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What is a primary function of contractual saving institutions?
What is a primary function of contractual saving institutions?
What is the primary function of a financial system?
What is the primary function of a financial system?
What type of funds do finance companies primarily issue to provide lease finance?
What type of funds do finance companies primarily issue to provide lease finance?
What might happen in an economy without a financial system?
What might happen in an economy without a financial system?
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Which statement about unit trusts is correct?
Which statement about unit trusts is correct?
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What characteristic does a hybrid security possess?
What characteristic does a hybrid security possess?
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What types of instruments record the promises of future payments?
What types of instruments record the promises of future payments?
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In the context of the financial system, who are the surplus entities?
In the context of the financial system, who are the surplus entities?
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What defines secured debt?
What defines secured debt?
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What is indicated by the term 'deficit entities'?
What is indicated by the term 'deficit entities'?
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What is the legal process called when a company is winding up its affairs due to financial distress?
What is the legal process called when a company is winding up its affairs due to financial distress?
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Which of the following best describes how a financial system benefits society?
Which of the following best describes how a financial system benefits society?
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Which type of financial instrument can be sold in the financial market?
Which type of financial instrument can be sold in the financial market?
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Which type of instrument is NOT classified as a financial instrument?
Which type of instrument is NOT classified as a financial instrument?
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What is a derivative instrument primarily used for?
What is a derivative instrument primarily used for?
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What may limit surplus entities in utilizing their funds effectively?
What may limit surplus entities in utilizing their funds effectively?
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What is implied by the time value of money?
What is implied by the time value of money?
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What happens to demand when the supply of a particular feature increases while demand remains unchanged?
What happens to demand when the supply of a particular feature increases while demand remains unchanged?
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What does 'no arbitrage' imply in financial markets?
What does 'no arbitrage' imply in financial markets?
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Which of the following factors affects the rate of return on an investment?
Which of the following factors affects the rate of return on an investment?
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What does the financial system facilitate?
What does the financial system facilitate?
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What risk is associated with the possibility of decreasing the value of an investment?
What risk is associated with the possibility of decreasing the value of an investment?
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Which statement best describes surplus entities in the financial system?
Which statement best describes surplus entities in the financial system?
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What does liquidity in finance refer to?
What does liquidity in finance refer to?
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What are the main advantages of direct financing?
What are the main advantages of direct financing?
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Which of the following roles does a dealer perform in the securities market?
Which of the following roles does a dealer perform in the securities market?
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What is a potential disadvantage of direct finance?
What is a potential disadvantage of direct finance?
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What defines the broker's role in financial transactions?
What defines the broker's role in financial transactions?
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What advantage does financial intermediation provide to risk-averse lenders?
What advantage does financial intermediation provide to risk-averse lenders?
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Which of the following describes intermediate finance?
Which of the following describes intermediate finance?
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What is a common issue with direct financing in terms of lender-borrower relationships?
What is a common issue with direct financing in terms of lender-borrower relationships?
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What is the primary purpose of credit ratings?
What is the primary purpose of credit ratings?
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What does the term 'crowding out' refer to in the context of government borrowing?
What does the term 'crowding out' refer to in the context of government borrowing?
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Which of the following best describes treasury notes?
Which of the following best describes treasury notes?
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What role does the Euro market play in financial transactions?
What role does the Euro market play in financial transactions?
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Which sector is NOT part of the domestic economy's four-section division?
Which sector is NOT part of the domestic economy's four-section division?
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What is the primary function of derivative markets?
What is the primary function of derivative markets?
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What does fiscal policy involve?
What does fiscal policy involve?
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What is the primary objective of the World Bank?
What is the primary objective of the World Bank?
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Which of the following is included in the principle risks associated with derivative markets?
Which of the following is included in the principle risks associated with derivative markets?
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Study Notes
Introduction to Financial Systems
- Financial systems are complex mechanisms that transfer funds from surplus entities (those with more income than spending) to deficit entities (those with more spending than income).
- They do this through financial instruments, contracts that represent enforceable promises of future payments.
- Examples of financial instruments include debt, equity, and derivative instruments.
- Financial systems facilitate the creation of real assets, like factories, infrastructure, and housing, by connecting surplus entities to investment opportunities.
Key Financial Concepts
- Risk and Reward: Higher risk investments generally offer higher potential returns, but also carry greater possibility of loss.
- Supply and Demand: The price of a financial instrument is determined by the interaction of supply (available instruments) and demand (desire for the instrument).
- No Arbitrage: Efficient markets prevent the existence of arbitrage opportunities, where an investor could buy a financial instrument at a lower price in one market and sell it for a higher price in another.
- Time Value of Money: Money available today is worth more than the same amount of money in the future, due to the potential to invest and earn returns.
Financial Intermediaries and Institutions
- Financial institutions operate within the larger financial system, facilitating the flow of funds.
- Contractual Saving Institutions: Insurance companies and superannuation funds collect periodic payments from individuals and businesses, investing these funds in financial instruments.
- Finance Companies and General Financiers Issue debt instruments, such as commercial paper, medium-term notes, and bonds, to provide loans and leases to individuals and businesses.
- Unit Trusts: Pool funds from investors and invest these funds, guided by a trust deed, in various assets like loans or shares.
- Securitization: Transforming illiquid assets (like mortgages) into new, more liquid securities with different cash flow streams.
Financial Instruments
- Equity: Represents ownership in a company or asset, with the right to receive dividends (a share of profits) and participate in decisions.
- Ordinary Shares: Have no maturity date and are traded on stock exchanges.
- Dividends: Portion of company profits distributed to shareholders.
- Hybrid Security: Combines characteristics of both debt and equity.
- Debt Instruments: Enforceable agreements specifying the terms of a loan, such as interest rates, payment schedules, and maturity dates.
- Secured Debt: Backed by collateral, an asset that can be seized by the lender if the borrower defaults.
- Negotiable Debt Instruments: Can be traded in the financial market.
- Derivative Instruments: Synthesized financial instruments derived from underlying assets, used to manage risk exposures.
Direct and Intermediate Financing
- Direct Financing: Occurs when a borrower directly raises funds from lenders in the money and capital markets.
- Brokers: Agents who execute orders for their clients but do not trade on their own account.
- Dealers: Make markets by quoting both buy and sell prices for securities.
- Credit Rating Agencies: Evaluate the creditworthiness of borrowers, providing information on their ability to meet their financial obligations.
- Advantages of Direct Financing: Lower intermediation costs, access to diverse funding sources.
- Disadvantages of Direct Financing: Matching preferences of lenders and borrowers, transaction costs, default risk.
- Intermediate Financing: Involves financial intermediaries, such as banks, who facilitate the flow of funds between surplus and deficit entities by acquiring financial instruments created through transactions.
- Advantages of Financial Intermediation: Reduced risk for lenders, increased access to financing for borrowers.
- Euromarkets: Operate internationally, facilitating financial transactions in currencies different from the country where the institution operates.
- Government Debt: Government borrowing through short-term liquidity or long-term capital expenditure instruments like treasury notes and bonds.
- Crowding Out: When government borrowing reduces the amount of funds available for other borrowers in the financial system.
Financial Markets and Flows of Funds
- Foreign Exchange Market: Facilitates the buying and selling of foreign currencies.
- Derivative Markets: Offer risk management products like futures, forwards, options, and swaps, helping borrowers manage interest rate and exchange rate risks.
- Deficit Units: Borrowers or users of funds.
- Sectorial Flows of Funds: Movement of surplus and deficit funds between different sectors within an economy such as businesses, financial institutions, governments, and households.
- Fiscal Policy: Government's management of revenue and spending to influence the economy.
- Compulsory Superannuation: Retirement savings mandated by law in Australia, requiring employers to contribute to employee superannuation accounts.
International Organizations
- World Bank: A global organization dedicated to reducing poverty in developing countries.
- IMF (International Monetary Fund): International organization focused on promoting financial stability, trade, and economic growth.
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Description
This quiz explores the fundamentals of financial systems, including the transfer of funds, financial instruments, and key concepts such as risk and reward. Understand how these systems facilitate investment in real assets and the principles guiding financial markets.
