— FINANCIAL MARKETS AND INSTITUTIONS FINANCIAL ENVIRONMENT *Itis a part of an economy that affects the diverse functions of the — CG ON COU OCMC my cany on ORM eCPM SN OREM TE Cos Reo Cae caCTE CUE Ug Fm Coy een OReOny coo CEU oe Ur LaD i (Ry goods aroay ed LMT Gea ee MTEC ser TG rd CTA Uae Le RUS rossi M4 ‘The financial sector (or system) is vital for the smooth functioning UUM ALAR e ON EULUOM Cn cmc mot ean) Savers (or surplus units) to prospective borrowers (or deficit ur rh Financial Environment - is a part of an economy with the major players being firms, investors, and markets. Essentially, this sector can represent a large part of a well-developed economy as individuals who retain private property have the ability to grow their capital. Firms are any business that offer goods or services to consumers. Investors are individuals or businesses that place capital into businesses for financial returns. Markets represent the financial environment that makes this all possible. Historically, firms were very small or even nonexistent in economies or financial markets. Though a few firms have always been in existence, the ability for a large number of firms was not possible until markets became more mature. Mature markets allow for more access to resources necessary to produce goods and services. As firms begin to grow, expand, and multiply, higher capital needs to persist in order for firms to succeed. Capital sources include money from outside parties, such as investors. Many times investors are individuals who have more capital than is necessary to provide a sufficient living standard. Any excess capital can actually make individuals more money if they invest the funds into a firm that offers afinancial return. This symbiotic relationship in the financial environment allows both parties to increase their capital. Many different factors play a role for individuals making investments. Afew of these may include risk, current market conditions, and competition, among others. + Financial environment of a company refers to all the financial institutions and financial market around the company that affects the working of the company as a whole. The financial environment has a number of factors. It includes the financial institutions, government, individuals and firms around the business. Firms use their financial markets to keep their savings as property. It is extremely important for the monetary markets. + Components of financial environment The financial environment is composed of three key components: (1) financial managers, (2) financial markets, and (3) investors (including creditors). Surplus Units provide funds to the financial markets include: households with savings, while deficit units. while Deficit Units obtain funds from the financial markets , include: firms or government agencies that borrow funds. sf ZN @ FINANCIAL SYSTEM SENN CUSTOM ET TU LOIN IPTUr TENET acm InTITGrTE TU UCU aA eC CaI COUR UCL SR SEC Une Reams CUED aN cornU(g TIVO GEL Ue MCR OE MU coe ORE Tas SS ORTON LeU M ROLE Cane COMMUNES TUTOR ELAR CSI URC CO CAUSE SIMO RL eRe UT LC EE TI OUR NS CITC CCOu Co (Coa COEDS aera) I Financial System * A financial system functions as an intermediary between savers and investors. It facilitates the flow of funds from the areas of surplus to the areas of deficit. It is concerned about the money, credit and finance. * A financial system may be defined as a set of institutions, instruments and markets which promotes savings and channels them to their most efficient use. It consists of individuals (savers), intermediaries, markets and users of savings (investors). on of the Financial System ena SAVERS Ge tent BORROWES reat ae a — | @eficit units) SiO rn Bene nn Strand ee anc - Serre Cita Penta NLU) Three Ways to Transfer Financial Capital in the Economy Three Ways to Transfer Financial Capital in the Economy 1 2 3 Direct twanster of funds Indirect transter using the Indirect transter using the Investment banker financial interme diary Farm's secures (stocks, bond) 5 Foundations of Finance Pearson Prentix Figure 1.2 CWE EWI FINANCIAL INSTITUTIONS (Make available financial instruments) Lo SEN Te EU EUL Oa iny USO o Re oe CLD) FINANCIAL INSTRUMEBTS OCD ames ee CEC ened) Structure of Financial System MONEY Financial | Financial System | Financia! Markets | Inter meduries Government The financial system is composed of various components that work together to facilitate the flow of funds and support economic activities. Here is an overview of the structure of the financial system: Central Bank: The central bank is the apex institution in the financial system of a country. Its primary role is to regulate and control the money supply, manage monetary policy, and ensure the stability of the financial system. It acts as the banker to the government and commercial banks, and it also provides various financial services to the economy. Financial Institutions: Financial institutions play a crucial role in the financial system by providing various financial services to individuals, businesses, and the government. They include: - Commercial Banks: These are the primary depository institutions that accept deposits from individuals and businesses and provide loans and other financial services. - Investment Banks: Investment banks assist companies and governments in raising capital by underwriting securities, facilitating mergers and acquisitions, and providing advisory services. - Credit Unions: Credit unions are member- owned financial cooperatives that provide banking services to their members, often with a focus on specific communities or groups. - Insurance Companies: Insurance companies provide coverage and protection against various risks, such as life, health, property, and liability. - Pension Funds: Pension funds manage and invest funds on behalf of employees to provide retirement benefits in the future. - Mutual Funds: Mutual funds pool money from multiple investors to invest in a diversified portfolio of securities, such as stocks, bonds, and other assets. - Non-Banking Financial Companies (NBFCs): NBFCs are financial institutions that provide banking services without holding a banking license. They offer services like loans, leasing, hire purchase, and investment advisory. Financial Markets: Financial markets are platforms where buyers and sellers trade financial assets such as stocks, bonds, currencies, and commodities. They facilitate the allocation of capital and the pricing of financial instruments. Financial markets can be classified into: - Money Market: The money market deals with short-term debt instruments and provides a platform for borrowing and lending funds with maturities of one year or less. - Capital Market: The capital market deals with long-term debt and equity instruments and facilitates the issuance and trading of securities. - Foreign Exchange Market: The foreign exchange market is where currencies are bought and sold, enabling international trade and investment. - Derivatives Market: The derivatives market deals with financial contracts derived from underlying assets, such as options, futures, and swaps. Financial Instruments: Financial instruments are contracts that represent a financial value or right. They are traded in financial markets and include: - Stocks: Stocks represent ownership in a company and provide shareholders with a share of its profits and voting rights. - Bonds: Bonds are debt instruments issued by governments, municipalities, and corporations to raise capital. They pay periodic interest and return the principal amount at maturity. - Derivatives: Derivatives are financial contracts whose value is derived from an underlying asset or benchmark. They include options, futures, swaps, and forwards. - Commodities: Commodities are raw materials or primary agricultural products that can be bought and sold, such as gold, oil, wheat, and coffee. Money: Money serves as a medium of exchange, a unit of account, and a store of value. It includes currency (coins and banknotes) and demand deposits held in banks. The structure of the financial system may vary across countries, but these components are generally present in most economies. They work together to facilitate the efficient allocation of funds, promote economic growth, and manage financial risks. ETS RUM EUE TORU EON UOC ROE TOPO A Cum RC Cm OR OIET TNO aU OSA ORCL Ce HTC aC be very difficult for people in need to borrow to find other people FCA ORR RUSTE OME RRC CMU UT CCEA (H Cocca cme elo a Oem OOo ROMER RCO) Reis (orca Gi POC e UOMO CE UPTe RTOS TTTiTaeLiy Tin a Aue car Mme RCO etnies c nh * People and organizations with surplus funds are saving today in Com OE CCMTTN LCM OUTS TLC hoe OT CoO CCE Cnn TNO areen icons CeO Ce Cuca eR TCR MSP UH Let Coa THURS SUE So eee ad yg ERO e eM Oe CLL Cag must pay interest to those who provide that capital. y BORA 08 TGP MORELIA Cee TCIM ICCCSe COLT SET Co ORT OM ECU COU EO UTM Unt e Peace of Capital: Individuals and institutions who need to raise funds to , A SSI LT Re Ea On CEE Ca) PA CUCU HUM noe EM OSHC eee CMe OER a mn ORT ey CMO RSMO Cn: a 1. DIRECT TRA a. ee ae sity ron Cae rece aC) savers, HOS OU AU TEN eee NRT aT enn es amas n FINA oU ST HEB Terie Little capital raised. vi r ment bank; underwrites the issue, AOC RO LOM OUT OLUA TMC TtHTSITE PTA OM Ua Su to savers. ¢, Business securities and the savers money "pass through’ ment bank CUM agien Comer Tet) aCe UU ya ik ae EMCO SUPA PATO AAR ORCL I MULE PN Rca ne COT C Mel Reel a am ORINEN Re Cy i | d. Existence of intermediaries greatly increases the efficiency of a a SU eC Ease 1, Direct Transfers Business * Savers (Borrower) Funds (Investors) 2. Indirect Transfers through an Investment Banker Firm's Stocks Business Helps corporations issue or Bonds Savers ‘secures (stocks orbonds) (Investors) Receivesteestomtbeissues * Inemediany’s Uabily c Business 15 Usestundstobuycreateloans Savers (Borrower) andother financial instruments (Investors) Fi Payse retuminterestto attract Fi funds fromsavers Diagram of the Capital Formation Process Three types of Transfers Process 1. Direct Transfer - a business sells its security directly to investors. 2. Indirect transfer through an Investment banker - a business sells its security to an investment banker, which in turn sells the same security to individual investors. 3. Indirect transfer through a Financial Intermediary - a financial intermediary obtains funds from investors by offering its own securities and uses funds to buy other business securities. SERVICES PROVIDE BY FINANCIAL SYSTEM * Risk Sharing: The Financial System provides risk sharing by allowing savers to hold many assets and enables individuals to transfer risk. Financial markets can create instruments to transfer risk from savers to borrowers who do not like uncertainty in returns or payments to savers or investors who are willing to bear the risk. * Liquidity: It provides for savers and borrowers liquidity. If an individual needs their assets for their own consumption and investment, they can just exchange it. Bonds, stocks, or checking accounts are created by financial assets, which have more liquid than cars, machinery, and real estate. * Information: The first informational role the financial system plays are to gather information which includes finding out about prospective borrowers and what they will do with borrowed funds. The second informational role that financial system plays is communication of information. Financial markets do that job by incorporating information into the prices of stocks, bonds, and other financial assets. Savers and borrowers receive the benefits of information from the financial system by looking at asset returns. Financial System Is based on the idea that sets of financial institutions make it possible for borrowers, lenders, and investors to exchange money with one another. The financial system provides borrowers with the funds necessary to finance initiatives, and it also provides investors with a return on their investments. RISK SHARING - by allowing savers to hold many assets, PU OCU UE Dee Und aE ig Dt \° « INFORMATION - about borrowers and returns on financial ets FUNCTIONS OF FINANCIAL SYSTEM oe eA i} RIENCE RC rm savings of people are transferred from MOO AC notre TT OM TUM STN PE {i EDDA Ce OEE CeCe Nanay PUTRTENIETOR OTT RU aan STO CS Ene UATE EMEA nCn an Enh ’ OCU GC caTMCU en ROU Nm UO igs Which leads to Capital Formation. 5 AURUE AEWA TAD ETO ener ae TENSOR NTIS Oey and services, New methods of payments like credit cards, debit cards, Pee od Facilitate quick and easy transactions, RAO Lua OSU LULL) / liquidate their investments, which are in instruments like shares, 4 COTA ns nig ren eee Poe mn Pre tLe different individuals and organizations. This facilitates optimum use of finances for productive purposes. ion against life, health, and STE Oe On Financial ree provide are EV TEUC ENCE RTECS ae financial assets. This helps the investors to compare different DURUM aU Sana Ea ONS a HH OIE CeO ORCS Ta CU Siena WU OM CCE EOC eT a aL Ce oes Me Cee EORTC ET iS Om TUTTO SCO TS supplied to them by financial markets, ACS CAae SLUT TMEOTen RoC BITC PSMA La) interest eg seme — eu DE SOU Oa EL CO These functions collectively contribute to the efficient functioning of the financial system and its role in supporting economic activities. FINANCIAL MARKET HERR a Ce EU eae Ree Re OC ty Menecanetom QerkstrCe tna taai ety exchangeable items (fungible items) and derivatives of value at low PRO ee Rue eee UD roe Keon + Itis a place where the savings from several sources are mobilized towards those who need funds. Se enn eMC Coe Ce OL Me Ocoee cies oe TZ FINANCIAL MARKET n Un7y eS a pb” - Investors inancial TENE ah ET Cy Banks & other Governments and ae financial institutions Companies vs mes rs ITE te nao TEN) S Financial Markets + The financial markets are comprised of several participants, including borrowers, lenders, and investors who arrange loans to make investments. * Financial markets are markets where borrowers and lenders meet and exchange funds. Relationship between Lenders & Borrowers Lenders - Individuals, Companies, Banks Financial Intermidiaries - Banks, Insurance Companies, Pension Funds, Mutual Funds Financial Markets - Interbank, Stock Exchange, Money Market, Bond Market, Foreign Exchange Borrowers - Individuals, Companies, Central Government, Municipalities, Public Corporations + Lenders -The lender temporarily gives money to somebody else, on the condition of getting back the principal amount together with some interest or profit or charge. * Borrowers - Individuals borrow money via bankers’ loans for short term needs or longer term mortgages to help finance a house purchase. Companies borrow money to aid short term or long term cash flows. They also borrow to fund modernization or future business expansion. It is common for companies to use mixed packages of different types of funding for different purposes — especially where large complex projects such as company management buyouts are concerned. eee Rogen eas et market are markets for financial assets - focus on DS eee een oC eae core See ae Oe eC eee evi ice a F 7 Se eT ere nenr en Bearer Chrsene cra) Prey ao a6 Be eet meec aoe @ FINANCIAL INSTITUTIONS NR Re ag et a GROG ag ee St Sea Gomen katt ay hang SEE eu ene ee Chant ENS ae Et nS m that provides access to financial markets, both to TORIaCY PSUR or De ek ek ons eum PRR SEL ae pls ay are that c borrowers) eC branras “i Sieur B Tr enerally guaranteed that the firm will raise Bune Le Pee net Cntr eke TCLs bs? Pe aE CU CUCL A, POR ec Ce Meet eu ee Ca the trust Eero a sa SRO ETT Revo nt eaieret SMa Se ee ENR RNE UR ered ng-term bonds, or short-term debt instruments issued by businesses or government units. Da EER UR n es Ce STC D me Aaron Presa s PAR O eee eo ne Part Robes enon Ts Cee Tey Soe thn ECC Ee ered Ester eos Cee renee ome test Teo grr) Pacers om Se ee ons that operate much like hedge funds; but rather than SCHED SA oer aaa ee Berrien iret