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Finance Notes: Week 1 (Chapter 1)

The Financial System

Chapter Aims

• Outline the functions of the Australian financial system • Identify the elements of the Australian financial system

Overview of Financial Systems

• A financial system facilitates financial transactions through the creation and transfer of financial assets • The key elements of the Australian financial system are □ Financial instruments □ Financial markets □ Financial institutions

Functions of a Financial System

• Facilitates the efficient flow of funds between lenders and borrowers via financial instruments • Allows individuals to allocate funds according to current and future consumption • Facilitates the implementation of government monetary policy

Financial Instruments

• Attributes of financial instruments □ Return or yield □ Risk □ Liquidity □ Time pattern of cash-flows

1. Equity □ Shares represent an ownership position □ An entitlement to share in the profits of the organisation □ Equity types – Ordinary shares – Preference shares – Quasi-equity instruments

2. Debt □ Debt instruments represent a contractual claim on the borrower to make specific payments in the form of interest and principal amounts □ Debt may be issued with a fixed or floating interest rate, or at a discount, secured or unsecured, short or long-term

3. Derivates □ Derivate instruments derive their price from physical market instruments (either equity or debt) □ Futures, forwards, options and swaps □ Used to manage financial risk

Financial Markets

• Financial markets facilitate the flow of funds between borrowers and lenders • Categories of financial markets □ Primary markets □ Secondary markets □ Wholesale and Retail markets