What is Finance? (1)
What does efficient flow of funds allow?
It ensures that surplus and deficit units have sufficient liquidity. This refers to deficit units being able to raise the capital they need, in order to invest/consume, and surplus units to have enough capital to meet the demand of deficit units
Commercial Bank
They take deposits, provide business/personal/mortgage loans, as well as debit account services.
Financial Intermediary, and examples
A ______ ________ is an entity that acts as the middleman between two parties in a financial transaction, such as a commercial bank, investment bank, mutual fund, or pension fund.
Deficit Units. Give examples
A ______ spending unit is an economic term used to describe how an economy, or an economic group within that economy, has spent more than it has earned over a specified measurement period. Both companies and governments may experience a deficit spending unit.
Surplus Units. Give examples
A ________- spending unit is an economic unit with income that is greater than or equal to expenditures on consumption throughout a period. A _________ spending unit earns more than it spends on its basic needs and therefore has money left over to invest into the economy through the form of purchasing goods, investing, or lending. A ________ spending unit can be a household, business, or any other entity that makes more than it spends for the purpose of sustaining itself.
How can you achieve efficient flow of funds?
By not mispricing capital. Therefore, the prices paid is not inappropriate such that it is under or overvalued
What are 3 ways for the flow of funds occur in an economy?
1. Direct transfer between surplus and deficit units 2. Indirect transfer; using an investment bank (a type of financial intermediary) 3. Indirect transfer; using a financial intermediary
Underwriter
an insurer that ensures that you raise the amount of capital that is desired by the entity issuing shares. The underwriter essentially buys all the shares and assumes the liability of selling all the shares to the public. The process of acting as an intermediary between an issuer of a security and the investing public.
Maturity-risk premium
his is the additional return required by investors in longer term securities to compensate for the greater risk of price fluctuations due to changes in the interest rate.
Private placement
refers to a security offered and sold to a limited number of potential investors. These are an alternative to the sales of securities to the public or a restricted group of investors through a privilege subscription. During this process, the firm will set out the details of the offering on a face to face basis with the investors
Inflation premium
refers to an amount paid to compensate for anticipated inflation that is equal to the price change over the life of a bond or investment instrument.
Public offering
refers to the individual and institurional investors having the opportunity to purchase the securities, these securities are usually made available to the public by an investment banking firm specialising in hlping firms raise money
IPO (initial public offering)
the first sale of stock by a private company to the public
Nominal interest rate
the interest rate before taking into account inflation. This may also be the stated interest rate on a loan without taking into considera on any fees or compounding rates of interest. OR This is the interest rate paid on debt securities without an adjustment for any loss in purchasing power Nominal interest rate = real risk-free interest rate +inflation premium +default-risk premium +maturity premium + Liquidity-risk premium
Underwriting
the purchase and subsequent resale of a new security issue, the risk of selling the new issue at a satisfactory price is assumed by the investment banker
Real risk-free interest rate
the theoretical rate of return of an investment with no risk. This represents the minimum return an investor will expect for a risk-free investment. OR This is the interest rate on a fixed income security that has no risk in an economic environment of zero inflation ** risk free interest rate includes compensation for inflation whereas real risk-free interest rate is the risk-free interest rate after inflation has been taken into account. ** Therefore: risk free interest rate = real risk-free interest rate + inflation premium real risk-free interest rate = risk free interest rate - inflation premium
Premium
the total value paid to purchase insurance. The premium the holder of an insurance policy holder makes
Default-risk premium
this is the additional amount required by investors to compensate for the risk of default. risk of a borrower defaulting, not making, debt repayments). Higher default risk = high default-risk premium
Liquidity-risk premium
this is the additional return required by investors for securities that cannot be quickly converted into cash
Flow of Funds
where capital is transferred from surplus units to deficit units in an economy. This is important as it enable money to be transferred from those who have excess capital to those who need it.
What other term can be used in place of Financial Instrument?
Financial assets
What are financial instruments in Australia; examples & classify them as debt/equity
Financial assets that can be traded. These are primarily types of debt and equity that are vehicles for the flow/transfer of funds. Debt based instruments may be in the form of loans and bonds. Whereas equity-based instruments include stock op ons, and equity futures. https://nexia.com.au/news/accounting/aasb-9-financial-instruments-understanding-the-basics
How does the flow of funds help an economy grow and develop? (link to macroeconomics)
FoF is important for the economy, as it promotes investment, and consumption, thus stimulating economic growth. Without the flow of funds, businesses are unable to grow or even survive, thus creating unemployment as businesses are unable to keep staff due to the reduced aggregate demand
What are financial institutions in Australia; give examples & classify them
* Businesses that facilitate the flow and transfer of funds by providing intermediation Banks- NAB, Commonwealth Credit unions and building societies Life & general & health insurance companies Common funds https://www.rba.gov.au/fin-stability/fin-inst/main-types-of-financial-institutions.html
What are financial markets in Australia; give examples
* Financial Markets are the place where trading of securities, bonds, shares and currencies (financial instruments) take place. Major markets in the Australian financial system are the credit market, stock market (eg. ASX) , money market, bond market and the foreign exchange market https://www.abs.gov.au/ausstats/[email protected]/Lookup/by%20Subject/1301.0~2012~Main%20Features~Financial%20markets~267
Why can't all businesses engage in direct financing?
***** Unsure**** - more at risk - unsafe ????
Benefits of direct financing
- Allows borrowers to diversify funding sources therefore enabling borrowers to access non-standard or unique products that are not offered by intermediaries - Saves or avoids the cost of intermediation as hiring a third party incurs further costs - Deficit units can issue finance that is specific funding requirements, instead of relying on a generic product, this allows for greater flexibility in funding
Disadvantages of direct financing
- Difficulty on matching preferences between surplus and deficit units - Higher risk of liquidity and marketability of direct finance instruments - Higher search and transactions costs - Difficulty in assessing risks
What is another term for "flow of funds"?
- Movement of funds - Transfer of capital
Investment Bank
An intermediary that specialises in large and complex financial transactions. They have the role of negotiating mergers and acquisitions and facilitate corporate recognition
What is the difference between investment and commercial banks?
Commercial banks are insured by governments, which enables them to maintain a degree of protection and security for customer accounts. However investment banks differ as they are much more loosely regulated, therefore lesser protection is offered. However, this allows a degree of operational freedom
Another name for the Rate of Return
Opportunity cost of funds
Difference between surplus and deficit units; & examples
Surplus units are those units who receive more money than they spend. They can be termed as investors. They provide their net savings to the financial markets while deficit units are those units who spend more money than they received. They are also termed as borrowers. They access funds from the financial markets. Surplus units provide funds to the financial markets while deficit units obtain funds from the financial markets. Surplus units include households with savings, while deficit units include firms or government agencies that borrow funds
Public market
These are a central market place open to the public where buyers and sellers meet to trade
Wholesale market
These are markets that involves large sums of money and usually direct financial flows between investors and borrowers. The cost of funds is determined by the levels of liquidity, interest rates expectations and maturity structures
Retail market
This is the market that sells smaller amounts of funds and directs flows between intermediaries, households and small & medium businesses
Benefits of financial intermediations
To the average consumer; safety, liquidity, and economies of scale involved in banking and asset management. Although in certain areas, such as investing, advances in technology threaten to eliminate the financial intermediary, disintermediation is much less of a threat in other areas of finance, including banking and insurance.
Direct financing; and examples
When borrowers borrow funds directly from the financial market without using a third-party service, such as a financial intermediary, it is called direct finance. Brokers, dealers, and investment bankers play essential roles in direct financing. eg. Rate settler (helping individuals get better rates that suit their preferences, such as lending money at a higher rate, or helping borrowers w a lower credit rating getting a lower rate), Go Fund Me, Shark Tank
Private market
Where buyers and seller transact without open advertisement and only includes a small portion of the public
Money market
are financial markets where financial instruments with high liquidity and short maturities / life span are traded. [maturity period of 1 year or less]. These short-term securities are usually issued by borrowers with high credit ratings. These securi es are 'very liquid'
Primary market
are where investors are able to be issued securities from the issuing company themselves
Secondary market
investors purchases assets or shares from other investors
Capital market
is where individuals and ins tu ons trade long term financial instruments that have a longer-term maturity period that extends beyond 1 year. (shares, bonds etc). Public and private companies often sell securities on capital markets to raise funds
Inflation
measure at the rate at which average price level of a basket of goods and services has increased over a specific period of time.