Advanced Finance Dr. Parviz Aghili 1390-91 2 nd term Introduction - - PowerPoint PPT Presentation

1390-91 2nd term

Sharif University of Technology Graduate School of Management and Economics

Advanced Finance

• Dr. Parviz Aghili



The financial system is the mechanism through which loanable funds reach borrowers. Through the operation of the financial markets, money is exchanged for financial claims in the form of stocks, bonds, and other securities, effectively transforming savings into investment so that production, employment, and income can grow.

Introduction



A financial asset is …  a claim against the income or wealth of a business firm, household, or unit of government,  represented usually by a certificate, receipt, computer record file, or other legal document,  and usually created by or related to the lending of money.

The Creation of Financial Assets



 Financial assets are sought after because they promise future returns to their owners and serve as a store of value (purchasing power).  They do not depreciate like physical goods, and their physical condition or form is usually not relevant in determining their market value.  Their cost of transportation and storage is low, such that they have little or no value as a commodity.  Financial assets are fungible – they can easily be changed in form and substituted for other assets.

Characteristics of Financial Assets



 Any financial asset that is generally accepted in payment

for the purchases of goods and services is a form of

• money. Examples include currency and checking accounts.

 Equities represent ownership shares in a business firm

and are claims against the firm’s profits and proceeds from the sale of its assets. Common stock and preferred stock are equities.

Different Kinds of Financial Assets



 Debt securities entitle their holders to a priority claim

• ver the holders of equities to the assets and income of

an economic unit. They are either negotiable or

• nonnegotiable. Examples include bonds, notes, accounts

payable, and savings deposits.

 Derivatives have a market value that is tied to or

influenced by the value or return on a financial asset. Examples include futures contracts, options, and swaps.

Different Kinds of Financial Assets



large time deposits, Institutional money-market funds, repurchase agreements, and

• ther larger liquid

assets.

+

M 3 Household holdings of savings deposits, small time deposits, and non- institutional money market funds.

+

M 2

What is Money?

The most liquid forms

• f money,

namely currency and checkable deposits. M 1



 Financial systems change constantly in response to shifting demands from the public, the development of new technology, and changes in laws and regulations.  Over time, the ways of carrying out financial transactions have evolved in complexity.  In particular, the transfer of funds from savers to borrowers can be accomplished in at least three different ways.

The Evolution of Financial Transactions



 Direct Finance – Direct lending gives rise to direct claims

against borrowers.

The Evolution of Financial Transactions

Ultimate user of funds (DBUs) Ultimate supplier

• f funds

(SBUs)

Flow of funds

(loans of spending power for an agreed-upon period of time)

Primary Securities

(stocks, bonds, notes, etc., evidencing direct claims against borrowers)

 Simple  Difficult to match & risky



 Semidirect Finance – Direct lending with the aid of market

makers who assist in the sale of direct claims against borrowers.

The Evolution of Financial Transactions

 Lower search (information) costs  Risky & matching is still required

Ultimate users

• f funds

(DBUs)

Ultimate suppliers

• f funds

(SBUs)

Flow of funds

(loans of spending power)

Security brokers, dealers, & investment bankers Primary Securities

(direct claims against borrowers)

Primary Securities

(direct claims against borrowers)

Proceeds of security sales

(less fees and commissions)



 Indirect Finance – Financial intermediation of funds.

The Evolution of Financial Transactions

 Low risk & affordable

Ultimate users of funds (DBUs) Ultimate suppliers of funds (SBUs)

Flow of funds

(loans of spending power)

Financial intermediaries

(banks, savings and loan associations, insurance companies, credit unions, mutual funds, finance companies, pension funds)

Secondary Securities

(indirect claims against ultimate borrowers issued by financial intermediaries in the form of deposits, insurance policies, retirement savings accounts, etc.)

Primary Securities

(direct claims against ultimate borrowers in the form of loan contracts, stocks, bonds, notes, etc.)

Flow of funds

(loans of spending power)



 Lesser-developed financial systems are often bank- dominated financial systems, in which banks and other similar institutions dominate in supplying credit and attracting savings.  The more mature systems today are becoming security- dominated financial systems, in which traditional intermediaries play lesser roles and growing numbers of borrowers sell securities to the public to raise the funds they need.

Bank-Dominated Vs. Security-Dominated Financial Systems



 where financial instruments are bought and sold  these markets provide

 liquidity for buying/selling  information through prices  risk-sharing among buyers/sellers

 classified in various ways…

Financial Markets



 primary market

 newly issued securities

• - investment banking

 secondary market

 brokers match buyers and sellers  dealers act as buyers and sellers

• - “market-makers”

Primary vs. Secondary Markets



debt security

 cash flows are fixed  bonds, loans

equity security

 cash flow variable, residual  common stock

Debt vs. Equity Markets



 exchange

 buying & selling of securities in physical location  NYSE

 OTC (over-the-counter)

 dealers in many locations buy & sell securities

Exchanges vs. OTC Markets



 money market

 short-term debt securities (up to 1 yr.)  highly liquid, low risk

 capital market

 longer-term debt  equity

Money vs. Capital Markets

Money Market

20% 25% 39% 9% 0% 4% 3%

U.S. Tbills CDs Commercial Paper Banker's Acceptances Repos Federal Funds Eurodollars

Capital Market

4% 8% 11% 18% 59%

Stock Mortgages U.S. bonds Municipal bonds Loans



 Depository institutions derive the bulk of their loanable funds from deposit accounts sold to the public.

 Commercial banks  savings and loan associations  savings banks  credit unions.

Classification of Financial Institutions



 Contractual institutions attract funds by offering legal contracts to protect the saver against risk.

 Insurance companies  pension funds.

Classification of Financial Institutions



 Investment institutions sell shares to the public and invest the proceeds in stocks, bonds, and other assets.

 Investment companies  money market funds  real estate investment trusts.

Classification of Financial Institutions