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FMI week 1 The Financial System - Coggle Diagram
FMI week 1 The Financial System
The role of financial system
economic units
households
businesses
governments
budget positions
Surplus: income>expenditure
Deficit:income<expenditure
balanced
comprised of
Financial instruments
money&tradable assets
cash instruments
capital instruments
derivative instruments
Financial markets
markets for buying/selling financial instruments
Financial institutions
firms in between parties that want to buy/sell financial instruments
5 roles of FS
1.Flow of Funds
from SSUs to DSUs via trading FIs
provide a range of FI to meet preferences
2.Settlement of Transactions
transfer of funds through Financial Transactions
Financial Transaction
: between SSU and DSU exchange assets with payment
provides mechanism using payment system
Payment System
: allows funds to be transferred.
Efficiency: speed,cost,stability
financial institution strength
settlement mechanism
Settlement could be immediate/specific horizan
3.Provision of information
facilitate financial decision
provide sufficient information to make informed decisions
disclosure obligation imposed on participants
4.Transferring and managing risks
participants have different tolerance to risk
transfer risks
5.Managing incentive problems
Adverse selection
Moral Hazard
Agency problem
mitigate them when they arise in financial contracts
Effective Financial System
1.Efficiency
Allocative Efficiency: allocate resources in the most productive and valuable use
Operating Efficiency: deliver products/services with lowest cost
Informational Efficiency:market price reflect relevant information
Dynamic Efficiency:delivers price signals, balance consumption and savings.
2.Resilience
handle normal/extreme economic conditions
ensure institutions cannot cause shocks
3.Fairness
Non-discriminatory and fair for participants
Participants act
Financial Institutions
Two ways of transferring funds
Direct Financing:
DSU issue claims sell directly to SSUs, no intermediaries.
Indirect Financing
: Intermediaries purchase claims from DSUs and sell to SSUs
Financial intermediaries
Services
Denomination divisibility
Maturity flexibility
Credit risk diversification
Liquidity
Currency transformation
Benefits
Economies of scale
lower transaction costs in searching credit information
important but sensitive information
better information
Types of FIs
Financial advisors, brokers, investment bankers, funds etc.
Financial Markets
Well-functioning Characteristics
Price discovery: supply and demand
Liquidity:convert assets into cash with low cost
Low frictions: search costs, information costs.
Types of FMs
primary markets vs secondary markets
exchange markets vs over the counter markets
money market vs capital markets
cash markets vs derivative markets
international markets vs domestic markets
centralised vs decentralised markets(block chain)
Financial Instruments
Equity securities
Common stock
Preferred Stock
Fixed income securities
Money markets: T-bills, commercial papers etc.
Bond market: T-bond, corporate bond
Derivative securties
futures, forward, options, SWAPs, CDs
Hybrid securtries
Both fixed and equity features: convertible bonds, preferred shares etc.
Foreign exchange markets
Insurance contracts