4/12/2018 6:44 PM Financial Markets

Financial Intermediaries Financial Markets Indirect Finance Financial Intermediaries Funds Funds Funds Lenders Savers Households Business Governments Foreigners Borrowers Spenders Households Business firms Governments Foreigners FinancialMarkets Funds Funds Direct Finance Interactive guide to capital markets http://www.goldmansachs.com/s/interactive-guide-to-capital-markets/

Means to Reduce Risk (E.g. Insurance) What Do Financial Markets Provide? Payment Mechanisms Investment Opportunities Funds to Borrow Means to Reduce Risk (E.g. Insurance) How the Economic Machine Works: https://www.youtube.com/watch?v=PHe0bXAIuk0

Key Role of Financial Intermediaries Address the ‘conflict of preferences’ between borrowers and lenders. FINANCIAL INTERMEDIARIES CONSIDER PREFERENCES FOR Liquidity/ Maturity Risk Financial intermediaries can help to address the ‘conflict of preferences’ between borrowers and lenders. Think about the preferences for: Risk Liquidity/Maturity Volume/Size Volume/ Size

Gain Benefits How do Financial Intermediaries Gain Benefits? Expertise Reputation and Trust Gain Benefits Economies of Scale Pooled Resources

Types of Financial Institutions Banking Sector retail, corporate, investment finance houses, savings and loans, credit unions Long Term Savings Pension and insurance funds Risk Spreaders Mutual funds, investment trusts Risk Takers Private equity, hedge funds Broker Acts as a agent on behalf of a client Assists in buying/selling securities Can provide (indirect) access to markets Broker‐Dealer can also trade for their own account may be a market maker Inter‐Dealer Broker Facilitates trades between broker‐dealers and other financial institutions rather than individuals

Key Features About Equity Raising Capital Bank loans Bonds Equity Key Features About Equity If it’s the first time the company has done this, we call it a ‘new issue’ If the company already has shareholders, it may approach them with the opportunity to buy more shares in the company, called a rights issue The reward for the shareholders by way of income is the dividend

Classification of Capital Markets Debt Equity Short Term (Money Markets) Long Term Bonds Shares Capital Markets is not the same as Financial Markets

Classification of Financial Markets Capital Markets Foreign Exchange Debt Equity Commodity Derivatives Short term (Money Markets) Long term Bonds Shares Agriculture, Metals, Energy

Primary and Secondary Markets Primary Markets Secondary Markets When a financial instrument is first issued and offered for sale this is known as the primary market The market in which funds are first raised Throughout the life of the instrument there is the possibility of buying and selling This is the secondary market No new funds are raised through secondary market deals but profits (and losses!) can be generated The existence of a secondary market encourages investment in the primary market

Over‐the‐counter (OTC) Exchange Traded and OTC Markets Over‐the‐counter (OTC) Exchange Traded Physical or virtual Products are standardized (e.g. stocks, bonds, futures) Heavily regulated Transaction costs tend to be low Trades between two parties on a private basis Custom products Lacks transparency

The Role of the Central Bank

Central Bank Activities Supervision of the Banking System Advising the Government on Monetary Policy Issue of Banknotes Acting as Banker to the Other Banks Acting as Banker to the Government Raising Money for the Government Controlling the Nation’s Currency Reserves Acting as ‘Lender of Last Resort’ Liaison with International Bodies

KEY PECULIARITIES OF MONETARY POLICIES Monetary Policy Monetary Policy Fiscal Policy Relates to government tax and spending Relates to the supply of money KEY PECULIARITIES OF MONETARY POLICIES MANAGED ROLE OF CENTRAL BANKS KEY CONSIDERATIONS CONTROL MECHANISMS In developed nations this is normally managed by an independent central bank. Set the monetary policy or Implement a government set policy Price Stability – controlling inflation Economic growth Employment Exchange Rates Interest rates are a major mechanism for control Fiscal policy rates to government tax and spending Monetary Policy relates to the supply of money In developed nations this is normally managed by an independent central bank. Central banks may be free to set the policy, or only how choose how to implement a government set policy. While economic growth, employment, exchange rates, etc may all be considerations, price stability (i.e. controlling inflation) is often seen as key. Interest rates are a major mechanism for control

Let us consider the European Central Bank Banknotes Let us consider the European Central Bank Key Function controls the issue of Banknotes Coins MODERN PAYMENT MODES Cash Cheques Standing Orders Consider the European Central Bank The central bank controls the issue of banknotes and possibly, but not necessarily, coins also. Most payments these days do not involve cash but cheques, standing orders, direct debits, credit cards, mobile payments, and so on. Nevertheless, cash is important as banks’ cash holdings are a constraint on the creation of credit. Direct Debits Mobile Payments why is controlling issue of cash important? Cash is important as banks’ cash holdings are a constraint on the creation of credit.

For whom does the central bank acts as a banker? Bankers to the Other Banks For whom does the central bank acts as a banker? Other Banks in the Economy Holding Accounts with International Bodies World Bank “Other banks hold non‐interest‐bearing reserves with it in proportion to their deposits” Central Bank WHAT PURPOSE DOES THIS SERVE? The central bank will act as banker to the other banks in the economy, as well as holding accounts with international bodies like the International Monetary Fund (IMF) and the World Bank It is a common habit for the central bank to insist that the other banks hold non‐interest‐bearing reserves with it in proportion to their deposits Apart from helping the bank to make a profit, these serve as an instrument of control over the money supply 1 Helps the bank make a profit 2 Serves as an instrument of control over the money supply

Acts as the government’s banker Bankers to the Government Acts as the government’s banker Receives Pays Out Revenues for taxes or other income. Money for the government’s expenditure. Government Central Bank Lenders Funds Funds Normally, a central bank acts as the government’s banker. It receives revenues for taxes or other income and pays out money for the government’s expenditure Usually, it will not lend to the government but will help the government to borrow money by the sales of its bills and bonds Bills and Bonds Bills and Bonds

Raising Money for the Government While the Treasury or Ministry of Finance sometimes handles government issues, it is much more common for the central bank to control this and to settle payments through the accounts that banks and financial institutions have with it Over time, the debt grows and is not, in any real sense, ever ‘paid off’. Does this matter? The first point is that, for any individual, how serious debt is depends on their income. Inflation is also a key factor Finally, to whom is the money owed?

Acting As Lender of Last Resort Acting as lender of last resort not only refers to the role of the bank as a periodic rescuer of banks in trouble, it also refers to the fact that the central bank will help the other banks temporarily when they meet problems with their liquidity During 2008, the US, the UK and all European central banks and governments engaged in widespread liquidity support schemes in order to support their banking systems

Liaison with International Bodies Central banks will liaise with other international financial bodies like the IMF and the International Bank for Reconstruction and Development (IBRD), usually called the World Bank. They also liaise with and take part in discussions at the Bank for International Settlements (BIS) in Basel Regular meetings between G7, G10 and G20

Inflation is the key target for central banks. Position of Central Bank Today Inflation is the key target for central banks. How do we Measure Inflation? Accountability is Another Current Issue. Do We Need a Central Bank? Questions: How do we measure inflation? Accountability is another current issue. Do we need a central bank?

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