Topic 1: What is Finance?

Financial Intermediation & Direct Financing

Financial Intermediation uses 3rd party to: - Bring together surplus and deficit units - Allow the preferences of both to be met Direct financing is when deficit and surplus unit seek each other out and enact the flow of funds between them without the use of an intermediary.

Key benefits of Financial Intermediation

- Asset Transformation: turning deposits into loans - Credit risk transformation & diversification: low risk deposits turn into high risk loans and different types of loans. - Liquidity transformation: short-term debt(deposits) used to fund long-term assets(loans) - Economies of scale: the larger banks are, the cheaper intermediation becomes.

Disadvantages of Direct Finance

- Difficulty in matching preferences between deficit & surplus units. - Higher risk of liquidity & marketability of direct finance instruments. - Higher search and transaction costs - Difficulty in accessing risk.

List of Financial Market

- Primary market: where financial securities are created. - Secondary market: where financial securities are traded after creation. - Public market: a central market place open to public where buyers & sellers are meet to trade. - Private market: where buyers & sellers transact without open advertisement and inclusion of the public - Money market: short term financial instruments, < 12months - Capital market: long term financial instruments, > 12months - Wholesale market: a direct and private market where large fund flow transactions between government/institutions/corporate surplus and deficit units. - Retail market: primary and intermediary market where surplus and deficit units are individual, household and small business involve small transactions.

How do we Finance?

- Raising equity 1. Existing funds of owners 2. Sharing ownership (selling part of the business to the public) - Raising Debt 3. Borrow money

Advantages of Direct Finance

- Saves on the cost of intermediation as hiring the 3rd party is not free - Allows access to non-standards/unique products not offered by intermediaries - Allows for greater flexibility in funding.

The flow of funds occur within the financial system of an economy such as?

1. Financial Institutions: businesses that facilitate the flow and transfer of funds by providing intermediation 2. Financial Instruments: primarily types of debt & equity that are vehicles for the flow/transfer of funds 3. Financial market: where financial instruments are created and traded

What is Finance?

The raising of money(capital)

What is Investment?

The raising of money, using capital

How do we Invest?

Used to buy assets that make money (generate a return) - Assets bought depend on the type of business being run - The process of using capital to buy assets

Flow of funds

Where capital is transferred from surplus units to deficit units in an economy