banking and finance

FINANCE AND BANKING

By: TRAN THI THU NHUNG

TABLE OF CONTENTS

• Chapter 1: INTRODUCTIONS TO MONEY, BANKING AND FINANCIAL MARKETS

• Chapter 2: DIRECT FINANCE• Chapter 3: INDIRECT FINANCE

• Chapter 4: FUNCTIONS OF MONEY AND EVOLUTION OF

THE PAYMENTS SYSTEM • Chapter 5: ECONOMIC ANALYSIS OF FINANCIAL

STRUCTURE • Chapter 6: BANKING AND THE MANAGEMENT OF

FINANCIAL INSTITUTIONS • Chapter 7: THE BANKING INDUSTRY • Chapter 8: FOREIGN EXCHANGE MARKET

THE WHOLE PICTURE

THE WHOLE PICTURE

Categorizations of financial markets:

- Debt and Equity Markets

- Primary and Secondary Markets

- Exchanges and Over-the-Counter Markets

- Money and Capital Markets

FINANCIAL MARKET INSTRUMENTS

Money market instruments: * United States Treasury Bills

* Negotiable Bank Certificates of Deposit

* Commercial Paper

* Banker’s Acceptances

* Repurchase Agreements

* Federal (Fed) Funds

Capital market instruments:* Stocks

* Mortgages

* Corporate Bonds

* US Government Securities

* US Government Agency Securities

* State and Local Government Bonds

* Consumer and Bank Commercial Loans

INDIRECT FINANCE

Types of Financial

Intermediaries

Depository Institutions Investment Intermediaries

•Savings and Loans Associations

•Mutual Savings Banks

•Credit Unions

•Commercial Banks

•Contractual Savings Institutions

•Life Insurance Companies

•Fire and Casualty Insurance Companies

•Pension Funds and Government Retirement Funds

•Finance companies

•Mutual funds

•Money market mutual funds

MONEY

• Meaning of money

• Functions of money

• Evolution of the payment system

BANKING

• Development of the banking system

• Evolution of the banking industry

• The bank balance sheet

• Basic banking

• General principles of bank management

CHAPTER 1WHY STUDY FINANCIAL MARKETS?

• Definitions- financial markets- the stock market- the foreign exchange market

- an interest rate - the foreign exchange rate- a security - a common stock- a bond -


Financial markets

Bond market Stock marketForeign exchange

market


• The Bond market- A bond: a debt security that promises to make payments periodically for a specific period of time.- Function of the bond market: enable corporations and governments to borrow to finance their activities.

• Interest rates- An interest rate: the cost of borrowing

- Types of interest rate: mortgage interest rates, car loan rates, bond interest rates, and so on.- Importance of interest rates: influence on decisions of individuals, financial institutions, business, and the overall economy.


VIETNAM BANKS RAISE LENDING INTEREST RATES TO NEARLY 20%

“Commercial banks in Vietnam have raised interest rates for medium and long-term loans in dong to almost 20% per annum, the one-year record high, as a result of the dong

fund shortage.”

• How are you influenced by this increase in interest rates as you are a manager of a company/ a flat owner – who borrow money from the bank?


The stock exchange

- A common stock represents a share of ownership in a corporation. It is negotiable

- Function of the market: (1) helps corporations to raise funds; (2) helps shareholders to buy or sell their stocks whenever they want to do so; (3) can bring profits for business owners/shareholders.


The foreign exchange market

- Definition: a place where the conversion of currencies take place.

- Foreign exchange rate: the price of one country’s currency in terms of another’s.

- A change in exchange rates has a direct effect on consumers’ decisions.

CHAPTER 1WHY STUDY BANKING AND FINANCIAL

INSTITUTIONS?

Financial institutions include:

- banks

- insurance companies

- mutual funds

- finance companies

- investment banks


INSTITUTIONS?

Banks:

- commercial banks

- savings and loan associations

- mutual savings banks

- credit unions

Banks accept deposits and make loans

Types of bank deposits: checking accounts, savings accounts and others


INSTITUTIONS?

Financial innovation:

- ATM (automatic teller machine)

- E-finance (new means of delivering financial services electronically)

CHAPTER 1WHY STUDY MONEY AND MONETARY

POLICY?

Definitions:- money: anything generally accepted in payment for goods and services or in the payment of debts- money supply: is the total amount of money available in an particular point in time.- aggregate output: the total production of goods and services.- business cycle: the upward or downward movement of aggregate output produced in the economy.- recessions: periods of declining aggregate output.


POLICY?

Definitions:

- aggregate price level: the average price of goods and services in an economy.

- inflation: a continual increase in the price level.

- inflation rate: the rate of change of the price level.

- unemployment rate: the percentage of the available labor force unemployed.


POLICY?

Conclusions:

- There is a positive association between inflation and the growth rate of the money supply.

- As the money growth rate rises, the interest rate may rise with it.

- As the aggregate output falls, the unemployment rate may rise.


POLICY?

Macro-economic policies- Monetary policy:

+ money supply + interest rates

- Fiscal policy:+ government spending+ taxation

CHAPTER 2DIRECT FINANCE


Functions of financial markets Channeling funds from lender-savers to

borrower-spenders Bringing profits & benefits for both lenders

and borrowers Promoting economic efficiency


Categorizations of financial markets:

- Debt and Equity Markets

- Primary and Secondary Markets

- Exchanges and Over-the-Counter Markets

- Money and Capital Markets


Debt and

Equity

Markets

Debt markets Equity markets

- Debt instruments: bond or mortgage

- Maturity of a debt instrument: + short-term (< a year)

+ intermediate-term ( one – ten years)

+ long-term (> ten years)

- Regular intervals paid by the borrower

- Equities: common stock- No maturity date- Periodic payments (dividends) to shareholders


Primary and

Secondary Markets

Primary Markets Secondary Markets

- New/fresh securities

- Not well known to the public

- Underwriting securities by investment bank

- Help a corporation to acquire new funds

- Outstanding securities

- Well known to the public

- Brokers and dealers have crucial role

- Make the financial instruments more liquid

-The price of new securities is determined in the secondary markets


Secondary markets

Exchanges OTC markets

- One central location- Examples:

+ The New York Stock Exchange

+ The Chicago Board of Trade

- No single location but via computer links- Examples:

+ The US Government Bond Market


Money and

Capital

Markets

Money Markets Capital Markets-Short-term debt instruments

- More liquid securities with smaller fluctuations in prices

- Preferential to banks and corporations for temporarily surplus funds

-Long-term debt and equity instruments

-Less liquid securities

- Preferential to financial intermediaries (insurance companies or pension funds)


Money market instruments• US Treasury bills: - short-term debt instruments - issued by The Treasury to finance the temporary

shortage in the state budget. - maturities: in 3, 6, and 12 months - no interest payments - initially sold at a discount - the safest and most liquid of all the money market

instruments


• Negotiable Bank Certificates of Deposit

- sold by a bank to depositors

- annual interest; the original purchase price at maturity.

• Commercial paper• Banker’s Acceptances• Repurchase Agreements• Federal (Fed) Funds

CHAPTER 3 INDIRECT FINANCE

CHAPTER 3INDIRECT FINANCE


Functions of financial

intermediaries

Transaction costs Risk sharing Information costs


Transaction costs:

- The time and money spent in carrying out financial transactions

- Financial intermediaries can reduce transaction costs


Risk sharing:- Risk: uncertainty about the returns investors will

earn on assets- Asset transformation : financial intermediaries

create and sell assets with less risk and purchase other assets with more risk

- Diversification: investing in a collection (portfolio) of assets.


Asymmetric Information: Adverse Selection and Moral Hazard

- Adverse selection: the problem created by asymmetric information before the transaction occurs

- Moral hazard: the problem created by asymmetric information after the transaction occurs


REGULATION OF THE FINANCIAL SYSTEM Increasing information available to investors Ensuring the soundness of financial intermediaries

- restrictions on entry

- disclosure

- restrictions on assets and activities

- deposit insurance

- limits on competition

- restrictions on interest rates

QUESTIONS FOR DISCUSSION• Why is a share of IBM common stock an asset for

its owner and a liability for IBM?• Some economists suspect that one of the reasons

that economies in developing countries grow so slowly is that they do not have well-developed financial markets. Does this argument make sense?

• The U.S. economy borrowed heavily from the British in the 19th century to build a road system. What was the principal debt instrument used? Why did this make both countries better off?

QUESTIONS FOR DISCUSSION

• “Because corporations do not actually raise any funds in secondary markets, they are less important to the economy than primary markets.” Comment.

• If you suspect that a company will go bankrupt next year, which would you rather hold, bonds or equities issued by the company? Why?

• Discuss some of the manifestations of the globalization of the world capital markets?


• How can adverse selection problem explain why you are likely to make a loan to a family member than to a stranger?

• Why might you be willing to make a loan to your neighbor by putting funds in a savings account earning a 5% interest rate at the bank and having the bank lend her the funds at a 10% interest rate rather than lend her the funds yourself?

• How does risk sharing benefit both financial intermediaries and private investors?


• Why do loan sharks worry less about moral hazard in connection with their borrowers than some other lenders do?

• If there were no asymmetry in the information that a borrower and a lender had, could there still be a moral hazard problem?

• If you are an employer, what kinds of moral hazard problems might you worry about with your employees?

CHAPTER 4FUNCTIONS OF MONEY AND EVOLUTION OF

THE PAYMENTS SYSEM

The fountain Circle of Money (Kreislauf des Geldes) in Aachen, Germany. The figurines show different persons dealing with money, while the rotating water symbolizes the circle of money. Sculptured by Karl-Henning Seemann, sponsored by the Sparkasse Aachen.


THE PAYMENTS SYSEM

* Meaning of money

* Functions of money

* Evolution of the payments system


THE PAYMENTS SYSEM

• Money: anything is generally accepted in payment for goods and services or in the payment of debts.

• Currency: one type of money consisting of paper money and coins, (narrower in meaning).

• Wealth: the total collection of pieces of property including bonds, stocks, art, land, furniture, cars, and houses, etc, (broader in meaning).

• Income: a flow of earnings per unit of time.


THE PAYMENTS SYSEM

FUNCTIONS OF MONEY• Medium of Exchange: used to pay for goods and

services.• Unit of Account: used to measure the value of

goods and services in terms of money.• Store of Value: a repository of purchasing power

over time. • Standard of Deferred Payment:


THE PAYMENTS SYSEM

Medium of Exchange - the most important function Money promote economic efficiency by:

- eliminating much transaction costs

- encouraging specialization To be accepted as a medium of exchange, money

must have other functions of unit of account and store of value as well.


THE PAYMENTS SYSEM

Types of money Commodity money: any good that serves as a medium of exchange, such as gold, silver, copper, etc Token money: a means of payment whose purchasing power greatly exceeds its cost of production


THE PAYMENTS SYSEM

Types of money:• Commodity money: any commodity is used for the

exchange purpose• Fiat money: token money that is issued by the command of

the sovereign (commonly paper money)• Fiduciary money: any bank assures the customers to pay in

different types of money and when the customers can sell the promise or transfer it to somebody else – it is called fiduciary money, ex: checks, banknotes, demand deposits in which withdrawals can be performed via checks, bank drafts, using ATMs, through online banking.

• Money Supply: consists of currency (banknotes and coins) and demand deposits


THE PAYMENTS SYSEM

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http://upload.wikimedia.org/wikipedia/commons/b/b1/ATM_750x1300.jpg


THE PAYMENTS SYSEM

EVOLUTION OF THE PAYMENTS SYSTEM

Commodity money

Fiat money

Checks

Electronic payment

CHAPTER 6BANKING AND THE MANAGEMENT OF

FINANCIAL INSTITUTIONS

THE BANK BALANCE SHEET BASIC BANKING GENERAL PRINCIPLES OF BANK

MANAGEMENT



EQUOATION OF THE BALANCE SHEET

Total assets = total liabilities + capital

• Liabilities: Sources of bank funds

• Assets: Uses of funds


FINANCIAL INSTITUTIONSLIABILITIES

Checkable deposits: bank accounts that allow the owner of the account to write checks to third parties such as demand deposits, NOW accounts, money market deposit accounts (MMDAs)

Non-transaction deposits: can’t write checks but higher interest rates, consist of savings accounts and time deposits (CDs)

Borrowings: funds borrowed from Fed, the Federal Home Loan banks, other banks, and corporations

Bank capital: the bank’s net worth – by selling new equity (stock) or from retained earnings



ASSETS Reserves: deposits in an account at the Fed Cash items in process of collection: deposits from a check written on

an account at another bank. Deposits at other banks: deposits of small banks held at larger banks

in exchange for services Securities: an important income-earning assets, including U.S.

government and agency securities, local government securities, other securities

Loans: liabilities for individual or corporation receiving it, less liquid with highest return to the bank.

Other assets: bank buildings, computers, and other equipments



Basic operation of a bank: Selling liabilities with one set of characteristics (a

combination of liquidity, risk, size and return) Using the proceeds to buy assets Providing a set of services: check clearing, record

keeping, credit analysis, etc.



GENERAL PRINCIPLES OF BANK MANAGEMENT Liquidity management: the acquisition of sufficiently

liquid assets to meet the bank’s obligations to depositors. Asset management: pursuing low level of risk for assets

acquired with low rate of default; diversifying assets holdings.

Liability management: acquiring funds at low costs. Capital adequacy management: decisions on the amount

of capital the bank should maintain & acquisition of the needed capital.



Please write any your own ideas on how a financial

institution deals with liquidity management:

CHAPTER 6BANKING AND THE MANAGEMENT OF FINANCIAL

INSTITUTIONS

Please write any your own ideas on how a financial institution deals with Asset management

CHAPTER 6BANKING AND THE MANAGEMENT OF FINANCIAL

INSTITUTIONS

Please write any your own ideas on how a financial institution deals with Liability management

Please write any your own ideas on how a financial institution deals with Capital adequacy management

Thank you for your Thank you for your attention!attention!

banking and finance

Documents

financial markets chapter

study financial markets

study money

bond chapter

financial services

study banking

banking industry chapter

financial innovation