Introduction to finance

LECTURE 2
(financial systems)
Finance is the application of economic principles to decision-making that involves
the allocation of money under conditions of uncertainty. In other words, in finance
we worry about money, and we worry about the future. So, we can say finance is
about managing money.

*If you want to invest it means you want to buy an asset either this asset
financial asset or real asset but if you deposit your money in the bank it`s
considered as savings.

There are two parties in the financial systems borrowers and savers.

Borrowers: have a shortage of fund because they consume more than their income,
but they have an investment opportunities.

Savers: have an excess of fund but they don`t have an investment opportunityFinancial
systems: is the channel through which the economic entities that have anexcess of fund
can meet the other entities that have a shortage of fund.
deposits interest

Ex: Savers Banks Borrowers

Interest loans

In this case the savers have claims on the bank not the borrowers. This type of
financing is indirect finance because The banks and the other financial institutions
They are intermediaries and responsible for transferring money between savers and
borrowers.
Financial systems

Financial markets financial institutions

Playing an important role as they are the financial

A direct channel between the intermediaries between the

Issuers and investors. savers and Borrowers.

1
Introduction to finance

Examples on financial institutions: banks, mutual fund, pension fund, insurance

companies and others.
*mutual funds: A mutual fund is an investment vehicle that pools investors'
money and invests it mainly in financial markets to generate returns. The
combined holding of the fund is known as its portfolio.
*pension fund: A Pension funds commits the employer to make regular
contributions to a pool of money to cover the pensions of employees after their
retirement in the future. The fund invest that money mainly in the financial
market to multiply it, which will potentially provide more benefit to the retirees.
*insurance companies: the insurance companies guarantees to compensate the
insured for any losses incurred due to the covered contingency occurring. The
contingency is the occurrence that results in a loss. It might be the
policyholder's death or the property being damaged or destroyed. insurance
company portfolios are largely made up of fixed-income securities .

In corporates when

1-) the expenses > revenues it needs to raise fund in other

words to make a finance decision to cover the gap that

happening due to insufficient revenues.

2-) the revenues > expenses the corporate has an excess

fund that will invest it so it will make an investment decision.

2
Introduction to finance

*If the corporate wants to raise fund by selling securities they have to sell themin
the financial market by issuing financial securities.

Financial securities

Equity securities Debt securities

Stocks(cs, preferred) (bonds)

Issuer(Corp) financial security security holder(Corp, retail)

*if the investor going to the financial market and buying a stock of specific
corporate it is consider as a direct finance because the two parties knowing each
other.

* if the investor wants to buy units in mutual fund this is an indirect investment in
the financial markets

* when the investor investing by himself in the financial market he is called retail
investor and if the financial institution such as pension fund or mutual fund
investing in the financial market we called them institutional investor.

How The Fund Flow in the economy ?

Through the financial system

3
Introduction to finance

The arrows show that funds flow from lender-savers to borrower-spenders via two
routes: direct finance, in which borrowers borrow funds directly from financial
markets by selling securities, and indirect finance, in which a financial intermediary
borrows funds from lender-savers and then uses these funds to make loans to
borrower-spenders.

financial intermediaries such as pension funds, mutual funds, insurance companies

when they have excess of fund they invest by themselves directly in the financial
markets.

The economic function of the financial system is to make an efficient allocation of

funds and this is happening by encouraging people to invest their money in the system
rather than keeping it as savings.

Types of financial markets based on their maturity

Financial markets

Money market capital market

Have a maturity less than one year Have a maturity more than one year
Ex: treasury bills ( by government) Ex: stocks, bonds, units of mutual
Commercial papers ( by corporate) funds, ETFs.

Capital market (financial securities)

Equity securities Debt securities

Common preferred corporate treasury

Stocks stocks bonds bonds

4
Introduction to finance

What are the differences between the common stocks and preferred stocks?

*Common stocks and preferred stocks have no maturity date .and the only
issuerfor them is the publicly held corporation. The individual who holds the
common stock is called investor.

Bonds

5
Introduction to finance

*bonds can be issued either by the corporates or government . The individual whohold the
bond is called creditor.

* treasury bills issued by the government.

* if you sell the bond before it`s maturity date the return on it will be the
interest rate and the difference in the market price of the bond , but if you sell it
on maturity you will get the interest rate and the face value.

* Preferred stocks and bonds are fixed income securities.

How the corporates issuing the financial securities ?

If the corporate unlisted and wants to be listed in the exchange market it needs
an investment bank. That helping it to going public for the first time in the primary
market
*investment banks is a type of financial institutions that help the issuers in selling
their stocks.

6
Introduction to finance

Investment bank vs commercial bank

Investment banks Commercial banks

Don`t take deposits Take deposits

Don`t provide loans Providing a lending service to their

customers (loans)

Have a few hundred core May have millions of clients

customers or less

Providing services: assist in Providing services: current, saving

raising financial accounts.
capital by underwriting or acting
Credit and debit cards
as the client's agent in
the issuance of securities. may Mortgages and personal loans
also assist companies involved Don`t provide strategic advice to
in mergers and acquisitions companies

Ex of Investment banks in Egypt: Ex of Commercial banks in Egypt:

• National Bank of Egypt.
• Miser Financial Investments • Agricultural Bank of Egypt.
Company • Bank of Alexandria.
• NAEEM Financial Investments • Commercial International Bank (CIB)

• EFG Hermes
• Pharos Holding for Financial
Investments

7
Introduction to finance

Primary market vs secondary market

Basis of Comparison Primary Market Secondary Market

Meaning A platform that offers The market where

security for the first investor’s trade already
time is the primary issued securities is
market. known as the secondary
market.
Type of product Products are limited, and Many products are
mainly include initial available such as shares
public offering (IPO) and bonds.
Purchase type All the purchases in this The issuer (company
market happen directly. raising capital) is not
involved in the trading
Frequency of selling Security can be sold to Here the traders can buy
the investors just once in and sell the shares as
this market. many times they want.
Parties involved Company and the Here investors buy and
investors are involved in sell the securities among
buying and selling the themselves.
security.
Beneficiary Company Investor
Intermediary Underwriters are the Here the intermediaries
intermediaries in the are the brokers and
primary market. dealers.
(investment bank)
Purpose Help new and existing Does not provide funding
companies to raise to companies; rather
capital for expansion help investors to make
money.

8
Introduction to finance

Price The company sells the Both buy and sell-side

shares to the investors investors work towards
at a fixed price. (par finding the best price for
value) the trade. (market
value)
Rules and The company investors and brokers
Regulations issuing securities goes need to follow the rules
through a lot of set by The Financial
regulation set by The Regulatory Authority
Financial Regulatory (FRA)
Authority (FRA)