Academy of Economic Studies
Faculty of International Business and Economics
“International Finance and Payments”
Course II
“International Financial Markets and
Institutions”
Lect. Cristian PĂUN
Email: cpaun@ase.ro
URL: http://www.finint.ase.ro
International Financial System - review
• IFS ensures the capital transfers between the investors and financing
beneficiaries (or debtors) – main function;
• IFS is composed by financial markets, financial institutions and
financial instruments;
• Bretton Woods Agreement is the base for actual IFS;
• the evolution of IFS was determined by several factors;
• EMS was an European alternative for IFS;
• BP registers all the commercial and financial transactions of a country with
the rest of the World;
• we use this BP to determine the need for financial resources for a country
• this BP should be in equilibrium and the deficits can be reduced using
different policies;
• the fixed exchange rate ensures an automatic equilibrium for a BP.
Course 2: International Financial
Markets and Institutions
2
Financial System - structure
Financial
transactions
Private
companies
Government
Financial
Financial
transactions
Institutions
Population
Course 2: International Financial
Markets and Institutions
Financial
transactions
Financial Markets
3
Financial Markets - characteristics
FINANCIAL MARKETS
Money Markets (maturity < 1 year):
-very liquid;
- transactions with credit
instruments;
- small fluctuations for the
securities prices => low risk
Capital Markets (maturity > 1 year):
- transactions with debt and equity
securities (bonds, equities)
- higher prices fluctuations
International Credit Markets, Euromarkets
and FX Markets
-Primary market: is a financial market in which new issues of a
security are sold to initial buyers;
- Secondary market: is a financial market in which security
(previously issued) can be resold by the investors for cash.
Exchange offices (NYSE, CBOT)
OTC Markets
Course 2: International Financial
Markets and Institutions
4
Financial Markets - characteristics
Characteristics
Money Markets
Capital Markets
Maturity
Under 1 year
Below 1 year
Risks
Lower
Higher
Instruments
Credit instruments
Debt and Equity instruments
Liquidity
Higher
Lower
Transaction volume
Lower
Higher
Credit instruments
Debt and Equity Instruments
- Treasury bills;
- Common Stocks
- Commercial Papers;
- Preferred Stocks
- Banker’s Acceptance;
- Bonds
- DC;
- Investment Funds Participations
- Credits;
- Insurance Policies
- Pension Funds Policies
- Derivatives
Course 2: International Financial
Markets and Institutions
5
Financial Resources for a company
Internal
Resources
- Reinvesting the
profits;
- Increasing capital;
-Debt to equity
conversion;
- Amortization.
Financing
Decision
External
Resources
- Credits;
- Bond issuing;
- Equity.
Course 2: International Financial
Markets and Institutions
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Why we should use internal resources ?
Advantages:
• increase the company value;
• higher autonomy from financial institutions;
• lower costs (such as banking commissions and taxes);
• advantages from fiscal regimes applied to reinvested profits;
• small companies or new business;
• leveraged companies (high debt).
Disadvantages:
• opportunity costs;
Real cost for internal financial resources
• taxation.
Internal resources are the most expensive
financial resources !!!
Course 2: International Financial
Markets and Institutions
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Why we should use external resources ?
Advantages:
• mature business – “cash-flow cows”;
• less costly then own financial resources;
• important financial resources that can be obtained;
• higher maturity;
• fiscal regimes in case of the interest paid to a bank;
Disadvantages:
• additional costs (taxes, commissions applied);
• the dependence from the financial institutions;
• the reimbursement program;
• a good projection for your business development (future income and cashflow prediction).
Course 2: International Financial
Markets and Institutions
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Direct Financing vs. Indirect Financing
Financial
Intermediaries
Indirect Financing
Debtor
(Beneficiary)
Investor or Creditor
Direct Financing
Course 2: International Financial
Markets and Institutions
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Direct Financing vs. Indirect Financing
Advantages for indirect financing:
• a good information about capital resources;
• lower risks (some institutions share or cover the financial risks);
• financing consultancy;
• financing facilities;
• different financing alternatives;
• financing condition imposed by the financial institutions;
• lower transaction costs.
Disadvantages for indirect financing:
• higher operational costs;
• inexistence of a direct contact with financial markets;
• historical relations with a financial institution.
Course 2: International Financial
Markets and Institutions
10
Services provided by financial institutions
• selling and buying financial securities;
• international payments;
• international financing (incl. export financing);
• financial consultancy;
• international markets surviving (rating agencies);
• insurance against financial risks;
• guarantees for financial transactions;
• managerial expertise;
• companies surviving (competitors, clients);
• portfolio management;
• investment funds management.
Course 2: International Financial
Markets and Institutions
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Financial Institutions
I. International Financial Institutions:
-International Monetary Fund;
-World Bank (IBRD, IDA, IFC, IMGA);
-EBRD;
-European Investment Bank;
-Bank for International Settlements;
II. Government Institutions:
-Export Credit Agencies;
-Export Guarantee Credit Agencies;
-Export Insurance Agencies;
III. Depository Institutions:
-Commercial Banks;
-Savings and Loans Associations;
-Mutual Savings Banks;
-Credit Unions.
IV. Non – depository Institutions:
-Investment Banks;
-Mutual Funds;
-Pension Funds;
-Insurance Companies;
-Financing Companies;
-Venture Capital;
-Stock Markets Brokers and Dealers.
Course 2: International Financial
Markets and Institutions
Public
Financial
Institutions
Private
Financial
Institutions
12
Primary Assets and Liabilities of Financial Intermediaries
Type of intermediary
Primary liabilities (sources of funds)
Primary Assets (uses of funds)
- Commercial Banks
Deposits
Business and consumer loans,
Municipal Bonds, T-Bonds
- Savings and loan
associations
Deposits
Mortgages loans
- Mutual Savings Banks
Deposits
Mortgages loans
- Credit Unions
Deposits
Consumer loans
1. Depository institutions:
2. Contractual Savings Institutions
- Life Insurance Companies
Premiums from policies
Corporate Bonds and Mortgages
- Fire and casualty Insurance
Companies
Premiums from policies
Municipal Bonds, corporate Bonds,
Treasury securities
- Pension Funds
Employer and employee contributions
Corporate bonds and stock
- Financing Companies
Commercial papers, stocks, bonds
Consumer and business loans
- Mutual Funds
Shares
Stocks, Bonds
- Money market mutual
funds
Shares
Money market instruments
3. Investment Institutions
Course 2: International Financial
Markets and Institutions
13
Type of intermediaries
US Financial Institutions
Com m ercial Banks
4.95%
Savings and loan associations,
m utual banks
13.04%
26.14%
Credit unions
Life Insurance Com panies
4.98%
Fire and casualty insurance
com panies
Pension Funds
9.63%
5.74%
1.81%
State and local governm ent
retirem ent funds
Finance com panies
12.43%
16.82%
Mutual Funds
4.46%
Money m arket funds
Course 2: International Financial
Markets and Institutions
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Financial Instruments
• A financial instrument is a contract between lender and borrower;
• This particular contract establish:
• the financing mechanism;
• the role of each institution / participant in the mechanism;
• the amount;
• the maturity;
• the currency;
• the financing cost (interest rate) and the payment method;
•the risk allocation between the participants;
• the payback of the loan;
• other aspects (special clause).
Course 2: International Financial
Markets and Institutions
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Financial Instruments
Financial Instruments
Direct Investment
Money Market:
• Treasury Bills;
• Negotiable
bank certificates
of deposit;
• Commercial
papers;
• Banker’s
acceptances;
• Repurchase
Agreements;
• Government
Funds.
Indirect Investment
Capital Market
Fixed Income Instr.:
T-bonds;
Municipal Bonds.
Corporate Bonds.
Equities:
Common stocks;
Preferred Stocks;
GDR.
Course 2: International Financial
Markets and Institutions
- Investment Funds
Participations;
- Insurance Policies;
- Pension Funds
Participations.
Derivatives:
Futures;
Options;
Swaps;
Caps;
Floors;
Collars.
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Money market instruments
• Treasury Bills;
• Negotiable bank certificates of deposit;
• Commercial papers;
• Banker’s acceptances;
• Repurchase Agreements;
US Money Market Instruments - 1996
• Federal Funds.
8.10%
3.90%
Treasury Bills
1.02%
32.97%
Negotiable bank
certificates of deposit
Com m ercial papers
Banker’s acceptances
33.05%
Repurchase Agreem ents
Governm ent Funds
20.96%
Course 2: International Financial
Markets and Institutions
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A. Treasury Bills
• short term debt instruments
• maturity of 3, 6 or 12 month;
• have no interest payments (initially sold at a discount);
• the most liquid financial instruments;
• the safest financial instrument (no default risk)
• can be issued in different currencies (usually are issued in local
currency)
• “risk free rate” instruments;
B. Negotiable Bank Certificate of Deposits
• debt instrument sold by a bank to depositors (one of the most important capital
source for banks);
• pays annual interest;
• at maturity pays back the original purchase price;
• can be negotiable now
Course 2: International Financial
Markets and Institutions
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C. Commercial Papers
• short term instruments issued by banks or well known companies
• a high growth rate for this instruments (2000% between 1970 – 1996 in US);
• no interest payments (usually issued at a discount);
• interest rates are related to the issuer’s risk
D. Banker’s Acceptances
• were developed in accordance with international trade development
• represent banks drafts (a promise of payment similar to a check) issued by a
company for a future date and guarantee for a fee by the bank
• the bank acceptance = the guarantee
• these instruments are often resold on secondary market at a discount
• high growth rate (250% in US between 1970 and 1996)
Course 2: International Financial
Markets and Institutions
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E. Repurchase Agreements - repos
• short term loans based on a collateral
• this instruments were introduced in 1961
• increase the liquidity for financial instruments
• reverse repo’s
F. Federal Funds
• overnight loans between banks and Central Bank
• the banks pay an interest rate
• federal funds rate (refinancing rate)
Course 2: International Financial
Markets and Institutions
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Capital market instruments
• Stocks (common stocks, preferred stock);
• Mortgages;
• Treasury Bonds;
US Capital Market Instruments
• Municipal Bonds;
5.49%
• Corporate bonds
3.73%
Corporate stocks
3.54%
4.87%
Mortgages
Corporate bonds
45.22%
11.95%
T-Bonds
Municipal Bonds
Bank Com m ercial Loans
6.27%
Consum er Loans
18.92%
Course 2: International Financial
Markets and Institutions
Com m ercial and Farm
Mortgages
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Financial Instruments – risk classification
Level 4: High Risk Instruments
Derivatives, junk bonds
Level 3: Potential Growth Rate Instruments:
Blue chips, Mutual Funds Participations, Convertible Bonds.
Level 2: Sure Income Instruments:
T-Bills, Municipal Bonds / T-Bonds.
Level 1: Risk free rate instruments:
Cash, Deposit Certificates, Insurance Policies.
Course 2: International Financial
Markets and Institutions
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