“international finance and payments” course ii “international financial markets and...

“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

Course 2: International Financial Markets and Institutions

2

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.


3

Financial System - structure

Government

Population

Private companies

Financial InstitutionsFinancial

transactions

Financial transactions

Financial transactions

Financial Markets


4

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


5

Financial Markets - characteristics

Characteristics 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


6

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.


7

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 !!!


8

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 ?


9

Direct Financing vs. Indirect Financing

Debtor(Beneficiary)

Investor or Creditor

Direct Financing

Financial Intermediaries

Indirect Financing


10

Direct Financing vs. Indirect Financing

Advantages 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.


11

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.


12

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.


13

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


14

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 banks

Credit unions

Life Insurance Companies

Fire and casualty insurancecompanies

Pension Funds

State and local governmentretirement funds

Finance companies

Mutual Funds

Money market funds


15

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).


16

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.


17

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 deposit

Commercial papers

Banker’s acceptances

Repurchase Agreements

Government Funds


18

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


19

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)


20

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)


21

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


22

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” course ii “international financial markets and...

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