FINS2618: Capital Markets and Institutions
Lecture 1: Introduction Financial system & Banking
Roadmap for TODAY’s lecture
1. Course Requirements & Expectations
2. Introduction to Financial System (Chapter 1)
3. Banking (Chapter 2) – continuing in week 2
FINS2618
Course Expectations T1 2024
Time Planning
 What is the expected number of hours that you dedicate to 6 UOC?
 150 hours for 10 weeks
 15 hours per week
 2 hours lecture
 1.5 hours tutorial
 Pre-assigned readings (1-2 hours)
Expectations
 McGrawHill chapters
 Pre-lecture slides
 Pre-assigned tutorial question (attempt) ( 1 hour)
 McGrawHill SMART BOOK Questions (1-2 hour)
Roughly 8 hours per week
 The rest of 7 hours?
 iLab, group assignment, exam preparation
5 Sector Economy
Economics 101
Introduction to Finance
Viney Chapter 1
Learning
Objectives
Learning
Objectives –
chapter
1 1
Chapter
Explain
Explain the functions of a financial system
Categorise Categorise the main types of financial institutions
Describe
Describe the main classes of financial instruments
issued in a financial system
Distinguish between various types of financial markets
Distinguish according to function
Financial
System
LO1: The function
of financial
System
• The financial system is part of a country’s economic system
• A financial system comprises a range of financial institutions, financial instruments and
financial markets which interact to facilitate the flow of funds between deficit and
surplus unit, under the supervision of the central bank and the prudential supervisor
• Financial institutions permit the flow of funds between borrowers (deficit unit) and
lenders (surplus unit) by facilitating financial transactions
Financial markets and flow of funds relationship
Finance and
the real
economy
• What is Finance? Why is it so
important?
Finance is essentially
the study of how we
allocate capital in an
economy toward its
most productive use.
1. Financial
Financial
Institutions
LO2:
Institutions
• Financial institutions are classified into five categories based on the differences between
the institutions’ sources and uses of funds
1.Depository financial institutions
2.Investment banks and merchant banks
3.Contractual savings institutions
4.Finance companies
5.Unit trust
1a:Depository financial institutions
Commercial banks
obtains a large proportion of their funds from deposits lodged by savers.
A principal business of these institutions is the provision of loans to borrowers in the
household and business sectors
E.g.
1b: Investment banks
 Major function is to provide off-balance sheet advisory services to support their corporate and
government clients
 Off balance sheet business includes advising clients on mergers and acquisitions, portfolio
restructuring, underwriting new debt and equity issues (IPO/SEO) and risk management
 These institutions may provide some loans to clients but are more likely to advise and assist a
client to raise funds directly in the capital markets
1c: Contractual savings institutions
Financial institutions such as life insurance offices, general insurers and
superannuation funds
Their liabilities are mainly contracts which specify that, in return for periodic
payments to the institution, the institution will make specified payouts to the
holder of the contract if and when the event specified in the contract occurs.
The periodic cash receipts received by these institution provide them with a
large pool of funds that they invest.
1d: Finance companies
These institutions raise funds by issuing financial securities
such as commercial paper, medium term notes and bonds
in the money markets and the capital markets
They use those funds to make loans and provide lease
finance to their customers in the household sector and the
business sector
1e: Unit trusts
 A unit trust is formed under a trust deed and is controlled and managed by
a trustee or responsible entity
 Unit trusts attract funds by inviting the public to purchase units in a trust.
 The funds obtained from the sale of units are pooled and then invested by
funds managers in asset classes specified in the trust deed.
 There is a wide range of unit trusts, including equity trusts, property trusts,
fixed interest trusts and mortgage trust.
Financial Institutions
2. Financial Instruments/Assets
• Assets can be divided into:
1. Real assets-Assets that can be put to productive use to generate
a return
2. Financial assets-Assets that represent a claim to a series of cash
flows against an economic unit.There is an entitlement to future
cashflows
2. Difference between Financial Asset vs Financial Security
LO3: Financial
Assets
A financial
asset is
defined as
entitlement
to future
cashflows
Know the
difference
financial asset
vs financial
security
A financial security is a financial
asset that can be traded in
secondary market.
2. Attributes of financial assets
• Return-Total financial compensation received from an investment
expressed as a percentage of the amount invested
• Risk -Probability that actual return on an investment will vary from
the expected return
• Liquidity-Ability to sell an asset within reasonable time at current
market prices and for reasonable transaction costs
• Time pattern of Cash flows-When the expected cash flows from a
financial asset are to be received by the investor or lender
2. Different Types of Financial Instruments
• Equity
• Ownership interest in an asset
• Residual claim on earnings and assets
• Dividend
• liquidation
• Debt
• Contractual claim to:
• periodic interest payments
• repayment of principal.
• Ranks ahead of equity
• Derivatives
• A synthetic security providing specific future rights that derives its price from
another asset
• Used mainly to manage price risk exposure and to speculate
• Hybrid
• Features both equity & debt characteristics
What is a
market?
Why do we
need it?
3. Markets
Matching principle
Primary vs secondary market transactions
LO4: Financial
Direct vs intermediated finance
markets
Money markets vs Capital markets
Wholesale vs Retail
Matching Principle
• Short-term assets should be funded with short-term (money market) liabilities;
e.g. seasonal inventory needs funded by overdraft.
Matching
•principle
Longer term assets should be funded with equity or longer term (capital market)
liabilities; e.g. equipment funded by bonds
• lack of adherence to this principle accentuated effects of frozen money markets
with the ‘sub-prime’ market collapse.
Primary vs Secondary market transactions
Primary Market
Secondary
Market
Direct Financing
Intermediated finance
• Intermediated financial flow markets
• A financing arrangement involving two separate contractual agreements whereby the saver
provides funds to an intermediary and the intermediary provides funding to the ultimate user
of the funds
(cont.)
Wholesale vs
retail markets
Wholesale
markets
• Direct financial flow transactions
between institutional investors
and borrowers
• Involves larger transactions
Retail
markets
• Transactions conducted primarily
with financial intermediaries by
the household and small- to
medium-sized business sectors
• Involves smaller transactions
Money
vs
Capital
markets
Money
markets
Wholesale markets
in which Short-term
securities are issued
Capital
markets
• Wholesale markets
in which Long-term
securities are issued
Introduction to Banking
Viney Chapter 2
Evaluate the functions and activities of commercial banks
Learning
Objectives
Chapter 2
Identify the main sources and uses of funds for commercial
banks
Outline the importance of banks’ off-balance-sheet business
Regulation and prudential supervision of bank
Capital Adequacy Requirement
Examine liquidity management
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BANKS
• What do banks do and how do they do it?
• Regulators: why do we need them? And how do they regulate
banks?
• What is capital adequacy and why is it matters? Basel 1, 2, & 3
1: Commercial banks
Commercial banks provide a full range of financial services
Pre 1980’s - Asset management
• Loans portfolio is tailored to match the available deposit
base
Post 1980’s - Liability management
• Deposit base and other funding sources are managed to
meet loan demand
Commercial banks
Importance of banks
• A major “financial intermediation” which provides the following benefits to the financial system:
• Asset transformation
• Maturity transformation
• Credit risk diversification & transformation
• Liquidity transformation
• Economies of scale
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2. Banks – SOURCES of FUNDs
ASSET
LIABILITIES
Personal and housing finance
Current account deposit
Commercial lending
Call deposit
Lending to Government
Term Deposit
Other bank assets
Certificates of deposit
Bill acceptance liabilities
Debt liabilities
Foreign currency liabilities
EQUITIES
Loan capital (hybrid securities) and
shareholders’ equity
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2. Banks – USES of FUNDS
ASSET
LIABILITIES
Personal and housing finance
Current account deposit
Commercial lending
Call deposit
Lending to Government
Term Deposit
Other bank assets
Certificates of deposit
Bill acceptance liabilities
Debt liabilities
Foreign currency liabilities
EQUITIES
Loan capital (hybrid securities) and
shareholders’ equity
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3 : Off-balance sheet Activities
• OBS transactions are a significant part of a bank’s business
• OBS transactions include:
1. direct credit substitutes
2. trade- and performance-related items – Doc LC
3. Commitments – credit cards, Underwriting, Repos
4. foreign exchange, interest-rate- and other market-rate-related
contracts
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