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Chapter 3

The financial
markets

PowerPoint to accompany:

Objectives

Define financial markets

Explain the role of financial markets in a developed


economy

Describe financial intermediaries in a developed financial


market

Discuss movement of funds to finance business activities

Describe the various component market groups that


make up the overall Australian financial markets

Outline the main pattern of fund flows underlying the


financing of businesses in Australia

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

What are financial markets?


A complex of institutions,
procedures and arrangements
that facilitate a transfer of funds
from one entity in the economy
to another
Examples of financial sub-markets:
debt market & share market

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Role of financial markets


Net savers of funds
Surplus savings
Suppliers of funds
Fu
nd
s

FINANCIAL
INTERMEDIARY
Facilitation
Fu
nd
s

Net users of funds


Shortage of savings
Demanders of funds

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Development of a financial
market system: Figure 3.1 p. 62

Stage 1

Real assets = net worth

Stage 2

Cash + Real assets = net worth

Stage 3

Cash + Real assets


+ other financial assets
= financial liabilities + net worth

Stage 4

The addition of loan brokers, security


underwriters, and secondary markets

Stage 5

The addition of financial intermediaries

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Types of assets
Real assets

Tangible assets

Houses, equipment, inventory

Financial assets

Securities (e.g. shares, debentures, bills, notes)

Claims for future payments

Owners anticipate earning a future rate of return

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Financial intermediaries

Financial intermediaries facilitate the movement of


money from savers to borrowers:

commercial banks

non-bank authorised deposit-taking institutions

investment banks

insurance companies

superannuation funds

investment companies

private equity firms

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Movement of funds
Examples:

Banks, building societies, credit unions, life insurance


companies, trust funds

Sell indirect securities to net savers

Use the proceeds to purchase direct securities with


increased size and maturity

e.g. Fixed term deposits, life insurance policies

e.g. Debentures, shares

This process is called asset transformation

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Direct transfer of funds: Figure 3.2


(p.69)

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Indirect transfer of funds: Figure


3.3 (p.69)

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Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Components of Australian financial


markets

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Stock market and Bond market

public offerings and private placements

primary and secondary markets

Foreign-exchange markets

Derivatives markets

Money and capital markets

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Foreign-exchange markets

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Transfer of purchasing power from one currency


to another

Networks of licensed foreign-exchange dealers

Very efficient markets

Major types of transactions

Spot transactions

Forward transactions

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Derivatives markets

Derivatives are financial instruments that are


derived from, or based on, the value of an
underlying asset. They are often used to
manage risk
Examples of derivatives:
Futures, options, & swaps
Derivatives may be traded through an organised exchange or
over-the-counter (OTC)

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Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Derivatives markets

(cont)

Futures markets
A

futures contract is a legally binding agreement to buy


or sell the underlying financial instrument or commodity

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specific quantity

specific quality

deliverable at an agreed location

deliverable at an agreed future time

at an agreed price

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Derivatives markets

(contd)

Options markets
An

options contract is an agreement that gives the


holder the right (but not the obligation) to buy or sell
the specified commodity or financial instrument on or
before a specified date

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Call option: the right to buy an asset

Put option: the right to sell an asset

There is a large variety of options-type products

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Money and capital markets


Capital markets

Markets in long-term financial instruments

By convention: terms greater than one year

Long-term debt and equity markets

Bonds, debentures, shares, leases, convertibles

Money markets

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Markets in short-term financial instruments

By convention: terms less than one year

Treasury notes, certificates of deposit, commercial bills,


promissory notes

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Public offerings and Private


Placements

Public offerings

New securities offered to the public

Securities issued through a share-broking firm or a


syndicate of firms

Examples: shares, bonds

Private placements

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New securities only offered to some investors

Often only to existing investors in the company

Examples: shares, bonds

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Primary & Secondary Markets


Primary markets

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Selling of new securities

Funds raised by governments and businesses

Secondary markets

Reselling of existing securities

Adds marketability and liquidity to primary markets

Reduces risk on primary issues

Funds raised by existing security holders

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

The Australian Securities Exchange


In July 2006, the ASX and SFE merged

Australian
Stock
Exchange

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Australian
Securities
Exchange

Sydney
Futures
Exchange

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

The Australian Securities Exchange


(contd)

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Major primary and secondary equity market

Secondary market for debentures, notes and


bonds

Publicly listed company

ASX listing rules

Aim: To provide an efficient, honest, competitive


and informed market for trading

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Pattern of fund flows in Australias


financial markets: Figure 3.4 (p.77)

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Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

End of Chapter 3

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Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition