Introduction To Financial Markets PDF

Introduction to Financial Markets Unit 1 The Financial System Prof. Dr. M. De Ceuster Prof. Dr. M. De Ceuster Introduction to Financial Markets 1 / 40  The Actors...

Introduction to Financial Markets Unit 1 The Financial System Prof. Dr. M. De Ceuster Prof. Dr. M. De Ceuster Introduction to Financial Markets 1 / 40  The Actors Section 1 The Actors Prof. Dr. M. De Ceuster Introduction to Financial Markets 2 / 40  The Actors Haves or Havenots? The economy consists out of haves and havenots. Haves possess capital and can lend it out (Lenders). Havenots have more needs than money and they will have to raise capital (borrowers). Would you consider the following entities as haves or havenots on a macroeconomic level? Corporates The government Households The financial industry The rest of the world Prof. Dr. M. De Ceuster Introduction to Financial Markets 3 / 40  The Actors The Main Actor: Households When a single household owns a house of 100 but at the same time has a remaining mortgage debt of 80, its net wealth is 20. Net wealth = assets - liabilities The household balance sheet gives an overview of the assets and the liabilities of a single household. Prof. Dr. M. De Ceuster Introduction to Financial Markets 4 / 40  The Actors The Household Balance Sheet Prof. Dr. M. De Ceuster Introduction to Financial Markets 5 / 40  The Actors Kinds of assets An asset is a possession that has value in an exchange transaction. Tangible assets or real assets derive value from their physical character and the utility they generate. Intangible assets derive value from a legal claim to some future benefit. Financial assets are intangible assets that represent a claim to future cash. Prof. Dr. M. De Ceuster Introduction to Financial Markets 6 / 40  The Actors Real versus Financial Assets Source: Credit Suisse, Global Wealth Report 2018 Prof. Dr. M. De Ceuster Introduction to Financial Markets 7 / 40  The Actors Asset Classes Traditional Common stock Bonds Cash (and cash equivalents) Alternative Real estate Commodities Private equity Hedge funds Venture capital Currencies (forex) Prof. Dr. M. De Ceuster Introduction to Financial Markets 8 / 40  The Actors Liabilities Mortgage loans Consumer loans Tax debt Prof. Dr. M. De Ceuster Introduction to Financial Markets 9 / 40  The Actors Growth Drivers in Net Wealth Value changes in assets and liabilities Net-income from labour, capital or transfers (i.e. pensions, social security based income) Inheritances, gifts Prof. Dr. M. De Ceuster Introduction to Financial Markets 10 / 40  The Actors Wealth Creation “Assets put money in your pocket, whether you work or not, and liabilities take money from your pocket.” Robert Kiyosaki Prof. Dr. M. De Ceuster Introduction to Financial Markets 11 / 40  The Actors Wealth Creation Prof. Dr. M. De Ceuster Introduction to Financial Markets 12 / 40  The Actors Wealth is Not Uniformly Distributed Prof. Dr. M. De Ceuster Introduction to Financial Markets 13 / 40  The Actors Wealth Distribution Prof. Dr. M. De Ceuster Introduction to Financial Markets 14 / 40  The Actors What Does This Really Mean? VISIT: https://www.gapminder.org/dollar-street/matrix VISIT: https://www.gapminder.org/ignorance/ search for “Hans Rosling” on YouTube Prof. Dr. M. De Ceuster Introduction to Financial Markets 15 / 40  The Actors Wealth Inequality Prof. Dr. M. De Ceuster Introduction to Financial Markets 16 / 40  The Actors Final Thought Do you fully realize that households are the ultimate owners of all assets in the economy? bearers of risk within the financial system? Prof. Dr. M. De Ceuster Introduction to Financial Markets 17 / 40 How do the Balance Sheets of Other Actors Look Like? Section 2 How do the Balance Sheets of Other Actors Look Like? Prof. Dr. M. De Ceuster Introduction to Financial Markets 18 / 40  How do the Balance Sheets of Other Actors Look Like? Corporates Prof. Dr. M. De Ceuster Introduction to Financial Markets 19 / 40  How do the Balance Sheets of Other Actors Look Like? Leverage Companies can be funded with shareholder funds (equity) consisting out of the original equity, rights issues and the retained profit. debt When companies use debt to finance their operations, they use leverage. Most companies use leverage to raise the ROE above the ROA. ROE = return on equity i.e. profit/equity ROA = return on assets i.e. profit/assets Prof. Dr. M. De Ceuster Introduction to Financial Markets 20 / 40  How do the Balance Sheets of Other Actors Look Like? Leverage The famous Dupont scheme relates the ROE to the ROA: ROE = ROA x LM The Leverage Multiplier (LM) is the Assets/Equity ratio. Prof. Dr. M. De Ceuster Introduction to Financial Markets 21 / 40  How do the Balance Sheets of Other Actors Look Like? Financial Sector - Bank Prof. Dr. M. De Ceuster Introduction to Financial Markets 22 / 40  How do the Balance Sheets of Other Actors Look Like? Financial Sector - Bank Prof. Dr. M. De Ceuster Introduction to Financial Markets 23 / 40  How do the Balance Sheets of Other Actors Look Like? Financial Sector - Mutual Fund Prof. Dr. M. De Ceuster Introduction to Financial Markets 24 / 40  How do the Balance Sheets of Other Actors Look Like? Financial Sector - Insurance Company Prof. Dr. M. De Ceuster Introduction to Financial Markets 25 / 40  How do the Balance Sheets of Other Actors Look Like? The Government How does the balance sheet of a government look like? Prof. Dr. M. De Ceuster Introduction to Financial Markets 26 / 40  The Financial System Section 3 The Financial System Prof. Dr. M. De Ceuster Introduction to Financial Markets 27 / 40  The Financial System The Financial System Source: https://www.suomenpankki.fi/en/financial-stability/the-financial-system-in-brief/ Prof. Dr. M. De Ceuster Introduction to Financial Markets 28 / 40  The Financial System Importance Economic growth is linked to financial development. The role of the financial system is to facilitate production, employment, and consumption. Resources are funneled through the system so resources flow to their most efficient uses. Prof. Dr. M. De Ceuster Introduction to Financial Markets 29 / 40  The Financial System The Financial System (Semi-)Direct finance through financial markets Borrowers sell securities directly to lenders in the primary market. After issuance, these securities often can be traded in the secondary market. Money markets Capital markets Direct finance provides financing for governments and corporations. Indirect finance through financial intermediaries An institution stands between lender and borrower. We get a loan from a bank or finance company to buy a car. Prof. Dr. M. De Ceuster Introduction to Financial Markets 30 / 40  The Financial System The financial system Prof. Dr. M. De Ceuster Introduction to Financial Markets 31 / 40  The Financial System Composition of the Financial System Source FSB, Global Monitoring Report on Non-Bank Financial Intermediation, 2018 Prof. Dr. M. De Ceuster Introduction to Financial Markets 32 / 40  Role of the Government Section 4 Role of the Government Prof. Dr. M. De Ceuster Introduction to Financial Markets 33 / 40  Role of the Government Role of the Government in Financial Markets Financial markets play a prominent role in the economy. This calls for regulation if market failure (i.e. not producing services efficiently at the lowest cost) may arise. Disclosure regulation in order to prevent issuers from defrauding (actual or potential) investors by concealing relevant information. Market conduct regulation a.k.a. financial activity regulation in order to prevent insider trading, in order to impose trading rules,... Financial institution regulation in order to prevent the default of financial intermediaries and in order to safeguard the payment system. Restrictions on foreign participants in order to control e.g. the money supply. Prof. Dr. M. De Ceuster Introduction to Financial Markets 34 / 40  Role of the Government Other Potential Roles of the Government Act as financial intermediary (e.g. credit support through loans and guarantees) Influence the markets through monetary policy (i.e. government sensu lato since this task is performed independently by the central bank.) Provide bail outs The last potential role has been actively used in the past but is under discussion. No bail out policies Systemically Important Financial Institutions (SIFIs) Prof. Dr. M. De Ceuster Introduction to Financial Markets 35 / 40  Role of the Government Bail Outs (US) Prof. Dr. M. De Ceuster Introduction to Financial Markets 36 / 40  Review Questions Section 5 Review Questions Prof. Dr. M. De Ceuster Introduction to Financial Markets 37 / 40  Review Questions Unit 1 RQs Can you give examples of borrowers and lenders? How is “net wealth” defined? How can assets be defined? Give examples how assets be categorized? Which asset classes are considered to be traditional? Which asset classes are labelled as “alternative investments”? What are the major liabilities of households? What are money markets? / What are capital markets? What are securities and what are their characteristics? What are primary and secondary markets? Prof. Dr. M. De Ceuster Introduction to Financial Markets 38 / 40  Review Questions Unit 1 RQs Can you identify the growth drivers in net wealth? Under what conditions do you classify a household as poor, middle class or rich? Wealth is not distributed equally over the globe. How can this be visualised/illustrated? Do developed economies exhibit wealth inequality or is this only a characteristic of emerging markets? Explain the difference between equity and debt? What is leverage? Can you compute the the leverage multiplier based on a balance sheet? Do households use leverage? Can you depict the balance sheets of the financial players? Can you identify the main differences between the balance sheet of a corporate vis-à-vis the balance sheet of a bank? Prof. Dr. M. De Ceuster Introduction to Financial M arkets 39 / 40  Review Questions Unit 1 RQs What items are special/unique for the balance sheet of insurance companies? How does direct financing work? What is the difference between direct - semi-direct and indirect finance? Can you give examples of “fee business”? What is shadow banking? (see also chapter 2) Does the government have to play a role in the financial system? If not, argue why? If so, give some examples. Should governments bail out banks if they collapse? Prof. Dr. M. De Ceuster Introduction to Financial Markets 40 / 40