LEADSTAR UNIVERSITY COLLEGE

POSTGRADUATE PROGRAM
MASTERS OF BUSINESS ADMINISTRATION

Individual Assignment I for the Course Financial Institutions and

Markets

By
Frewoyine Gebremedhin
MBA/12/246, Sec. B

Submitted to: Desalegn Mosisa (Ass. Professor)

January 2021
Addis Ababa
 Chapter One – Introduction to the Financial System
The process of flow of money from savers to users is called financial system. Whereas a
financial asset is a non-physical asset whose value is derived from a contractual claim, such as
bank deposits, bonds, and stocks. The owner of the financial asset is referred to as investor.
Types of Financial Assets: These all can be classified in different categories according to the
features of the cash flow associated with them.
Treasury bill: These are government bonds or debt securities with maturity of less than a year.
Description
Bonds: A bond is a legal document that states money the investor has lent the borrower and the
amount when it needs to be paid back (plus interest) and the bond’s maturity date.
Stocks: Stocks do not have any maturity date. Investing in stocks of a company means
participating in the ownership of the company and sharing its profits and losses.
The role of financial asset: In general, financial assets serve two main economic functions: the
first is to transfer funds from those who have surplus funds to invest to those who need a source
of financing tangible assets. The second is to redistribute the risk associated to the investment in
tangible assets between different counterparties according to their preferences and risk aversion.
Financial market helps in connecting those with money with those who require money. It has
three economic roles: Price discovery process, liquidity, and reduction of transaction costs.
Classification of Money Financial Market –Money Market: It deals with monetary assets and
short-term funds such as a certificate of deposits, treasury bills, and commercial paper etc. which
mature within twelve months. Capital Market: It trades medium and long term financial assets.
On the other way, primary market is where securities are created, while the secondary market
is where those securities are traded by investors.
Market players: The most important organization or people in the market are customers.
Suppliers may sell directly into the market, Complementary, Competitors, Substitutes…
Financial innovation is the process of creating new financial products, services, or processes.
Types of financial Innovations: Market broadening instruments, Risk management instruments,
Arbitrage instruments. There are peculiar characteristics that are inherent in financial assets that
are normally used partly to determine their pricing in the financial markets. Moneyness- easily
convertible to cash, Divisibility and denomination- denominated in smaller size, Reversibility-
they are like deposits in accounts of customers with the banks, Maturity period…
 Chapter Two – The Structure of Financial Market
Financial markets comprise six key components: the money market, the bond market, the stock
market, the foreign-exchange market, the mortgage market, and the derivative market.

The money market refers to trading in very short-term debt investments. At the wholesale level,
it involves large-volume trades between institutions and traders. At the retail level, it includes
money market mutual funds bought by individual investors and money market accounts opened
by bank customers. In all of these cases, the money market is characterized by a high degree of
safety and relatively low rates of return.

Bond Instruments are traded in the debt market, also often referred to as the debt market. The
bond market is important to economic activities because it provides an important channel for
corporations and governments to finance their operations. Interactions between investors and
borrowers in the bond market determine interest rates.

Stock instruments are traded in the equity market, also known as the equity market. It is
important because fluctuations in stock prices effect investors’ wealth and hence their saving and
consumption behavior, as well as the amount of funds that can be raised by selling newly issued
stocks to finance investment spending.

Foreign-exchange markets are where currencies are converted so that funds can be moved from
one country to another. Activities in the foreign-exchange market determine the foreign-
exchange rate, the price of one currency in terms of another.

A mortgage is a long-term loan secured by a pledge of real estate. Mortgage-backed securities

(also called securitized mortgages) are securities issued to sell mortgages directly to investors.
The securities are secured by a large number of mortgages packaged into a mortgage pool.

Financial derivatives are contracts that derive their values from the underlying financial assets.
Derivative instruments include options contracts, futures contracts, forward contracts, swap
agreements, and cap and floor agreements. These instruments allow market players to achieve
financial goals and manage financial risks more efficiently.

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 Chapter Three - Financial Institutions and Operation
Financial institutions encompass a broad range of business operations within the financial
services sector including banks, trust companies, insurance companies, brokerage firms, and
investment dealers.

Financial institutions are broadly categorized as: Depository and Non depository institutions.

Depository Institutions: An organization, which may be either for-profit or non-profit, that

takes money from clients and places it in any of a variety of investment vehicles for the benefit
of both the client and the organization.

Liability – Sources of Funds

Besides owners' equity, the major source of funds for a bank is deposits and borrowings,
with deposits being the larger percentage of a bank's liabilities. Deposits are considered a
liability because it is money that is owed to its customers

Depository institutions provide four important services/functions to the economy: They provide
safekeeping services and liquidity; they provide a payment system consisting of checks and
electronic funds transfers; they pool the money of many savers and lend it out to people and
businesses; and they invest in securities.

Because depository institutions receive funds from the public for safekeeping and are major
sources of credit and the main providers of a payment system, these institutions are heavily
regulated by central bank (National Bank of Ethiopia in our country). Those that accept
deposits from customers including; commercial banks, savings banks, and credit unions are
depository institutions.

Non-depository institutions are not banks in the real sense. They make contractual
arrangement and investment in securities to satisfy the needs and preferences of investors.
Those financial institutions that do not accept deposits including finance companies,
insurance companies, pension funds, investment companies, mutual funds and brokerage firms
are non-depository institutions.
 Chapter Four – Risk Management in Financial Institutions
Risk is defined as the chance that an outcome or investment's actual gains will differ from an
expected outcome or return. Risk includes the possibility of losing some or all of an original
investment. However, Risk management is the process of identifying, assessing and controlling
threats to an organization's capital and earnings.

Types of Risk in Financial Institutions

Credit risk: is the risk a business takes when it provides a loan, product or service without
upfront payment. This risk is common in all kinds of businesses. To manage credit risks:
Screening and monitoring, Establishment of long-term customer relationships, Loan
commitments, Collateral, Compensating balance requirements, and Credit rationing.

Interest rate risk: is the risk that the value of a loan will change due to fluctuating interest rates.
If an interest rate increases, businesses with outstanding loan debt will have to pay more, which
can impact their operations. To manage this type of risk; make shorten loan terms, take out loans
at the right time and use risk management products. Liquidity Risk

Liquidity risk: is a risk businesses face that can take several forms, including: When a business
has assets that may not be able to be sold for their true value or for a profit, When there is not
enough cash or cash equivalents to meet financial demands such as order fulfillment or payroll
and When a business has inventory that will not be sold at all because of a lack of consumer
desire. To mitigate liquidity risks; avoiding risky assets, avoiding acquiring too many assets,
tracking assets, selling when the time is right.

Insolvency risk: The risk that an individual or especially a company may be unable to service its
debts. Bankruptcy risk is greater when the individual or firm has little or no cash flow, or when it
manages its assets poorly. Banks assess bankruptcy risk when considering whether to make a
loan. It is also called insolvency risk.
 Chapter Five – Regulating the Financial Market

Financial regulation refers to the rules and laws firms operating in the financial industry, such
as banks, credit unions, insurance companies, financial brokers and asset managers must follow.

Regulation consists of requirements the government imposes on private firms and individuals to
achieve government’s objectives. These include consumer protection, ensuring bank solvency,
improving macroeconomic stability, ensuring competition, stimulating growth, and improving
the allocation of resources.

Here’s a rundown of the different types of government regulations on financial market:

Disclosure Regulation: requires all investment fund managers to disclose, for all investment
funds that they manage, the manner in which sustainability risks are integrated into investment
decisions and the results of the assessment of the likely impacts of sustainability risks on the
returns of the relevant funds, or if not deemed relevant, the reasons why. Additional disclosure
requirements apply to investment fund managers in respect of investment funds which promote
environmental / social characteristics or have a sustainable investment objective.

Financial regulation: refers to the rules and laws firms operating in the financial industry, such
as banks, credit unions, insurance companies, financial brokers and asset managers must follow.
Currently, the Ethiopian financial system consists of financial institutions such as the National
Bank of Ethiopia with aim to regulate the finance industry in the country.

Liquidity requirement: The liquidity coverage ratio is the requirement whereby banks must
hold an amount of high-quality liquid assets that's enough to fund cash outflows for 30 days.
Capital requirements: are standardized regulations in place for banks and other depository
institutions that determine how much liquid capital (that is, easily sold securities) must be held a
certain level of their assets.

Regulation of the Commercial Banking (CBS) sector: Because of the special role that
commercial banks play in the financial system, they are regulated and supervised by
governments. The common regulations include: Minimum Capital requirement for CBs, Capital
Adequacy, Liquidity requirement, Asset Quality, Portfolio diversification, Ceiling imposed on
interest rate payable on deposits, Geographical restriction on branches…
 Chapter Six – Ethiopian Financial Market and Institutions

Money market basically refers to a section of the financial market where financial instruments
with high liquidity and short-term maturities are traded. Money market has become a component
of the financial market for buying and selling of securities of short-term maturities, of one year
or less, such as: government treasury bills, time deposits and interbank loans.

Government treasury bills: debt instruments issued by the federal government. have maturities
of 28 days, 91 days and 182 days are sold at a discount through non-competitive auction.

Time deposits (CDs): issued by commercial banks investors include other banks, non-bank
financial institutions, private corporations, public enterprises, and retail customers time deposits
are kept with varying maturities of a months to more than 2 years.

Capital Markets: Capital markets refer to the places where savings and investments are moved
between suppliers of capital and those who are in need of capital. Capital markets consist of the
primary market, where new securities are issued and sold, and the secondary market, where
already-issued securities are traded between investors

Capital market enhanced saving mobilization, help in resource allocation, promote efficient
financial system, improve capital structure, and allow de-concentration of ownership.

Mortgages: Mortgages are also known as "liens against property" or "claims on property."
With a fixed-rate mortgage, the borrower pays the same interest rate for the life of the loan.

When we see the relative size of financial institutions in our country the majority part (81%) is
hold by commercial banks, the rest 15% and 4% is taken by micro financial institutions and
insurances respectively.

Formal financial institutions: excluding banks which are under formation, currently in our
county there are 19 banks, of which 16 are private while 2 are state owned.

Financial market regulation in Ethiopia: NBE regulates the financial market; issues licenses
to banks, insurance firms, and microfinance institutions, regulates the financial sector through
issuance, directives, Supervises banks, insurance companies and MFIs.