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Financial Institutions and Market: (ACFN, 2 Credit Hour)

The document provides an overview of key concepts in financial systems, including: 1. Financial systems aim to efficiently transfer funds from entities with surplus funds to those needing funds, potentially spurring economic growth. They consist of financial markets, intermediaries, and regulators. 2. Financial assets are claims that provide future income or asset ownership. Major assets include money, equity, and debt securities. Intermediaries facilitate transactions by obtaining funds from lenders and investing in borrowers. 3. Financial markets allow buying and selling of assets, facilitating efficient allocation of funds. Major markets include stock, debt, money, and capital markets. 4. The financial system provides functions like savings, payments, credit,

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Mikias Degwale
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58 views

Financial Institutions and Market: (ACFN, 2 Credit Hour)

The document provides an overview of key concepts in financial systems, including: 1. Financial systems aim to efficiently transfer funds from entities with surplus funds to those needing funds, potentially spurring economic growth. They consist of financial markets, intermediaries, and regulators. 2. Financial assets are claims that provide future income or asset ownership. Major assets include money, equity, and debt securities. Intermediaries facilitate transactions by obtaining funds from lenders and investing in borrowers. 3. Financial markets allow buying and selling of assets, facilitating efficient allocation of funds. Major markets include stock, debt, money, and capital markets. 4. The financial system provides functions like savings, payments, credit,

Uploaded by

Mikias Degwale
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Financial Institutions and Market

(ACFN, 2 credit hour)

Debre Markos University


College of Business and Economics
Department of Accounting and
Finance (PG-program)
Chapter one
Overview of Financial System
Introduction
• It is through a country’s financial system that entities
with funds allocate those funds to those who have
potentially more productive ways to deploy those
funds, potentially leading to faster growth for a
country’s economy.
• A financial system makes possible a more efficient
transfer of funds by overcoming the information
asymmetry problem between those with funds to
invest and those needing funds.
Cont’d
• The financial system of an economy consists of three
components: (1) financial markets; (2) financial
intermediaries; and (3) financial regulators.
Definition of Financial system
• Financial system is a system that aims at establishing and
providing a regular, smooth, effective and efficient linkage
between depositors and investors.
• Financial system is a set of complex and closely
connected instructions, agents, practices, markets,
transactions, claims and liabilities relating to financial
aspects of an economy.
• Financial system is a system that comprises the interaction
between financial institutions, financial market and
participant in an attempt to transfer funds from severs to
borrowers using financial instrument.
Features of Financial System
 Financial system provides an ideal linkage between depositors
and investors. →It encourages savings and investment.
 Financial system facilitates expansion of financial markets
over space and time.
 Financial system promotes efficient allocation of financial
resources for socially desirable and economically productive
purposes.
 Financial system influences both the quality and the pace of
economic development.
Financial Concepts
An understanding of the financial system
requires an understanding of the following
important concepts.
 Financial asset / financial instruments
 Financial intermediaries
 Financial market
1.Financial Assets
• Financial assets are claims against the assets or
resources of other economic units and are held as a
store of value and for the return that is expected.
 A financial asset is a claim on a stream of income
and/or a claim on a particular asset.
 The entity (or the economic unit) that offers the
future cash flows is the issuer of the financial
instrument; and the owner (holder) of the security
is the investor.
Kinds/Classification of Financial Assets

Although the diverse kinds of securities created and/or


issued whenever money is borrowed and lent in the
financial system constitute what we call financial assets,
there are three basic forms within which all of these
instruments can be categorized. These are:
1. money
2. equity, and

3. debt securities.
Characteristics of Financial Assets
 They are promises to future returns to their
owners.
 They serve as a store of value/store of
purchasing power.
 They cannot be depreciated or do not wear &
tear over time. Moreover, their physical
condition is not relevant in determining their
market value.
Cont’d
 They are represented by a piece of paper that serves
as a contract.
 They do have little and/or no value as a commodity.
 They do have low (or minimal) transport & storage
costs relative to their value.
 They are fungible, that is, easily changed inform
Debt vs. Equity Instruments

 A financial instrument can be classified by the type of


claims that the investor has on the issuer.
 A financial instrument in which the issuer agrees to pay the
investor interest plus repay the amount borrowed is a debt
instrument.
 The interest payments that must be made by the issuer are
fixed contractually. The key point is that the investor in a
debt instrument can realize no more than the contractual
amount. For this reason, debt instruments are often referred
to as fixed income instruments.
Cont’d
 In contrast to a debt obligation, an equity instrument
specifies that the issuer pay the investor an amount
based on earnings, if any, after the obligations that the
issuer is required to make to investors of the firm’s
debt instruments have been paid.
 Some financial instruments fall into both categories
in terms of their attributes. Preferred stock and
convertible bonds are an example. These financial
instruments have the characteristics of both debt and
equity instrument.
Role of Financial Asset

Financial assets serve two principal economic


functions.
1. They allow the transference of funds from
those entities who have surplus funds to
invest to those who need funds to invest in
tangible assets.
2. Risk diversification
Properties of Financial Assets

1. Moneyness
2. Divisibility and denomination
3. Reversibility
4. Cash flows and return predictability
5. Term of maturity
6. Convertibility
7. Currency
8. Liquidity
9. Complexity
10. Tax status
2. Financial Intermediaries
•The term financial intermediary includes all
kinds of organizations which intermediate and
facilitate financial transactions of both individual
and corporate customers.
•Financial intermediaries obtain funds by issuing
financial claims against themselves to market
participants, then investing those funds.
Cont’d
•Thus, it refers to all kinds of financial institutions and
investing institutions, which facilitate financial
transactions in financial markets.
•Financial intermediaries include depository institutions,
regulated investment companies, investment banks, and
insurance companies.
Cont’d
• The role of financial intermediaries is to create
more favorable transaction terms than could be
realized by lenders/investors and borrowers dealing
directly with each other in the financial market.
• This is accomplished by financial intermediaries in
a two-step process:
(1)obtaining funds from lenders or investors and
(2) lending or investing the funds that they borrow to
those who need funds.
Economic Functions of Financial
Intermediaries
 Maturity intermediation
 Risk reduction via diversification
 Cost reduction for contracting and information
processing
 Providing a Payments Mechanism
3. Financial Markets
• A financial market is a market where financial
instruments are exchanged.
• A financial market is a market in which funds are
transferred from people who have an excess of
available funds to people who have a shortage.
• They facilitate buying and selling of financial assets.
• Financial markets such as bond and stock markets are
crucial to promoting greater economic efficiency by
channeling funds from people who do not have a
productive use for them to those who do.
Cont’d
Financial markets provide the following three
major economic functions:
 Price discovery
 Liquidity
 Reduced transaction costs
Classification of financial markets
1. Classification by type of financial claim
A. Equity (Stock) market
B. Debt market
2. Classification by maturity of claim
C. Money market
D. Capital market
3. Classification by origin
E. Primary Market
F. Secondary Market
4. Classification by organizational structure
G. Auction market
H. Over the counter (OCT) market
Cont’d
5. Other Classifications
A. Foreign exchange markets: which facilitate
the trading of foreign exchange
B. Insurance markets : which facilitate the
redistribution of various risk
C. Derivatives markets: which provide
instruments for the management of financial
risk (eg. Forward, future and options)
Functions of the Financial System
There are seven basic functions of the financial system in
modern society. These are:
1. Savings Function
2. Wealth Function (store of value)
3. Liquidity Function
4. Credit Function
5. Payments Function
6. Risk Function; and
7. Policy Function
Financial System and Economic Development

Individual Assignment (10%)


 Select one article per group related to the role or
relationship or influence of financial system on
economic development and submit the revised article.
 Each group must include not more than three
members.
 It should be submitted after two weeks

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