Global financial markets Global financial markets Hult international business school Frédéric Chartier 1 Session 1 OVERVIEW OF FINANCIAL SYSTEMS: LANSCAPE AND PURPOSE 2 What does that concept mean to...

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Global financial markets Global financial markets Hult international business school Frédéric Chartier 1 Session 1 OVERVIEW OF FINANCIAL SYSTEMS: LANSCAPE AND PURPOSE 2 What does that concept mean to you? Think of some keywords. 3 FINANCIAL SYSTEM 3 Financial system Institutions Banks Insurance companies Brokerage firms Investment banks Central banks markets Stock markets Bond markets Foreign Exchange markets Derivatives markets Commodities markets instruments Money Stocks Bonds Currencies Futures contracts Mutual funds participants Investors Lenders Commercial firms Governments Regulators 4 4 5 What is a Financial system? A set of institutions, instruments, and participants. What is its role? To channel funds from savers to borrowers The 3 key functions of a Financial system: Risk sharing Liquidity information 6 6 7 Markets Institutions Short term Long term Money markets Bond markets Bear Sterns Fannie Mae … instruments: MBS, CDO, CDS. Interbank lending Stock markets Merrill Lynch Lehman Brothers, etc. Federal Reserve Bank Freddy Mack Subprime lenders 8 Markets Institutions Short term Long term Money markets Commodity markets Central Banks Sovereign wealth funds … instruments: stimulus checks. Interbank lending Stock markets Government Treasuries Pension funds Mortgage markets What is the Financial System for? Facilitate payment in the ‘real economy’, Consider three markets: The factors market (labor, capital) The product market (goods, services) The financial market (payment function) 9 Households Firms Labour, capital Goods, services Flow of income Flow of expenditure Circular flow Financial markets facilitate action in two other markets – the market for factors market and the product market. We can illustrate this in a diagram called the circular flow. The simplest form is with just households and firms. In the factor market, households provide labour and capital to firms in return for income. In the product market, firms provide good and services in return for consumer expenditure. [Diagram of circular flow – HH and firms][Y income = Y output] Even in this simple system, the financial system performs a payments function, allowing you to receive wages in money rather than in goods and to buy goods with money rather than barter. 9 What is the financial system for? Facilitate saving in the ‘real economy’ Saving, income not consumed, is a flow In a model with just households and firms, saving = investment Financial wealth, cumulative saving, is a stock 10 Households Firms Labour, capital Goods, services Flow of income Flow of expenditure Circular flow Saving Investment We said that households provide labour and capital but how did they get that capital and how do firms use the capital to help produce goods and services. We can add to the simple model the fact that households do not consume all their income but also save some of it. Saving not used by other households, so net household saving, is used by firms for investment. We can add this to the flows. Saving is a second function of the financial system. It is a flow, since you can ask how much did you save in 2019. Cumulative saving builds up a stock of financial assets, creating financial wealth, a third function of the financial system. [Add to diagram Y income = C + S, Y output = C + I, therefore financial S = I in absence of G and abroad] 10 What is the financial system for? The financial system provides credit. Real assets are owned by somebody. Financial assets are owed to somebody by someone else. Financial assets are matched by financial liabilities. 11 The financial system offer risk protection. Life and financial assets carry risk, people are risk averse. Insurance policies and derivative instruments provide hedging against real and financial risks. Unlike real assets – such as houses, cars, clothes, etc. – financial wealth is a claim on the future flow of funds of someone else. All financial wealth is matched by financial liabilities. Individuals and firms take on financial liabilities in return a flow of funds when they need credit. The financial system helps to match those who need credit with those who wish to save, creating financial liabilities and assets. [Financial assets = Financial liabilities] Wealth is a form of self-insurance, as it can be drawn upon when you have a need. However, households and firms also purchase risk protection from financial institutions such as life and non-life insurance companies as they are risk-averse, preferring to exchange a small outflow of income in good times for an inflow if the insured event occurs. 11 What is the financial system for? The financial system provides liquidity Able to convert into cash quickly, with little risk of loss Real assets often illiquid: houses, vehicles, clothes, etc. Financial assets more liquid: money, bonds, stocks, etc. 12 Households Real assets Flow of expenditure Saving Financial assets Financial wealth is often in forms such as cash, bank deposits, money market funds, or equities in liquid stocks that can be spent or easily converted and then spent. The financial system therefore creates liquidity. This is in contrast to real assets such as houses, cars, clothes, etc. that are often hard to use for barter or convert into other forms without considerable effort and loss of value. This important feature leads the financial market to be divided into a more liquid money market – generally taken to be dealing in financial assets with up to one year’s duration – and capital market dealing with financial assets with over one year’s duration. [Stock and flow, stock = balance sheet of real assets and financial assets, financial liabilities and net worth or shareholders funds][Financial assets and liabilities, like real assets, divide into current and non-current] 12 What the financial system is for Facilitates government policy Monetary policy manages the price and volume of money Fiscal policy withdraws tax, injects government spending 13 Households Firms Labour, capital Goods, services Flow of income Flow of expenditure Circular flow Saving Investment Government Tax Tax Spend Spend So far, our simple model has only had households and firms. We can add the state as a third player, with the government as its temporary manager. The state interacts with households and firms in many ways, including laws and regulations without which the factor, product, and financial markets would not function. The state also plays a policy role, including via two additional fiscal policy flows – government taxation and spending– that we can add to our illustration – and via an important financial institution, the Central Bank, which aims to use monetary policy to manage the price and quantity of money. The financial market therefore plays a policy role. 13 What the financial system is for Finally add ‘Abroad’ to make a four player model Trade balance: net exports NX = exports – imports Current account CA = NX plus factor income (dividends, interest, etc.) and cash transfers (remittances, foreign aid, etc.) Financial account FA = - CA = change in foreign assets Comparative Financial systems 14 Home (HH, firms, govt.) Abroad Exports Export revenue, factor income received, cash transfers received Import costs, factor income paid, cash transfers sent Imports Total production (GDP) = C + I + G + (X-M) 14 What is the financial system? Critically important functions, including these seven: Channeling payment for factors and for products Encouraging saving instead of immediate consumption Financing investment and accumulating as financial wealth Matched by liabilities when supplying us with credit Insuring against risks Creating liquidity in the economy Adjusted by monetary and fiscal policy … so ask yourself this, ‘Where would we be without it?’ 15 Unlike real assets – such as houses, cars, clothes, etc. – financial wealth is a claim on the future flow of funds of someone else. All financial wealth is matched by financial liabilities. Individuals and firms take on financial liabilities in return a flow of funds when they need credit. The financial system helps to match those who need credit with those who wish to save, creating financial liabilities and assets. [Financial assets = Financial liabilities] Wealth is a form of self-insurance, as it can be drawn upon when you have a need. However, households and firms also purchase risk protection from financial institutions such as life and non-life insurance companies as they are risk-averse, preferring to exchange a small outflow of income in good times for an inflow if the insured event occurs. 15 Beginning to compare systems Financial systems vary in key ways Payments vary mainly with economy size Gross savings vary from c13% to 50% of GDP Wealth varies but financial assets replace non-housing land Private credit scale and growth varies, as does state debt Insurance premiums vary from about 1% to 15% of GDP Liquidity is provided by money and by money markets Monetary and fiscal policies vary from tight to loose … so ask yourself this, ‘How is financial system in your country?’ 16 Unlike real assets – such as houses, cars, clothes, etc. – financial wealth is a claim on the future flow of funds of someone else. All financial wealth is matched by financial liabilities. Individuals and firms take on financial liabilities in return a flow of funds when they need credit. The financial system helps to match those who need credit with those who wish to save, creating financial liabilities and assets. [Financial assets = Financial liabilities] Wealth is a form of self-insurance, as it can be drawn upon when you have a need. However, households and firms also purchase risk protection from financial institutions such as life and non-life insurance companies as they are risk-averse, preferring to exchange a small outflow of income in good times for an inflow if the insured event occurs. 16 Case study: Russia in crisis 17 17 Case study: Russia in crisis How Russia’s financial system is impacted Payments risk if denied access to global SWIFT system Saving tends to rise in crises, depressing consumption Wealth falls with exchange rate, share prices, defaults Private credit hit by sanctions, state assists firms/banks Insurance rarely covers oil price, exchange rate risks Liquidity affects interbank rates, raising market rates Monetary policy sharply tightened, fiscal downside risk 18 Unlike real assets – such as houses, cars, clothes, etc. – financial wealth is a claim on the future flow of funds of someone else. All financial wealth is matched by financial liabilities. Individuals and firms take on financial liabilities in return a flow of funds when they need credit. The financial system helps to match those who need credit with those who wish to save, creating financial liabilities and assets. [Financial assets = Financial liabilities] Wealth is a form of self-insurance, as it can be drawn upon when you have a need. However, households and firms also purchase risk
Oct 15, 2021
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