Lecture 1 - Introduction The financial system is the mechanism through which loanable funds reach borrowers, and it consists of financial markets and financial institutions. There are two categories: · Real Assets: Natural resources, physical capital, human capital, cultural capital, intellectual property (intangible asset) etc · Financial Assets: Money, equity, debt, bonds, derivative products, securitised products etc Financial Assets These are: . A claim against the income or wealth of a business firm, household or unit of government · Represented usually by a certificate, receipt, computer record file or other legal document · Created by or related to the lending and/or borrowing of money. They also: · Promise future returns to their owners · Serve as a store of value · Provide owners with purchasing power Their key characteristics: · Divisibility: It refers to the extent to which fractional amounts of an asset can be either bought or sold e.g. Bitcoin . Liquidity: It refers to how quickly something can be turned into cash . They do not depreciate like physical goods, and their physical condition or form isn't usually relevant in determining their market value . They are convertible; they can be easily changed in form and substituted for other assets Financial Markets . Money markets: short-term assets i.e. < 1 year maturity assets are traded here · Capital markets: medium and long term assets i.e. >1 year maturity assets as well as equity are traded in these markets . Spot Markets: They refer to cash markets where financial assets and commodities are traded for immediate delivery · Forward markets: delivery is due to a later date . Primary Markets: Newly issued assets are traded in these markets e.g. an Initial Public Offering (IPO) of equity. · Secondary Markets: Existing assets are traded here. There are two types of secondary financial markets · Exchange Markets - Buyers and sellers meet physically to trade e.g. stock exchange . Over the counter - Electronic trades
Financial Institutions These are entities of the financial system which operate within or outside financial markets and play an intermediate role between savers and borrowers. There are two types of financial institutions: · Deposit taking (or depository): · Traditional (commercial) banks . Near banks - compete with commercial banks for collection of deposits and the provision of financial services. Types of near banks: . Trust companies - established because commercial banks are denied to act as trustees. These may act as trustees, such as administrators for an estate or deceased person · Mortgage and Loan Companies · Savings and Loan Associations (Thrifts) - They acquire funds by offering savings accounts, certificates of deposits, checking accounts and brokered deposits. Given that thrifts have to pay higher interest on deposits to attract depositors, they engage in riskier projects that promise higher returns. . Credit Unions - Composed of members who share a common bond. The bond is based on similarity of occupation, religion affiliation or geographical location of its members. In many cases, these allow a perpetual membership