Financial Environment and Financial Planning - Vocabulary

What is Finance?

• Study of how individuals, institutions, governments, and businesses:
  • Acquire money and other financial assets.
  • Spend money and assets.
  • Manage money and assets.
• Everyday decision to:
  • Spend now (e.g., clothes, dinner).
  • Save or invest for future spending.

Origins of Finance:

• Economics: Supply and demand determine prices and quantities.
  • Finance: Price of products/securities, exchange rates, interest rates.
• Accounting: Record-keeping of revenues, expenses, profitability.
  • Finance: Use financial statements to evaluate financial position, firm performance, project feasibility.

Functions of the Financial System

• Network of financial institutions and markets facilitating the movement of funds from savers to borrowers.
• Three components:
  • Financial Institutions / Intermediaries (FI).
  • Financial Markets (FM).
  • Economic Units.
• Functions:
  1. Ensure liquidity.
  2. Facilitate smooth financial transactions.
  3. Monitor corporate governance.
  4. Provide risk management.
  5. Enable economic activities and growth.

Financial Institutions / Intermediaries (FIs)

• Help financial system operate efficiently.
• Engage in financial activities to aid the flow of funds from savers to borrowers.

Types of FIs:

1. Depository Institutions (DI)
   • Commercial banks
   • Savings and loan associations
   • Savings banks
   • Credit unions
2. Contractual Saving Organizations
   • Insurance companies
   • Pension funds
3. Securities Firms
   • Investment companies (mutual funds)
   • Investment banking firms
   • Brokerage firms
4. Finance Firms
   • Finance companies
   • Mortgage banking firms

Depository Institutions (DI)

• Accept deposits from individuals.
• Lend pooled savings to businesses, governments, and individuals or invest in securities.
• Examples:
  • Commercial banks.
  • Savings and loan associations (S&Ls).
  • Savings banks.
  • Credit unions (CU).

Commercial Banks

• Accept deposits.
  • Sources of Funds:
  • Check-writing accounts.
  • Saving accounts.
  • Time deposits (Fixed, CDs).
  • Uses of Funds:
  • Make loans to businesses and individuals.
  • Invest in securities.

Types of Deposits at Banks

• Checking Accounts or Current Accounts
  • Liquid assets; money available on demand.
  • Require account and money in account.
• Savings Accounts
  • Money available on demand.
  • Passbook given, no checks.
  • Interest earned.
  • Risk: ↓, Return: ↓, Liquidity: ↑
• Fixed-Rate Accounts (Fixed Deposit/Time Deposit/Certificate of Deposit: CD)
  • Deposit equal amount for a fixed period (6, 12, 24 months, or 3-5 years).
  • Penalty for early withdrawals.
  • Non-Negotiable Certificate of Deposit(CD).
  • Interest: Fixed account > Savings account, Liquidity: Fixed account < Savings account

Economic Cycle

• Four phases: Expansion, Peak, Contraction, Recovery. Policy rate changes in response to economic conditions.
• Real GDP indicates economic trends.

Deposit Protection Agency (DPA)

• Guarantees deposits in financial institutions under DPA Thailand.
• Protected depositors: Retail and Juristic persons
• Deposits under DPA Coverage are protected, deposits not covered include: Foreign currency, Non-Resident Baht Accounts, Structured deposits, Interbank deposits, Deposits in Specialized Financial Institutions (SFI), E-wallets/E-money

Savings Banks

• Focus on consumer and mortgage loans.
  • Sources of Funds: Savings of individuals.
  • Uses of Funds:
  • Consumer loans or mortgage loans to individuals.
  • EX: car mortgage, home mortgage, etc.

Mortgage Loans

• Loan to buy real property (house, land, car).
• Secured Loans: Use real property as collateral.
• Collateral: Guarantees the loan.
• Amortization: Series of equal payments (annuity).
• Fixed interval payments for a specific time.

Savings and Loan Associations (S&Ls)

• Accept individual savings and lend to businesses and individuals.
  • Sources of Funds: Deposits.
  • Uses of Funds: Make mortgage loans to individuals and businesses (focus on individuals).

Credit Unions

• Cooperative, non-profit organizations.
• Organized by individuals with common bonds (occupation, labor, university).
  • Sources of Funds:
  • Savings of members.
  • Selling shares to members.
  • Uses of Funds: Provide consumer credits to members (financing automobiles, homes).

Contractual Savings Organizations

• Insurance companies and pension funds.
  • Sources of Fund:
  • Insurance companies: Premiums
  • Pension funds: Contributions.
  • Uses of Fund: Invest in debt and equity securities.

Insurance Companies

• Sell long-term contractual agreements.

• Provide financial protection for life, property, liability, health.

  • Sources of Funds: Premiums from policyholders.
  • Uses of Funds: Invest funds until claims must be paid.

• Types:

  • Life Insurance.
  • Health Insurance.
  • Property Insurance.
  • Liability insurance.

Pension Funds

• Provide pension benefits for employees at retirement.
• Organized by private or government-sponsored plans.
• Purpose: Provide income during retirement.
  • Sources of Funds: Contributions from employees and employers.
  • Uses of Funds: Invest the proceeds on behalf of employees.

Private Pension Fund

• Provident Fund (PVD): Voluntary contributions from employers and employees.

Government-Sponsored Plans

• May involve federal, state, or local government.
• Social Security (SS) is the largest federal pension plan.
• Provide only minimum retirement benefits.
• Funded by currently working individuals paying taxes.

Social Security (SS) Plan Benefits

1. Injury or sickness benefits, including health promotion and disease prevention
2. Maternity benefits
3. Disability benefits
4. Death benefits
5. Child benefits
6. Old-age benefits
7. Unemployment benefits

Securities Firms

• Deal with securities and investment.

Types of Securities Firms

• Investment companies (mutual funds, asset management companies).
• Investment banking firms (investment bank, IB).
• Brokerage firms (brokers).
• Dealers.

Investment Companies

• Combine small amounts of money from small savers and invest in securities.
  • Sources of Funds: Sell investment unit (shares) to investors.
  • Uses of Funds: Invest the pooled proceeds in securities.

Mutual Funds Function

• Invest money in portfolio of securities under investment strategies and objectives.
• Benefit: Diversification

Money Market Mutual Funds (MMMF)

Investment Policy:

• Invest in money market instruments only.
  Characteristics:
• Risk: ↓, Return: ↓, Liquidity: ↑.

Investment Banking Firms (IB, Investment Banks, Investment Bankers)

• Provide advice to businesses, help firms raise capital Function:
• Sell new securities issued by businesses to individual and institutional investors.
• Initial Public Offering (IPO): Initial sale of a firm’s equity to the public.

Functions of Investment Bankers

1. Originating
   • Public Offering (PO)
   • Private Placement (PP)
2. Underwriting
   • Underwriting Agreement
   • Best Effort Agreement
3. Selling
   • Lead banker
   • Syndicates

Public Offering (PO)

• Sale of securities to the public.
• Regulated by the SEC.

Private Placement (PP)

• Sale of securities to a small group of private investors.
• Fewer regulations.
• Securities sold to investors meeting SEC guidelines.

Originating

Investment Bankers recommend:

• Types
• Terms
• Offering price of securities
• Timing

Prospectus

• Details the issuer's finances and other performances required by SEC.
• Must be provided to each buyer of security.

Types of Underwriting

1. Underwriting Agreement
   • IBs buy all securities from an issuer at a predetermined price.
   • IBs resell securities to investors at offer price.
   • IBs receive spread: (Offer Price – Predetermined Price).
2. Best-Effort Agreement
   • IBs help to sell securities at their best effort (try).
   • IBs receive fees (commissions) for securities they sell.

Selling

• IBs sell new issues to individual investors.
• Need to resell securities above cost for expenses and profit.
• Regulatory authorities permit advertisement of security offerings in newspapers and others called tombstones

Syndicates

• Several IBs as a group.

Lead Bankers

• The IB chosen to originate and handle a flotation.

Brokerage Firms

• Act as customers’ agents, not gathering savings.
  • Functions: Assist individuals to buy/sell securities, earn commissions.

Ethical Issues

• Churning: Unethical practice of excessive trading to generate commissions.

Dealers

• Satisfy investors' trades by buying and selling securities from own inventory.
• Keep inventories of securities; trade with own capital.
• Make a profit on spread (Difference between Bid and Ask prices).

Finance Firms

• Make loans to households and businesses.

Types of Finance Firms:

• Sales and consumer finance
• Consumer finance companies
• Commercial finance companies

Sales Finance Companies

• Associated with large corporations to increase product sales.
• Make installment loans for automobiles and durable goods.

Consumer Finance Companies

• Provide small loans to individuals and households (e.g., Easy buy , AEON ).

Commercial Finance Companies

• Provide loans to businesses unable to obtain financing from commercial banks.
• Functions:
  • Factoring
  • Leasing

Factoring

• Firm sells A/R before maturity (Factors buy A/R at a discount).

Leasing

• Contractual arrangement between leasing company (lessor) and customer (lessee).

Ethical Decision Making

Building a culture of integrity in the workplace starts with management team which help promoting ethical behavior.
It is good for business, individuals, firms, the industry, and the markets, as well as society as a whole.

EX: Unethical Financial Practices

• Misleading advertising
• Predatory lending
• Ponzi schemes
• Conflict of interest