“ international finance and payments ”

“International Finance and Payments”Course II“International Financial Markets and Institutions”

Lect. Cristian PĂUNLect. Cristian PĂUN

Email: Email: [email protected]

URL: http://www.finint.ase.roURL: http://www.finint.ase.ro

Academy of Economic Studies

Faculty of International Business and Economics

mailto:[email protected]

mailto:[email protected]

Course 2: International Financial Markets and Institutions

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International Financial System - review• IFS ensures the capital transfers between the investors and financing beneficiaries (or debtors) – main function;

• IFS is composed by financial markets, financial institutions and financial instruments;

• Bretton Woods Agreement is the base for actual IFS;

• the evolution of IFS was determined by several factors;

• EMS was an European alternative for IFS;

• BP registers all the commercial and financial transactions of a country with the rest of the World;

• we use this BP to determine the need for financial resources for a country

• this BP should be in equilibrium and the deficits can be reduced using different policies;

• the fixed exchange rate ensures an automatic equilibrium for a BP.


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Financial System - structure

Government

Population

Private companies

Financial InstitutionsFinancial

transactions

Financial transactions

Financial transactions

Financial Markets


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Financial Markets - characteristics

Money Markets (maturity < 1 year):-very liquid;- transactions with credit instruments;- small fluctuations for the securities prices => low risk

FINANCIAL MARKETS

Capital Markets (maturity > 1 year):- transactions with debt and equity securities (bonds, equities) - higher prices fluctuations

International Credit Markets, Euromarkets and FX Markets

-Primary market: is a financial market in which new issues of a security are sold to initial buyers;

- Secondary market: is a financial market in which security (previously issued) can be resold by the investors for cash.

Exchange offices (NYSE, CBOT) OTC Markets


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Financial Markets - characteristicsCharacteristics Money Markets Capital Markets

Maturity Under 1 year Below 1 year

Risks Lower Higher

Instruments Credit instruments Debt and Equity instruments

Liquidity Higher Lower

Transaction volume Lower Higher

Credit instruments Debt and Equity Instruments

- Treasury bills; - Common Stocks

- Commercial Papers; - Preferred Stocks- Banker’s Acceptance; - Bonds

- DC; - Investment Funds Participations- Credits; - Insurance Policies

- Pension Funds Policies

- Derivatives


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Financial Resources for a company

Financing Decision

Internal Resources

External Resources

- Reinvesting the profits;- Increasing capital;-Debt to equity conversion;- Amortization.

- Credits;- Bond issuing;- Equity.


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Advantages:

• increase the company value;

• higher autonomy from financial institutions;

• lower costs (such as banking commissions and taxes);

• advantages from fiscal regimes applied to reinvested profits;

• small companies or new business;

• leveraged companies (high debt).

Disadvantages:

• opportunity costs;

• taxation.

Why we should use internal resources ?

Real cost for internal financial resources

Internal resources are the most expensive financial resources !!!


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Advantages:

• mature business – “cash-flow cows”;

• less costly then own financial resources;

• important financial resources that can be obtained;

• higher maturity;

• fiscal regimes in case of the interest paid to a bank;

Disadvantages:

• additional costs (taxes, commissions applied);

• the dependence from the financial institutions;

• the reimbursement program;

• a good projection for your business development (future income and cash-flow prediction).

Why we should use external resources ?


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Direct Financing vs. Indirect Financing

Debtor(Beneficiary)

Investor or Creditor

Direct Financing

Financial Intermediaries

Indirect Financing


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Direct Financing vs. Indirect FinancingAdvantages for indirect financing:

• a good information about capital resources;

• lower risks (some institutions share or cover the financial risks);

• financing consultancy;

• financing facilities;

• different financing alternatives;

• financing condition imposed by the financial institutions;

• lower transaction costs.

Disadvantages for indirect financing:

• higher operational costs;

• inexistence of a direct contact with financial markets;

• historical relations with a financial institution.


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Services provided by financial institutions• selling and buying financial securities;

• international payments;

• international financing (incl. export financing);

• financial consultancy;

• international markets surviving (rating agencies);

• insurance against financial risks;

• guarantees for financial transactions;

• managerial expertise;

• companies surviving (competitors, clients);

• portfolio management;

• investment funds management.


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Financial Institutions

Public Financial

Institutions

Private Financial

Institutions

I. International Financial Institutions:-International Monetary Fund;-World Bank (IBRD, IDA, IFC, IMGA);-EBRD;-European Investment Bank;-Bank for International Settlements;

II. Government Institutions:-Export Credit Agencies;-Export Guarantee Credit Agencies;-Export Insurance Agencies;

III. Depository Institutions:-Commercial Banks;-Savings and Loans Associations;-Mutual Savings Banks;-Credit Unions.

IV. Non – depository Institutions:-Investment Banks;-Mutual Funds;-Pension Funds;-Insurance Companies;-Financing Companies;-Venture Capital;-Stock Markets Brokers and Dealers.


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Primary Assets and Liabilities of Financial IntermediariesType of intermediary Primary liabilities (sources of funds) Primary Assets (uses of funds)

1. Depository institutions:

- Commercial Banks Deposits Business and consumer loans, Municipal Bonds, T-Bonds

- Savings and loan associations

Deposits Mortgages loans

- Mutual Savings Banks Deposits Mortgages loans

- Credit Unions Deposits Consumer loans

2. Contractual Savings Institutions

- Life Insurance Companies Premiums from policies Corporate Bonds and Mortgages

- Fire and casualty Insurance Companies

Premiums from policies Municipal Bonds, corporate Bonds, Treasury securities

- Pension Funds Employer and employee contributions Corporate bonds and stock

3. Investment Institutions

- Financing Companies Commercial papers, stocks, bonds Consumer and business loans

- Mutual Funds Shares Stocks, Bonds

- Money market mutual funds

Shares Money market instruments


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Type of intermediaries

US Financial Institutions

26.14%

5.74%

1.81%

12.43%

4.46%16.82%

9.63%

4.98%

13.04%

4.95%

Commercial Banks

Savings and loan associations,mutual banksCredit unions

Life Insurance Companies

Fire and casualty insurancecompaniesPension Funds

State and local governmentretirement fundsFinance companies

Mutual Funds

Money market funds


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Financial Instruments

• A financial instrument is a contract between lender and borrower;

• This particular contract establish:

• the financing mechanism;

• the role of each institution / participant in the mechanism;

• the amount;

• the maturity;

• the currency;

• the financing cost (interest rate) and the payment method;

•the risk allocation between the participants;

• the payback of the loan;

• other aspects (special clause).


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Financial InstrumentsFinancial Instruments

Direct Investment Indirect Investment

- Investment Funds Participations;- Insurance Policies; - Pension Funds Participations.

Money Market:• Treasury Bills;• Negotiable bank certificates of deposit;• Commercial papers;• Banker’s acceptances;• Repurchase Agreements;• Government Funds.

Capital Market

Derivatives:Futures;Options;Swaps;Caps;Floors;Collars.

Fixed Income Instr.:T-bonds;Municipal Bonds.Corporate Bonds.

Equities:Common stocks;Preferred Stocks;GDR.


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Money market instruments• Treasury Bills;

• Negotiable bank certificates of deposit;

• Commercial papers;

• Banker’s acceptances;

• Repurchase Agreements;

• Federal Funds.US Money Market Instruments - 1996

32.97%

20.96%

33.05%

1.02%

8.10%3.90% Treasury Bills

Negotiable bankcertificates of depositCommercial papers

Banker’s acceptances

Repurchase Agreements

Government Funds


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A. Treasury Bills• short term debt instruments

• maturity of 3, 6 or 12 month;

• have no interest payments (initially sold at a discount);

• the most liquid financial instruments;

• the safest financial instrument (no default risk)

• can be issued in different currencies (usually are issued in local currency)

• “risk free rate” instruments;

B. Negotiable Bank Certificate of Deposits• debt instrument sold by a bank to depositors (one of the most important capital source for banks);

• pays annual interest;

• at maturity pays back the original purchase price;

• can be negotiable now


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C. Commercial Papers• short term instruments issued by banks or well known companies

• a high growth rate for this instruments (2000% between 1970 – 1996 in US);

• no interest payments (usually issued at a discount);

• interest rates are related to the issuer’s risk

D. Banker’s Acceptances• were developed in accordance with international trade development

• represent banks drafts (a promise of payment similar to a check) issued by a company for a future date and guarantee for a fee by the bank

• the bank acceptance = the guarantee

• these instruments are often resold on secondary market at a discount

• high growth rate (250% in US between 1970 and 1996)


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E. Repurchase Agreements - repos• short term loans based on a collateral

• this instruments were introduced in 1961

• increase the liquidity for financial instruments

• reverse repo’s

F. Federal Funds• overnight loans between banks and Central Bank

• the banks pay an interest rate

• federal funds rate (refinancing rate)


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Capital market instruments• Stocks (common stocks, preferred stock);

• Mortgages;

• Treasury Bonds;

• Municipal Bonds;

• Corporate bonds

US Capital Market Instruments

6.27%

4.87%

3.54%

5.49%3.73%

18.92%

45.22%11.95%

Corporate stocks

Mortgages

Corporate bonds

T-Bonds

Municipal Bonds

Bank Commercial Loans

Consumer Loans

Commercial and FarmMortgages


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Financial Instruments – risk classification

Level 4: High Risk InstrumentsDerivatives, junk bonds

Level 3: Potential Growth Rate Instruments:Blue chips, Mutual Funds Participations, Convertible Bonds.

Level 2: Sure Income Instruments:T-Bills, Municipal Bonds / T-Bonds.

Level 1: Risk free rate instruments:Cash, Deposit Certificates, Insurance Policies.

“ international finance and payments ”

Documents

expensive financial

international finance

ifs bp

actual ifs

evolution of ifs

higher maturity fiscal

taxes advantages

securities prices