Money is a medium of exchange, it can be anything. As long as it is agreed. Banks don’t actually hold all our money, we treat our balances as money, even though it is not physical.
Money holds value.
A financial system brings together the users of funds with the providers of money, or financial instruments. Financial instruments are an entitlement to a future cash flow. Nothing will ever happen unless money actually moves. In America the economy is struggling because people are not moving money (buying/selling), this might occur when there is uncertainty surrounding governments, or their policies. The purchasing of consumer goods/everyday (consumption) items is not counted, it is the investment (a promise of future money) that drives economic growth and stability. Financial institutions facilitate the flow of funds through the economy, and set bench marks with interest rates.
Return or Yield – Is expressed in percentage form, and is the return on your investment. It can be actual return, or expected (probability weighted average) return. Risk - The chance of your return being high or low
Liquidity – The ability to take your investment and sell it before the project is complete (in the secondary market), and how much money you might lose by selling it early Pattern of cash flows – More regular cash flows are more valuable Portfolio – Is investing in more than one project, this spreads the risk around
There are 5 different categories of financial institutions Depository financial institutions – Our everyday banks
Investment banks and merchant banks – Advise clients on services such as mergers, portfolio restructuring and financial risk management
Contractual savings institutions – Are insurers and superannuation funds, their liabilities are contracts that require period payments, and the agreed payout with happen if the specific event occurs. These companies have large amounts of funds to invest
Finance companies – borrow funds by using commercial paper, notes and bonds in both the money markets and capital markets. The use these funds to loan finance to households and businesses Unit trusts – Trusts specialise in types of investments, and are controlled by a trustee
If you have equity (the sum of all the financial interest, generally shares (which represent ownership), an investor has in an asset) in a project means you get whatever is left over once the company has paid its debts off. A debt promises to pay you a fixed amount, so if the project goes exceptionally well, you don’t get the additional benefit. This is countered by the fact that you get your money first, then what is left goes to the equity holders.
Derivatives are essentially bets, when you get home insurance you are basically betting whether or not your house burns down, and in return for that you pay a premium every year. Forwards – Similar to a futures contract, but generally more flexible.
Futures – a contract to buy or sell an agreed amount of a commodity at a price determined today, in the future Options – A futures contract, but its optional to one party Swaps – an arrangement to swap specified future cash flows
Primary markets are direct dealing between the lender of funds, and the borrower of funds. The secondary market is really anything that occurs after that initial transaction.
Direct finance is similar to the primary market. You approach somebody with a project and give them money directly. Intermediated finance is through a bank/finance manage, superannuation is intermediated finance because you essentially are investing money in your super fund, and they are investing it on.
A retail market is something that I, as an individual can participate in, like buying shares on the internet, which would make me a retail trader. Large banks, doing deals with other large banks are wholesale investors, and there are numerous markets that are purely wholesale markets.