Financial Markets: Types of Financial

Markets,

Types of Financial Markets

12.1 The role of financial markets in the economy

 Play a crucial role in the operation of modern economies.

 Financial markets create products that provide a return for those who have
excess funds, making these funds available to those who want/need money.

 Individuals: savers, Businesses: borrowers

Financial intermediaries: are firms that receive the accumulated funds of individuals or
firms and then make other loans to other firms or individuals who can make use of these
funds. A bridge between savers and borrowers.

Sources of Savings Reasons for borrowing

 HH: the income that is not spent on
G+S
 Businesses: by not distributing
profits to owners
 Governments: when they budget
for a surplus.
 Borrowing from overseas to get
access to foreign savings
 Consumers: borrow when their
demand for G+S exceeds their
capacity to pay for them
 Businesses/ entrepreneurs:
borrow to expand business
 Government: borrow when they
are in deficit
 Australian Financial Institutions
lend money to overseas borrower.

Factor markets for capital: markets where services of the factors of production (not the
actual factors of production) are bought and sold. Financial markets act as a factor
market for capital.

12.2 Primary and Secondary financial markets

 Australia has second highest level of share ownership.

 Banks are now not the only financial institution for the use of consumers and
savers

Primary Financial Markets

 Facilitate the creation of financial assets (securities), that can then be sold into
the economy.
 Money received from investors goes straight to the company.
 E.g. sale of new Westpac shares.
Secondary Financial Markets
 The transactions with financial assets that have already been issued in the
primary market some time ago.
 Majority of transactions are on the secondary market
 Companies receive no money from these transactions.

$$$ $$$
Company Investor A Investor B

Shares Shares

Primary market Secondary Market

transactions transactions

Securities: are any form of financial instrument, including shares and bonds that provide
the holder of that instrument with a claim over real assets or a future income stream.

Australian Securities Exchange (ASX): is the major share market in Australia, where the
purchase and sale of most shares in public companies occurs. The share market brings
together people wishing to buy and sell shares to allow transactions to occur.

Main financial markets that exist in economies:

Share or equity market Ownership of shares in companies are

issued or exchanged
The debt market Debt securities are exchanged, or cash is
lent/borrowed.
The derivatives market Where people buy and sell financial
markets that are based off other financial
assets
The foreign exchange market Financial assets in one country’s currency
are exchanged in another.

Financial Institutions:

1. Finance companies: borrow funds by borrowing from the public.

2. Investment Banks: borrow on a short term basis from companies and lend these
funds to larger businesses and government.
3. Credit Unions: non-profit organisations for people in specific trade, industry or
profession.
4. Permanent building societies: mainly for home loans, sometimes business loans
as well.
5. Mortgage Originators: mortgage funds
6. Superannuation funds: help employees save for retirement.
12.3 Financial Market Products

Consumer Credit Allows a consumer to purchase consumer goods and services in

advance of actual payment. E.g. a credit card
Housing Loans Offered by banks and mortgage originators, these are long term
loans used to purchase property, requiring periodic repayments
with interest
Business loans Form of debt that allows businesses to invest in their business
operations such as with new technology or expand office space
Short term money Brings together those with temporary shortages and those with a
market surplus of funds. E.g. banks issuing debt securities to individuals
Bonds Are written records of debt. The borrower sells a bond in return for
the loan. The holder of the bond receives interest payments and the
final repayment. Only a small number of banks do this.
Financial Futures Are contracts to trade in financial instruments (such as a share or a
and options bond) at a later date for a certain price
Foreign exchange A market for buying and selling foreign currencies
market

12.4 The Share Market

Share: is a type of financial asset that provides an individual with ownership of a part of
a company or a business. Many rely on shares as a form of income.

What is a share market?

 The financial market where investors buy and sell shares
 Only “incorporated” companies (recognised as a separate legal entity) can be in
the share market. This means it has limited liability.
 Must also be a public company: its shares can be freely traded in the share
market
 Share market brings together the demand and supply of ownership of public
companies.
 Largest share market in Aus. is the Australian Securities Exchange (ASX)
 41% Aussies have shares (highest in the world)

Role and Function

Dividends: Is the profit returns received by the shareholder (owners) of a business.

Capital Gains: are the profits made by investors who sell their shares at a higher price
than originally bought at.
Float: occurs when a company lists itself on the stock exchange for the first time to the
general public.

Role for Investors

to gain a proportion of any profit the

company makes through dividends

Capital gain when they sell their

shares

gives investors the right to vote for a

company board of directors

Role for Companies

opportunity to raise new funds for
expansion of the business
however it does loose control over
full ownership

Effect on the economy

Speculation: occurs when investors buy assets with the intention of reselling them for a
higher price within a short period.

 Share market is seen as a general indicator of how an economy is doing.

 Reflects consumer confidence
 High market price reflects positive economic conditions (reverse for an economy
heading towards a recession.)
 Share market acts to allocate resources, we can predict where there will be
growth in an economy by looking at the areas of investment from shareholders
 However speculative purchases of shares can distort this.

12.5 Domestic and Global Markets

Pro: more investment from foreign sources leads to more capital

Con: more susceptible to foreign economic problem (GFC) and regular disturbances
from international sources

Foreign Exchange Market: enable the movement of funds around the world- Aus was
open to this since 1983

Global debt Market: important for Australia’s economic development because of its
dependence on foreign borrowing.

Equity Market: regulated by national governments, such as the New York Stock
Exchange

The global market is regulated in a minor way by:

  Bank of International Settlement- set standards for banking regulations
 International Monetary Fund: oversees general stability through the monitoring
of different economies.

Financial Regulators

Reserve Bank of Australia (RBA)

 Australia's central bank; overall management of the financial system
 Responsible for monetary policy, payment systems regulation and stability of the
financial system
 Three main objectives according to its charter: stability of Australia's currency,
maintenance of full employment and ensuring economic prosperity and welfare of
Australia n people
 Conducts monetary policy on behalf of the government- influences the cost and
availability of money in Australia by determining the general level of interest rates
 Primary aim of achieving a sustained low inflation rate while encouraging
economic growth
 Decides how much money will be printed based on consumer demand (actual
production of currency is done by The Mint)
 Responsible for the payments system; 'Banker to the banks'; has an exchange
settlement account with all Australian banks
 Oversees dealers in the foreign exchange market
 Provides banking to the governments
 Acts as a source of financial advice to the government

Australian Prudential Regulation Authority (APRA)

 Responsible for supervision and regulation of all deposit-taking institutions
(ADIs), insurance providers and superannuation funds
 Encourages behaviour by institutions to meet obligations to the people who place
money within them
 Provides assistance and recovery to ADIs that experience financial difficulty

Australian Securities and Investment Commission (ASIC)

 Responsible for corporate regulation, consumer protection and oversight of
financial services
 Aim of protecting investors and consumers
 Power to monitor, investigate and act in situations where the integrity of the
financial system has been undermined by illegal or unethical dealing
 National regulator of consumer credit and security markets
 Is not responsible for stopping companies making losses or people investing in
high-risk enterprises

Australian Treasury
 Responsible for advising the government on financial security issues and
constructs legislative and regulatory framework for the financial system
 Main source of economic policy advice for the government; fiscal policy
 Influences budgets, method of tax collection, regulatory setting for financial
markets etc
Supply of Funds

 There are four characteristics of money:

- It is a medium of exchange for goods and services
- It is a measure of value to compare goods and services
- It is a store of value to measure the worth of goods and services over time
- It is method of deferred payment to allow a system of lending and borrowing
to develop
 Money supply refers to the total amount of money in an economy
 Physical currency makes up approximately 5% of total money supply
 Credit is not included in the money supply
 Money supply can be measured with three main indicators called financial
aggregates:
 Money Base= Currency + Bank Deposits with RBA
 Consumer Price Index (CPI) refers to the change in price of necessities per
month
 Headline Inflation refers to a measure of inflation by taking into account the CPI
of a range of items
 Underlying Inflation refers to a measure of inflation that does not include
volatile items

Interest Rates and Domestic Market Operations

 Interest rates are the cost of borrowing funds expressed as a percentage of the
total amount borrowed (in other words, the cost of money)
 Interest rate differential is the difference financial institutions charge between
the borrowing rate (return given to those who place funds in financial
institutions) and the lending rate (amount charged by financial institutions to
those who borrow funds) and is how they make profit

Factors Affecting Interest Rates

Upward Pressure Downward Pressure
High demand for capital goods, leading Low demand for capital goods, leading
to increased levels of borrowing to increased levels of savings
High inflationary expectations, Low inflationary expectations, raising
reducing the value of financial assets the value of financial assets
High international interest rates, Low international interest rates,
resulting in more funds moving resulting in less funds moving offshore
offshore

 Essentially lower supply of funds upwards pressure on interest rates; higher

supply of funds downwards pressure on interest rates
 There is a 12-18 month time lag between the first and last steps of tightening/
loosening monetary policy