instruments. Organisations that facilitate the trade in financial securities. Once financial markets were located in coffeehouses and taverns. Then organised markets were created, like the New York Stock Exchange. Now transactions are mostly handled by electronic markets —> This has reduced the cost of processing financial transactions. There is a much broader array of financial instruments available.

financial markets funds transfeers - economic categories which can be savers and spenders

Financial markets and institutions allow transfer of funds from personal business without investment opportunities (lenders-savers) to the one who has them (borrowers-spenders).;.

financial markets

Financial markets refer broadly to any marketplace where the trading of securities occurs. The market is a complex organization and it is always characterized by operating rules. The roles of financial markets: Market liquidity: Ensure owners can buy and sell financial instruments cheaply. Keeps transactions costs low Information: Pool and communication information about issuers of financial instruments Risk sharing: Provide individuals a place to buy and sell risk They range from regulated markets (covered by special general rules and supervision, see Law on Finance (TUF), Legislative Decree 58/1998) to so-called over the counter markets (OTC: literally "over the counter") Markets can be restricted to particular categories of traders or open to the public and in particular to endinvestors. Another distinction is between wholesale and retail markets

Risks Faced by Financial Institutions

Financial risks ● Default (credit risk) ● Liquidity risk ● Interest rate risk ● Market (price and volatility) risk ● Foreign exchange risk ● Country or sovereign risk ● Off-balance-sheet risk ● Bank insolvency risk

Market efficiency: different meanings: fundamental efficiency

Fundamental efficiency: the prices that are formed are the economic foundations of the value of financial assets. ● The prices are derived from a discounting of future cash flows (e.g., dividends, cash flow). ● Fundamental Value does not mean objective value but simply the value that expresses the expected future cash flows and rates of return required. ● In the short term the fundamental value (FV) may differ from market prices. 24

Six parts of the financial systems:Government regulatory agencies

Government regulatory agencies —> To provide oversight for financial system. Government regulatory agencies were introduced by federal government after the Great Depression. Government regulatory agencies provide wide-ranging financial regulation — rules and supervision. Government regulatory agencies examine the systems a bank uses to manage its risk. The 2007-2009 financial crises has led governments to consider greater regulation.

Market efficiency: different meanings: Information efficiency:

Information efficiency: prices that are formed instantaneously reflect all available information. There is no way to "beat" the market because there are no undervalued or overvalued securities available (Fama, 1970)

Money vs. Capital Markets

Money markets • Markets that trade debt securities with maturities of one year or less (e.g., U.S. and Italian Treasury bills) • little or no risk of capital loss, but low returns Capital markets • Markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year • substantial risk of capital loss, but higher promised return

Six parts of the financial systems: money

Money —> To pay for purchases and store wealth. Money has changed from gold/silver coins to paper currency to electronic funds. -Cash can be obtained from an ATM any where in the world. -Bills are paid and transactions are checked online. -Central banks to avoid the situation to get worse during covid, they bought bonds in the market to give liquidity to the economy. Ir were kept at very low level. If bank had money left they have to give the money to central banks.

primary vs secondary markets

Primary markets Markets in which borrowers (e.g., corporations and governments) raise funds by selling newly issued financial instruments (e.g., stocks and bonds). Examples of primary markets: government bonds auctions, placements of private issuers (Public offerings of seasoned stocks/ IPOs) Secondary markets Markets where people trade (buy and sell) existing financial instruments (e.g., NYSE and Nasdaq, Italian Stock Exchange) The secondary market does not provide new resources to deficit units, but it is critical to: - ensure liquidity to the investors; - permit assessment of the securities issued in the continuous (and therefore to make possible the investment/divestment of institutional and private investors)

Institutional sectors and financial balances

Savers invest through financial instruments in indirect or direct way in terms of loans. Objective of the savers when investing in these instruments: Deposit: the investing is wiling to have his money available in every moment and isn't willing to get a renumeration. Bond: if saver is willing to buy a bond (maturity 16 yrs lets say) it means the saver is willing to get enumerated for quite a long period. Risk is higher, investor is postponing consumption. Today inflation is much higher than ir on the bonds. Ir should be higher than inflation. Stock: saver is buying part of a company and willing to be paid by dividends.

The yield or return to maturity: introduction

The return of a financial contract depends on: ● Interest rates. Types of interest rates: nominal (coupon), real, fixed, floating ● Dividends ● Price changes ● FX changes ● Inflation

The activities of the financial intermediaries in the markets: the provision of investment services

Under Security Market Law (art. 1) "Investment services and activities" we mean the following tasks when pertaining to financial instruments: a) proprietary trading b) execution of orders on behalf of clients c) underwriting and / or placement on a firm commitment or with residual commitment to issuers c-bis) placement without firm or residual commitment to issuers d) portfolio management e) reception and transmission of orders f) advice on investments g) management of (Multilateral Trading Facilities) MTFs: self-regulated financial trading venue. These are alternatives to the traditional stock exchanges where a market is made in securities, typically using electronic systems

requirements for market efficiency

Width: large order volumes ● Thickness: thick price distribution ● Elasticity: reactivity of orders for limited price variations

Depository versus Non-Depository FIs

● Depository institutions: ● commercial banks, savings banks, cooperative banks ● Non-depository institutions ● Contractual: ● insurance companies, pension funds, ● Non-contractual: ● securities firms and investment banks, mutual funds. ● Fis are authorized and supervised agents