Topic 5

How do financial markets perform the role of channelling funds?

Move savings from those with surplus funds to those who want to borrow and invest

How do financial markets perform the role of providing liquidity?

Let asset-holders convert their investments back into cash quickly when needed

How do financial markets perform the role of lowering costs?

reduce the search, information, and transaction costs of matching lenders to borrowers

How to households contribute to the sources of savings?

the proportion of household income not spent is saved

How to businesses contribute to the sources of savings?

not distributing all profits to their owner

How to governments contribute to the sources of savings?

when government budgets for a surplus it accumulates savings

How do consumers contribute to the reasons for borrowing?

demand for goods and services exceed their current capacity to pay for them

How do businesses contribute to the reasons for borrowing?

borrowing to fund expansions in businesses

How does the government contribute to the reasons for borrowing?

borrow money from overseas

What is the role for primary financial markets?

facilitate the creation of financial assets, known as securities, that can be sold into the economy

What is the role for secondary financial markets?

involve transaction with financial assets that have already been issued on a primary market some other time in the past

What is debt?

the borrower must repay principal plus interest. No ownership changes hands

What is the risk and return for debt?

fixed, contractual return, lower risk, lenders are repaid before equity holders

What is equity?

part-ownership of a company, a residual claim on its profits and assets

What is the risk and return for an equity?

variable return, higher risk, paid last after all debts

What is a derivative?

a contract whose value derives from an underlying asset

What are the risks and returns from a derivative?

used to hedge, or to speculate, leveraged on magnifying both gains and losses

What is consumer credit?

allows consumers to purchase consumer goods and services before actual payment.

What is a housing loan?

mortgages are offered by banks as well as non-finnacial institutions, these are long-term loans used to purchase property requiring periodic repayments with interest

What is a business loan?

A form of debt that allows businesses to invest in business operations

What is the short term money market?

bring together people and businesses with temporary shortages or surplus of funds. Those with surplus funds, such as banks, issue various forms of debt securities to those in need of funds

What is a bond?

bonds are longer term securities for which lenders receive regular fixed payments from the issuing institution, and receive the principal value of debt

What is a financial future and options?

are contracts to trade in financial instruments at a later date for a certain price

What is the foreign exchange?

The market for buying and selling of foreign currencies.

What is the share market?

a market for issuing and trading shares (equity), part ownership of listen companies

What is the role of the share market?

raises equity capital for companies through floats and capital raisings, and provides a liquid second market so investors can buy and sell, and allocates capital towards companies investors think are most productive

What is the share markets effect on the economy?

funds businesses investment, supporting output, jobs and growth.

What is a share?

a type of financial asset that provides an individual with ownership over part of a business or company

What is an investment?

is any current expenditure where the benefits will obtained in the future.

What is a public company?

is an entity whose shares are traded freely on the share market, and are not subject to any restriction in being transferred to other parties

What is a private company?

is an entity where shares are not traded freely

What is a dividend?

are the profit returns received by the shareholders of a businesses

What is a capital gain?

are the profits made by investors who sell their shares or assets at a price above the level that they originally paid fo them

What is a float?

when a company decides to list itself on the stock exchange and offer its shares to the public company for the time

are bonds debt or equity?

equity

are bonds safe or risky?

relatively safe

What are the benefits for investors in the share market?

can make limitless gains due to increasing share price, and losses are limited to only your investment in shares

What are the benefits for a company in the share market?

opportunity to raise funds for investment and growth, and they can list shares at any time by issuing a prospectus

What is a secondary financial market transaction?

When an existing shareholder sells to another investor via a stockbroker

What is the All Ordinaries Index?

measures the overall value of companies listed on the ASX

What is speculation?

where investors buy assets with the intention of re-selling then for a higher price within a short period?

What is the problem with speculation?

these decisions are based on hype and not real profitability. This can lead to a misallocation of resources

Why have global markets increased?

improvements in digital communication, deregulation of financial markets since 1980s

How can income and cash flow be a constraint on raising finance?

can the agent generate enough income or profit to service and repay the debt

How can existing debt be a constraint on raising finance?

high existing leverage limits how much more can safely be borrowed

How can market access and size be a constraint on raising finance?

governments and large firms reach bond and equity markets, households rely on banks

How can security/collateral be a constraint on raising finance?

assets pledged to back borrowing lower the lenders, risk and the cost of funds

How can the cost of funds be a constraint on raising finance?

the interest rate or return demanded rises with risk and with the RBA’s cash rate

How can regulations and confidence be a constraint on raising finance?

responsible lending and APRA rules, plus lender risk appetite that tightens in downturns

What does ASIC stand for?

Australian Securities and Investments Commission

What is the role of ASIC?

it is responsible for corporate regulation, consumer protection and oversight of financial service products

What does the RBA stand for?

Reserve Bank of Australia

What is the role of the RBA?

It is responsible for monetary policy, payments system regulation, providing banking services to the government, the supply of banknotes and the stability of the financial system

What does APRA stand for?

Australian Prudential Regulation Authority

What is the role of APRA?

responsible for prudential supervision and regulation of all deposit-taking institutions, life and general insurance, and superannuation funds

What is the role of the Australian Treasury?

advises the government on macroeconomic and financial stability issues as well as the legislative and regulatory framework for the financial system.

What does the ACCC stand for?

Australian Competition and Consumer Commission

What is the role of the ACCC?

to prevent producers from exploiting consumers with misleading information or by agreeing with their competitors to raise prices

What are Industrial relations

The name for the relationship between employees and employers, which involves the laws, institutions and processes established to resolve the conflict between employers and employees

What is a trade union?

A trade union is an association of workers that aims to advance the interest of its members by improving their wages and working conditions by negotiating wage increases. They also play a roles in presenting employee’s interests in issues such as safety in the workplace and organisation changes such as company restructures.

What are the types of employment contracts?

awards, enterprise agreements, common law contracts

What is the formal system?

awards and collective agreements (can’t be on both)

What are the informal system?

common law contract, and working business owners

What is an enterprise agreement?

It is a workplace agreement that is directly negotiating between an employer and a group of employees

Can enterprise agreements replace an award?

yes, or act as an ‘add on agreement’

How many of employers are on an enterprise agreement?

34%

What is a common law contract?

covers people who are not covered by wards or enterprise agreements

How much of the workplace is covered by a common law contract?

almost 40%

Can a common law contract offer pay rates and conditions below the equivalent award?

No, the only exception is when high pay rates are offered above $183,100

What is liquidity?

the ease with which a financial asset can be transformed into cash so it can be used as a medium of exchange

How does the transaction motive influence the demand for liquidity?

day to day transactions

How does the precautionary motive influence the demand for liquidity?

holding money for unpredictable circumstances and emergencies

How does the speculative motive influence the demand for liquidity?

individuals trying to predict market movements in order to ensure their financial assests bring capital gains

What is medium of exchange?

Goods and services are exchanged for money

What is a measure of value

money can be used to compare the relative value of goods and services and resources

What is a store of value?

Money can be used to measure the value of resources over time

What is a method of deferred payment

money allows a system of lending and borrowing

What is currency?

notes and coins held by the public (household and businesses)

What is m1?

currency and deposits held in transaction bank accounts

What is m3?

M1 + all non-transaction deposits at banks

What is broad money?

M3 + NBFI deposits - NBFI deposits in banks

What is an interest rate?

the rate of return on financial assets or financial instruments, such as shares and bonds. Therefore, it is also the cost of borrowing

What is the borrowing rate?

the borrowing rate is the rate of interest offered on these funds

What is the lending rate?

financial institution charge a rate of interest when they give loans to customers. This is known as the lending rate

What is the interst rate differential?

the difference between the borrowing and lending rate

What is a short term interest rate?

interest rates on loans with a maturity of less than a year are known as short-term interest rates

What is a risk with long term securities?

the potential for change over tiem and are less liquid

How does the demand for capital goods have an impact on market interest rates?

Stronger investment demand will usually lead to higher demand for borrowing by firms seeking to finance their capital expansion, putting upward pressure on interest rates.

How does the level of savings in the economy have an impact on market interest rates?

A higher level of savings means there is an increased supply of loanable funds, which should put downward pressure on interest rates.

How does the demand for liquid funds in the economy have an impact on market interest rates?

If individuals in the economy have a stronger preference for highly liquid funds, they may be willing to forgo the returns from buying securities, and instead choose to hold their funds in bank deposits or in the form of currency.

How does inflationary expectations in the economy have an impact on market interest rates?

if inflation is expected to rise in the economy, lenders would require a higher interest rate to be paid as compensation for the loss of value of their financial assets

How does the gov budget in the economy have an impact on market interest rates?

If the government has a greater level of spending than it receives in revenue, it has a budget deficit, and is a borrower in financial markets. This can result in higher interest rates

How do the international interest rates in the economy have an impact on market interest rates?

Inflation reduces the value of money and financial assets. Therefore, if inflation is expected to rise in the economy, lenders would require a higher interest rate to be paid as compensation for the loss of value of their financial assets

What is monetary policy?

It is a macroeconomic policy that aims to influence the cost and supply of money in the economy in order to influence economic outcomes such as economic growth and inflation

Who administers monetary policy?

The RBA

What is the cash rate?

the rate of interest in the overnight money market - the market for very short term loans between banks

What does the cash rate influence?

many other interest rates in the economy which in turn influence economic activity

How does he RBA use the cash rate?

as a policy tool to influence economic activity in Australia (monetary policy)

How is price used to implement monetary policy?

The price in the overnight money market is the interest rate on the loans. The RBA sets a target for the cash rate

How is quantity used to implement monetary policy?

the quantity traded in this market is called the Exchange Settlement balances, which are used to settle interbank transactions. The RBA can records the value of the ES accounts.