Chapter 12 - Types of Financial Markets

What are financial markets

• Connect savers (those with excess funds) with borrowers (those needing funds)

• Provide financial products offering returns for savers and access to capital for borrowers

• Act as the factor market for capital, which businesses need for production

Why are financial markets important

• One of Australia’s largest industries

• Supports all other sectors by enabling investment and consumption

Definition and role of financial intermediaries

• Definition: Firms (eg. banks) that hold savings as deposits and lend them to others

• Function: Bridge between savers and borrowers in the economy

Sources of savings

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Sector:	How They Save:

Sector:	How They Save:
Households	Income not spent on consumption is saved
Businesses	Profits not distributed to owners are retained as savings
Government	Surplus budgets (revenue > expenditure) lead to savings
Foreign Sector	Savings from individuals/firms/governments overseas are available to borrow

Reasons for borrowing

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Sector:	Why They Borrow:

Sector:	Why They Borrow:
Consumers	To buy goods/services exceeding current income (eg. homes, cars)
Businesses	To start, operate or expand operations
Government	To finance budget deficits (spending > revenue)
Overseas sector	Australia also lends overseas, but is a net borrower globally

Economic role of financial markets

• Enable unspent income to be used for investment and consumption

• Support aggregate demand by mobilising idle funds for current use

• Provide capital for business production, driving economic growth

Monetary policy (interest rate changes) affects

credit availability

Traditionally, consumers saved mostly through banks, now many households use

diverse financial instruments

• Shares

• Managed funds

• Superannuation

What are types of financial markets

Primary market

Secondary market

What is the primary market

Where new securities (shares/bonds) are issued

What is the secondary market

Where existing financial assets are bought/sold

Most financial transactions occur

in the secondary market

What is Australia’s major primary and secondary market

The ASX (Australian Securities Exchange)

Major global financial markets

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Market Type:	Description:

Market Type:	Description:
Share/Equity Market	Where company ownership shares are traded
Debt Market	Where bonds and loans are traded (eg. government bonds)
Derivatives Market	Where financial products based on other assets (eg. futures, options) are traded
Foreign Exchange Market	Where currencies are exchanged

What are financial intermediaries function and its two types

Function: Channel savings - borrowers (connect savers with those needing funds)

Two types:

• Banks: can accept deposits

• Non-bank Financial Intermediaries: Cannot accept deposits

Banks vs Non-Banks

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Feature:	Banks:	Non-Bank Institutions:

Feature:	Banks:	Non-Bank Institutions:
Accept deposits	Yes	No
Offer loans	Yes	Yes
Examples	NAB, CBA, ANZ	Finance companies, fintechs, credit unions
Regulatory challenge	Broadening services complicates oversight and regulation

Key Non-Bank Financial Institutions

Fill out the table

Institution:	Description:

Institution:	Description:
Finance Companies	Borrow funds (often via debt securities) and lend at higher rates. Many use AI for loan decisions (fintechs)
Investment Banks	Lend short-term to large businesses; provide financial advice, manage takeovers and trade securities
Credit Unions	Member-based, non-profit. Offer deposits and loans; profuts returned to members
Building Societies	Focus on home loans and some business/personal loans; interest rates may be state-regulated
Superannuation Funds	Invest employer/employee contributions for retirement income. Major part of financial sector since the 1990s

What is credit

Loans extended to individuals, businesses, governments

Borrowers use credit for consumption and investment

Credit is also

• An asset for the lender/financial intermediary (if generates income)

• A liability for the borrower (must be repaid with interest)

Types of financial market products

• Consumer credit

• Housing loan

• Business loans

• Short-term money market products

• Bonds

• Financial futures and options

• Foreign exchange market

What is consumer credit and an example

Allows present-day spending from future income

Eg.

• Credit cards

• Personal laons

• Buy Now Pay Later

What are housing loan

Long-term loans to purchase property

What are business loans

Used to fund business operations or expansion

What are short-term money market products

Used for temporary fund surpluses or shortages

Include:

• Bank bills

• Promissory notes

What are bonds (debt securities)

Issued by governments, large companies and banks

Provide fixed annual coupon payments

Repay face value at maturity

Yield = Coupon/Bond price

Traded on secondary markets

What are financial futures and options

Contracts to buy/sell assets at a set price in the future

Used to hedge risk (interest rate, currency, share price)

Futures: Binding contract

Options: Right but not obligation to transact

What is the Foreign Exchange Market (Forex)

Trade currencies

Operates 24/7

Employers contribute to employee’s super accounts, which are filled with investments including

shares

bonds

cash

property

Benefits of superannuation to the economy

• Reduces pressure on government retirement income

• Boosts participation in higher-return investments

• Funds help finance

- Mortgages

- Business investments

- New share issues (capital investment)

What is the share market

• A financial market where shares are bought and sold

What are shares

Part-ownership of a public company

The share market allows

companies to raise investment funds

individuals to earn returns on savings

What are the two types of company types and what are their features

Private Company (Pty Ltd): Shares are restricted, not traded on public exchanges

Public Company: Shares are freely traded on the share market. Must be incorporated

What does incorporation mean

A company is a separate legal entity, giving limited liability to shareholders

All trades on the ASX go through

a registered broker

Cboe Australia is

a competitor to the ASX

What is the difference for primary and secondary markets within the share market

Primary: Shares issued by company and funds go to company (eg. IPOs or floats)

Secondary: Existing shares are traded between investors and company receives no new funds

Why do investors buy shares

• Dividends: Profit paid to shareholders per share

• Capital Gains: Profit from selling shares at a higher price

• Voting Rights: Shareholders vote on company board members

• Limited Liability: Can only lose the amount they invested

• Average Returns: ~10% annually over 100 years (RBA data)

Why do companies list on the share market

• To raise funds for expansion and investment

• A company’s first public offering = Float or IPO

• Can issue new shares later with an approved prospectus

• New shares dilute ownership (existing shareholders own a smaller %)

How are share prices set

Determined by supply and demand on the ASX

Influenced by:

• Company earnings and growth

• Confidence in management

• Economic conditions

• Speculation and media hype

Share prices reflect

economic performance (economic indicator)

Share prices are more volatile than

real GDP

Efficient markets channel investment to high-growth industries. However speculation can distort prices and lead to:

Overvaluation of weak companies

Misallocation of resources

What does speculation mean

Buying shares for short term gains, not long-term investment

Advantages and Disadvantages of the Share Market

Advantages:	Risk/Issues:

Advantages:	Risk/Issues:
Raises funds for business expansion	Volatility in share prices
Offers high return potential for investors	Subject to speculation and hype
Allocates capital to high-growth sectors	Not always reflective of real company value
Encourages long-term wealth creation	Economic downturns reduce investor confidence

Key Terms:

Term:	Meaning:
Dividend
Capital Gain
Float/IPO
Fiduciary Duty
Speculation

Term:	Meaning:
Dividend	Profit paid to shareholders per share
Capital Gain	Profit from selling a share above its purchase price
Float/IPO	First sale of company shares to the public
Fiduciary Duty	Legal obligation for managers to act in shareholders’ best interests
Speculation	Short-term share buying for quick resale and profit

Australian financial markets are globally integrated because of

Factor:	Effect:

Factor:	Effect:
Technological advances	Faster fund transfers and communication
Financial deregulation (1980s+)	Opened Australia to foreign investors
Floating the AUD in 1983	Allowed free foreign exchange, removing exchange controls

Global equity markets

Feature:	Description:

Feature:	Description:
National regulation	Equity (share) markets are most country-based, eg. NYSE, Tokyo
Foreign ownership	Foreigners held $1.9 trillion in Australian assets (2023-24)
Aussie ownership abroad	Australians owned $2.4 trillion in foreign shares/assets
Regulation	Overseen by ASIC; foreign share pruchases subject to FIRB (Foreign Investment Review Board) approval

Key Global Financial Organisations

Organisation:	Role:

Organisation:	Role:
Bank for International Settlements (BIS)	Helps central banks ensure global financial stability
Basel Committee	Sets standards for banking regulation
International Monetary Fund (IMF)	Monitors global financial stability; offers aid to countries in crisis
IOSCO	Coordinates regulation of share markets
IAIS	Coordinates insurance regulation globally

Benefits of global financial integration

• Access to foreign capital for:

  -Households (eg. mortgages)

  -Businesses (eg. expansion loans)

• More investment opportunities overseas

• Lower borrowing costs due to larger capital pool

What are the risks of global financial integration?

Risk:	Explanation:

Risk:	Explanation:
Transmission of global shocks	Financial crisises overseas can quickly affect Australia
Speculation	Rapid cross-border speculation adds volatility
Foreign ownership concerns	Public concern about loss of control over key Australian industries

Key Terms

Term:	Definition:
Net borrower
Foreign exchange market
Deregulation
Basel Committee
FIRB
Speculation

Term:	Definition:
Net borrower	A country that borrows more from overseas than it lends
Foreign exchange market	Where currencies are bought and sold
Deregulation	Removal of government controls on financial markets
Basel Committee	Body setting international banking rules
FIRB	Foreign Investment Review Board - screens large investments in Australia
Speculation	Risky, short-term trading for quick profit; can destabilise markets

Why is regulation of financial markets important

• Stable financial markets are vital for:

  -Protecting household savings

  -Preventing business collapse

  -Maintaining confidence and economic growth

• Instability - job losses, bankruptcies, loss of investment, recession

• Government regulation and ensures long-term financial market stability

Main Financial Regulators in Australia

Regulator:	Role:

Regulator:	Role:
RBA (Reserve Bank of Australia)	Monetary policy, financial system stability, banknote issuance, payment systems
APRA (Australian Prudential REgulation Authority)	Supervises banks, insurers and super fudns (ADIs) to esnure financial safety
ASIC (Australian Securities and Investments Commission)	Regulates corporations, financial markets/products and protects consumers
Australian Treasury	Advises government on macroeconomic policy, regulation and financial system legislation

Council of Financial Regulators role

Coordinates policy during crises and has no separate legal powers, operates through collaboration

Reserve Bank of Australia

Function:	Description:

Function:	Description:
Monetary policy	Adjusts interest rates to control inflation and stimulate growth
Financial system stability	Monitors risks, advises APRA
Issues banknotes	Sole issuer of currency via Note Printing Australia
Regulates payment systems	Ensures efficient, safe payment methods
Bankers to banks	Manages settlement accounts and liquidity
Holds foreign reserves	For currency market operations
Government banker/adviser	Manages government accounts, provides economic reports

Australian Prudential Regulation Authority (APRA): regulates banks, credit unions, insurance firms, super funds

Role:	Details:

Role:	Details:
Prudential supervision	Ensures banks/insurers/super funds can meet obligations
Risk management	Sets minimum capital levels; requires risk-modelling systems
Failure resolution	Investigates and intervenes when institutions become unviable

Australian Securities and Investments Commission (ASIC)

Role:	Description:

Role:	Description:
Corporate regulation	Ensures honesty and integrity in companies
Financial market oversight	Prevents misconduct (eg. insider trading, price manipulation)
Consumer protection	Prevents deceptive/unethical practices; regulates credit markets

Treasury - Policy and Regulation Advisory Body

• Advises government on:

  -Financial legislation

  -Corporate and tax policy

  -Stability and structure of markets

• Designed JobKeeper in 2020

• Key adviser during GFC and Covid-19 downturns

Causes of the GFC

• Subprime mortgage defaults in US

• Collapse of confidence in global financial institutions

• Credit froze; asset values plummeted

Global impacts of the GFC

• Collapse of major US/UK/European banks

• Share market crash (~33% losses globally)

• Recession: Global GDP contracted for first time since WWII

Australian impact GFC

• Share market dropped by ⅓

• AUD fell (US95c-US60c)

• Collapse in commodity prices and house prices

• Major stimulus ($80 billion) and bank guarantees helped avoid recession

Outcomes of the GFC

• GFC disproved the myth that financial markets self-regulate

• Reinforced the need for strong financial oversight and intervention

Key Terms

Term:	Definition:
Monetary policy
Prudential regulation
FOFA reforms
CFR
Subprime mortgages

Term:	Definition:
Monetary policy	Central bank actions influencing interest rates and money supply
Prudential regulation	Ensuring financial institutions can meet their obligations
FOFA reforms	Financial adviser reforms ensuring client-first obligations
CFR	Council of Financial Regulators - coordinates RBA, APRA, ASIC Treasury
Subprime mortgages	High-risk loans often given to people with poor creedit history
Greenwashing	Misleading investors about environmental sustainability