Types of financial

Markets
The role of financial markets in the economy 12.1
What are financial markets?
A financial market is a market in which people and
entities can trade financial securities, commodities, and
other fungible items of value at low transaction costs and
at prices that reflect supply and demand.
[Securities include stocks and bonds, and commodities
include precious metals or agricultural goods.]
Financial markets
Create products that provide a return for those who
have excess funds
Make these funds available to those who need
additional money
Are one of the largest industries in Australia.
Influence all other industries because of its key role in
the economy
In the factor market economists traditionally viewed
Individuals as net savers
Businesses as the net borrowers in the economy
*however, it is more complicated as savings can come
from all parts of the economy e.g. over seas
Financial intermediaries: firms that receive the
accumulated funds of individuals or firms and make
loans to other firms or individuals who need them
Sources of savings
The proportion of house hold incomes that is
not spent on consumer goods
This becomes a form of savings
Businesses can save by not distributing part
of their profits to their owners
These funds can be retained in financial
markets until needed
When government budgets for a surplus
The funds accumulated become savings
Australia can borrow funds from over seas
This way they have access to foreign savings
Reasons for borrowing
Consumers
When their demanded goods exceeds their
capacity to pay for them
Businesses
When they want to fund an expansion for
their business
Government
When they budget for a deficit
Australian financial institutions
They borrow more money from overseas
sectors than they lend
Financial markets are also the factor markets for
capital in the economy.
Capital is required by businesses as an input to the
production process (so that the demanded goods and
services can be produced)
Financial markets also have important impacts on the
broader economy
When a credit supply shock occurs, where
businesses have difficulty in obtaining finance, GDP is
typically reduced
Primary and secondary financial markets 12.2
Traditionally, consumers saved money through
financial institutions e.g. banks
However, they have now turned to investment
Australia has the second highest level of share
ownership
The financial sector consists of a wide range of
financial institutions. It provides many different
financial services such as
Home mortgages
Credit cards
Personal loans
Superannuation management
Insurance
Investment products

Financial markets are divided in to two types
1. Primary financial markets
Facilitates financial assets call
securities.
Is a business wants to raise funds, it
can either borrow money by issuing
debt securities or expand the
ownership of company by selling new
shares
Money received goes directly to the
company
E.g. Westpac shares issued to the
public
2. Secondary financial markets
Involve financial transactions with
financial assets that have previously
been issued on a primary market.
The companies whose securities are
traded do not earn any profit from
these transactions

Securities: any form of financial instrument
including shares and bonds that provide the
holder of that instrument with a claim over real
assets or a future income stream.
*the markets dont need a physical location.
The majority of trade on the ASX (Australian
securities exchange)occurs over a set of
interconnected computer systems.
The amount of activity in the financial markets will
depend largely on the state of the economy and
strength of different industries and firms
The main financial markets that exist across the
world are
The share/equity market
Where ownership shares in companies are
traded
The debt market
Where debt securities are exchanged or
cash is lent or borrowed



The derivatives market
Where people buy and sell financial assets
that are based on the value of the financial
assets
The foreign exchange market
Where financial assets defined in one
countrys currency is exchanged for assets
defined in another countrys currency
Financial intermediaries perform the same basic
function
They channel excess savings (from the net savers)
to the borrowers (net borrowers)
Traditionally, the financial system has been divided
into banks (accepting savings and deposits) and non-
bank financial intermediaries. Because of the
blurring distinctions between different types of
financial service providers, this division has become
less relevant.
Almost all the services provided by banks are now
being offered by other financial institutions and
banks are also offering a range of products such as
- Insurance
- Superannuation funds
- Investment options
Which are not the traditional services offered by
banks.
Because of this, there has been a single system of
regulation for the entire financial sector rather
than separate ones for each part of the financial
sector.
*banks remain the largest and most important
part of the financial sector. The provide financial
services such as
accepting deposits
making advances (loans)
issue credit cards and travellers cheques
arranging overseas payments and collection
funds
provide safe deposit facilities
offer financial advice
arranging for external fund managers to
invest an individuals savings

Other financial institutions
finance companies
Obtain their funds by borrowing from the
general public, through the issue of debt
securities.
The funds are reloaned to households or
small businesses at higher rates of interest
investment banks
Also known as merchant banks
Generally borrow on a short term basis from
companies with surplus funds and lend these
funds to other large companies (for business
expansion purposes) and government
agencies.
They also provide financial advisory
services to large companies on issues such as
take overs or issuing securities
credit unions
Non-profit organisations whose members
belong to a particular trade, industry of
profession, or live in a particular area
People can deposit or borrow money with
any profits returned to members
permanent building societies
Accept deposits from the public and
provide funds mainly for home loans
They can also offer other personal and
business loans (although their interest rates
are controlled to some degree by state
governments.)

mortgage originators
Also referred to as mortgage funds
Many were bought by traditional banks
because it became difficult for them to obtain
money on financial markets to lend to
consumers

superannuation funds
Receive the contribution of employees and
employers and invest them in financial assets
in order to provide retirement income for
their contributors.




Financial Market Products 12.3
There are a variety of market products in the
economy to meet the various needs of lenders and
borrowers. They vary in risky, return and liquidity.
Consumer credit
Allow consumers to purchase consumer
goods and services in advance of actual
payment.
Most common type of consumer credit is a
credit card which allows consumers to
purchase goods and repay their borrowings
with interest at a later date (10-20%)
Credit cards are offered by banks, credit
unions and companies such as Master Card
and Visa
Major forms of consumer credit are
personal loans offered by banks and credit
unions
These are charged at a higher interest
than housing loans (10-15%)

Housing loans
Offered by banks as well as mortgage
originators
e.g. Aussie and Rams
They are long terms loans repaid
periodically

Business loans
A form of debt that allows businesses to
invest in their business operations
e.g. new technology, expanded office space
Large corporations may pay 1% more
interest than housing loans
Smaller ones may pay 5 % more

Short term money market
Brings together people and businesses
with temporary shortages or surplus of funds
Banks issue various forms of debt
securities with the surplus to those in need of
funds
these debt securities all have a maturity of
less than a year





Bonds
Also known as fixed/debt securities
A written financial document is issued to
the lender, an individual or company who is
known as the bond holder
The initial price of the bond written on the
document is the size of the loan (known as
the face value)
The bond holder is entitled to a fixed
stream of income payments (known as
coupon payments) which are like interest
payments until the initial loan amount has
matured
Bonds can also be sold in a secondary
market

Financial futures and options
Contracts to trade in financial instruments
e.g. bonds or shares at a later date or certain
price
Future markets allow investors to be
protected against adverse movements in
interest rates by agreeing on a certain price to
trade the financial product now even though
they dont have to make the transaction until
later

The foreign exchange or forex market
Is the market for buying and selling of
foreign currencies
Like individuals, investors also need
foreign currencies when they deal with
business over seas
the forex market provides a market for
people to buy and sell currencies and it
operates 24 hours a day

Superannuation
It is an important source of retirement
income
Reduces pressure on the governments to
provide age pension
Allows people to indirectly own shares and
participate in more sophisticated parts of the
financial sector with higher returns than
bank deposits
large pool of savings are made through
superannuation which promotes economic
growth


Can be loaned to financial institutions and
to house hold to purchase a house
Superannuation maybe directly invested in
new share issuances by businesses that are
used to raise money for new capital
investment
Share market changes are the main drivers
of superannuation balances because of the
amount of superannuation invested in shares.
Securities
Dow jones
All ordinaries
Shares
Commodities
Insurance
Debentures

The Share Market 12.4
Share market: A financial market where investors
buy and sell shares which are financial assets that
give their owner part owner ship of the company.
Share markets play an important role in the
Australian economy because businesses can sell
shares in their companies to raise funds needed for
growth, and for individuals or other businesses to
gain returns from their surplus funds.
For firms to be able to issue shares must be a
company.
It must be incorporated meaning it is a business
that is recognised as a separate legal entity from the
individuals who own or manage the business.
This means that it has limited liability which
protects the individual business operators from the
risk of bankruptcy
Incorporated companies may be
1. public
Whose shares are not subject to any
transfer restrictions (beyond those
established by government regulation)
Therefore, company shares can be traded
freely
2. private
Whose shares are limited to only few
individuals
There are also restrictions on share
transfers so that the ownership cannot be
freely bought or sold between individuals
*The share market only deals with the trade in shares
of public companies
Share market brings together the buyer and seller in
a medium of exchange.
Most transactions take place through a market
facilitator known as a stock exchange.
The stock exchange is just a manifestation of the
market with buyers and sellers that intend to trade in
a range of securities e.g. shares
The share market is not a physical location and
shares are mostly traded over the internet increasing
efficiency, speed and accessibility of market.
The largest share market in Australia is the
Australian Securities exchange (ASX).
The ASX provides a regulated environment for
investors to buy and sell shares by matching sellers
who have a set selling price with buyers who are
willing to pay that price.
An investor willing to buy or sell shares must do so
through a broker who is registered with the ASX.
Role and function
The role of the share market can be seen in the
perspective of the companies who are selling their
shares and investors who are trading the owner ship
of shares with money.
The main reason for investors to purchase shares is
to gain a stake in the companys profits and make
capital gains from the increase in prices.
Investing in shares also gives them a right to vote
for the companys board of directors who appoint the
companys senior managers and ultimately decide
how the company will act to maximised the wealth of
the share holders
Shareholders normally meet once a year to vote on
key company matters and voice their opinions
Managers have an ethical duty called the fiduciary
duty which requires them to manages the company
in a way that best serves the interest of their
shareholders.
Shareholders are the owners of the company are
entitled to share the success of the company.
If a company returns a profit, they are entitled to a
proportion of it
The proportions are called dividends and are
rewarded on a per share basis.
As the company grows, the value of their share
prices also increase. then shareholders may sell
their shares for profit for a capital gain (profit from
selling their financial assets/ securities)
Shareholders may profit or lose money from their
investment. However, if the firms become corrupt,
they hold no responsibility for their debt and only
lose the money they invested.
There has been an increase in the number of people
who rely on capital gains from their investment as a
source of income (especially around their retirement
age.)
For a company, the share market provides an
opportunity to raise new funds for investment and
business growth
When a company decides to list its self on the stock
exchange and offer its shares to the public for the
first time, it is called a float or initial offering (IPO)
Once a company has been listed, it can access more
equity funds at any time by issuing an approved
prospectus for the release of new shares
Equity fund: fund that invests in stocks
However, the issuing of new shares will mean less
control over the company since the shareholders are
earning more
The sale of new shares is a primary financial
market transaction
When an existing shareholder sells their shares to
another investor, this is called a secondary financial
market transaction
The ASX is both a primary and secondary market
since it facilitates both transactions



Changes in the market can also determine the
structure and operation of a company
Share prices are set by the market forces of
supply and demand
Reflects factors such as confidence in
management, previous earnings, expected
earnings and general economic conditions

A fall in a companys share price results in a
loss of value for shareholders who will
replace or put pressure on management to
improve their performance
A low share price may mean the company is
vulnerable to being taken over
Effect on the economy
Share market values are an indicator of the countrys
economic conditions because
Market prices rise in accordance with new and
netter economic prospects for companies
Rising share prices will generally suggest that the
economy is enjoying good conditions
An economy that is moving towards recession will
have fewer economic opportunities for companies
leading to lower share prices
i.e. fluctuation in the share market mirror changes in
economic growth.
Share markets also act as a method of allocating
resources to different types of production.
Those companies and sectors with the best growth
prospects will be able to use additional investment
funds more effectively and therefore will raise more
funds when floated.
In this way, an efficient share market will raise the
medium term growth prospects of an economy
Share prices will be higher for firms in industries
that are expected to experience a high growth
Assuming perfect market conditions, the areas
with higher share prices indicate areas of growth in
the economy


The problem to share markets
When we talks about the share market being an
indicator for areas of growth, we assume that
consumers purchase share with a genuine belief in
the solid future prospects of the industry or the
economy. However, many share purchases are
speculative. i.e. they are bought to be resold in a short
period instead of being bought for a long term
income stream of income. Since these speculations
are based on the latest hype in the market instead of
its profitability, it can lead to the misplacement of
resource.
Domestic and Global Markets 12.5
Australia is more integrated into the global financial
markets
This reflects developments in information and
communication technology. (This has lowered its
costs and increased the reliability and speed of
electronic transfer funds.)
There has been a dramatic increase in the
participation of foreign investors in Australian
markets through
Increased lending to Australia
Increased foreign ownership of Australian
companies
Because of their increased participation in the
global economy, there has been more opportunities
for them to invest and lend their surplus to foreign
companies
Australia has been dependant on foreign sources of
capital to finance its development, making the foreign
participation necessary in the Australian financial
market.
Foreign exchange markets enable the movement of
fund around the world.
Global debt markets are important for economic
development because we are more reliant on foreign
borrowing.
Equity markets are regulated by national
governments and exist primarily within individual
countries.

Regulation by governments is important for the
stability and efficiency of financial markets but in
global financial markets, small organisations perform
minor functions. E.g.
The bank of international settlements
An international organisation that helps
central banks like the reserve bank of
Australia promote financial stability through
appropriate market regulations

The international monetary fund
Over sees the general stability of the
international financial system through
monitoring economies and markets and
assisting countries having difficulty meeting
their international financial obligations.

International organisation of securities
commission
For share markets

International association of insurance
supervisors
For insurance markets
Benefits of global financial markets are that they
allow Australians to access foreign capital to invest in
houses and businesses.
Without access, we would face higher borrowing
costs or not be able to access finance in general
Global financial markets also offer the opportunity
to invest and earn returns from businesses over seas
*but a disadvantage to this would be that we are
more influenced by the disturbances in overseas
markets.
There is also a concern with the impact of high
level foreign ownership of Australian businesses on
the Australian economy
Whether it is in the nations interests
Whether this has a long term effect




Regulation of financial markets 12.6
Stable financial markets are critical for the
functioning of the economy.
If the steady flow of funds between investors and
savers are disturbed, it can result in a loss in savings
and companies in bankruptcy.
Instability in financial markets can also undermine
confidence more broadly across the economy and
reduce economic growth
Maintaining financial stability through regulation is a
key objective of government economic policy. In
Australia, 4 government bodies have the
responsibility for the regulation and supervision of
the financial system
Financial Market regulators
Reserve bank of Australia
(RBA)
Responsible for
monetary policy,
payments system
regulation and the
stability of the financial
system
Australian Prudential
Regulation Authority
(APRA)
Responsible for
prudential supervision
and regulation of all
deposit taking
institutions, life and
general insurance and
superannuation funds
Australian Securities and
Investments Commission
(ASIC)
Responsible for
corporate regulation,
consumer protection and
oversight of financial
service products
Australian Treasury Advises the government
on financial stability
issues and legislative and
regulatory framework for
the financial system


The council of financial regulators is a coordinating
body for financial market regulation that provides for
cooperation and collaboration amongst its 4
members
RBA
APRA
ASIC
AT

It is an informal body that allows sharing information
and coordinating advice but does not have any
function separate from its individual members.
The structure of responsibilities for financial market
regulation between the four agencies has been
around since the 1990s and was established in
response to an influential enquiry known as the
Wallis Committee.
The committee recommended significant changes
to regulation to keep pace with financial sector
changes such as new technologies, increased
competition and the breakdown of old distinctions
between different types of institutions.
these were the largest changes after the
deregulation of the financial sector in the early to
mid1980s which removed many government
controls over the finance sector and exposed the
industry to greater influence from domestic and
global market forces.
The global crisis of the late 2000s put the adequacy
of Australias financial sector regulation under
greater scrutiny. There were some changes made to
strengthen the market regulation in response to the
crisis:
An interim ban was imposed by ASIC in the
practise of short selling
A 3 year government guarantee was given for
15 million deposit accounts in Australian
owned banks, locally incorporated
subsidiaries of foreign banks, credit unions
and building societies alongside a guarantee
on whole sale finance issued by the same
institutions.
Australias Future of Financial Advice reform
package (2013) banned financial advisers
from receiving commissions and imposed a
duty on them to put the interests of clients
first.
The Reserve Bank of Australia
RBA is Australias central Bank.
A central bank has a role of controlling a countrys
money and banking system
Its primary purpose is the management of the
financial system in accordance with economic
objectives of the common wealth government.
The RBA was created in 1959
Limited central banking operations were
conducted by the Commonwealth bank.
The RBA is to be guided by four main objectives
1. The stability of Australias currency
2. The maintenance of full employment
3. The maintenance of economic prosperity and
welfare of the people in Australia.
4. Sustain low inflation (which is linked to sustaining
the currency)
Functions of the Reserve Bank of Australia
Conducting monetary policy on behalf of the
government
This is the most important and ongoing role of the
RBA
The monetary policy is the Reserve Banks action
designed to influence the cost and availability of
money in the Australian economy through
influencing the general level of interest rates.
The RBA conducts the monetary policy with
the aim of achieving a sustained low inflation
rate while encouraging economic growth.
Systemic stability
The tradition al where they needed to give
prudential supervision to banks is now the job of
APRA
The RBA still has the role of being responsible of
the overall stability of the financial system
it provides guidelines to foster the stability of
individual financial institutions and these guidelines
are enforced by APRA
It also seeks long term stability by
avoiding/reducing the risk of a financial crisis which
protects deposits of the members of public without a
formal guarantee for depositors funds.
Banks can determine how much of their assets can
stay in liquid form


Control of note issue
It is the sole issuing authority for the Australian
currency
All currency is printed by Note Printing Australia
which is a division of the reserve bank.
The volume of notes and coins on issue at any
point will vary according to the communitys demand
for funds.
Regulations of the payments system
The reserve bank is responsible for the payments
system
By means of ensuring efficiency and stability of
payment methods such as credit cards, electronic
cash, travellers cheques and store value cards.
This is carried out by the payments systems board
with in the reserve bank.
Banker to the banks
Banks hold exchange settlement accounts with the
reserve bank.
These accounts allow banks to settle a debt
between them as well as with the reserve bank at the
end of each days trading.
They can also be used by the banks to buy and sell
government securities from the RBA
Responsibility for holding Australias reserves of gold
and foreign currency dealings
The RBAs reserves provide the funds that can be
used to make international payments or for reserve
bank operations in the foreign exchange market.
Banker and source of financial economic advise to
governments
RBA provides banking and financial agency
services to the Commonwealth Government as well
as some state governments.
The government can lodge excess funds with the
reserve bank and obtain funds through the issue of
treasury bills.
The issue of treasury bills amounts to the RBA
printing new money the government needs.
RBA is also a financial agent for the government
raising short term (treasury notes) and long term
(government bonds) loans, making interest payments
on these loans, and buying them back on maturity.
RBA acts as a source of financial and economic
advice to the government.
It publishes regular assessments of the state
of the economy and financial markets
Publications are highly respected and have a
significant influence on the economic policy
making
Australian Prudential Regulation Authority (APRA)
They provide prudential regulation for all authorised
deposit taking institutions (ADIs) including
Banks
Superannuation funds
Insurance companies
Credit unions
Building societies
It has two main roles
1. Encourages behaviour by institutions that will
ensure they are able to meet their obligations to the
people who place money with them.
APRA regulates institutions to ensure deposit
holders have the right to withdraw their money at
their will, companies meet their policy obligations,
superannuation funds can pay people who with draw
their savings.
APRA requires its deposit taking institutions to
maintain certain levels of funds on hand and to
manage risks according to specific formulae.
2. for any (ADIs) insurance companies or
superannuation funds that experience financial
difficulty, APRA has the role of sorting out the
institutions financial position and ensuring that
policy or deposit holders receive as much of their
funds as possible.
a range on investigative powers support APRA
which gives them the right to intervene in any of its
related institutions if it feels they have become
financially unviable.


Australian Securities and investment commission
They regulate Australian companies and financial
markets with the aim of protecting investors and
consumers and improving the performance of the
financial system.
They have the power to monitor, investigate and
act in situations where the integrity of the financial
system has been undermined by the illegal acts of
individuals or the creation of unethical investment
products.
They also have powers to protect consumers
against misleading or deceptive an unconscionable
conduct affecting financial products and services.
ASIC also lifts standards of corporation behaviour
and maintaining confidence in financial markets.
Examples of offences they regulate are:
Insider trading where company directors use non-
public information about the company to buy and sell
shares in the market to make a profit and company
executives failing to inform the market price of
sensitive information.
ASIC typically has hundreds of investigations
underway at any point of time. People may be fined,
assets may be made frozen, and people may even be
jailed for major offences. Recently they have been
involved in high profile legal disputes.
In the recent years, ASICs role has been expanded.
2009, they became the national regulator for
consumer credit (e.g. loans, credit cards) taking over
from the states and territories
2010, ASICS= has increased responsibility for
supervising security markets such as the Australian
securities exchange.
The ASIC is not there to prevent investors from
making losses, try to stop people investing in high
risk ventures which may lead to corporate failure or
bail out or prevent companies from financial
difficulties.
While facilitating the flow of information and holding
participants to standards, ASICs role reflects a view
that financial markets will be more efficient and
better for investors in the long run if they operate
with minimum interference with the government.
Australian Treasury
They are the main source of economic policy advice
to the government and can influence hoe
governments devise budget, collect taxes, allocate
expenditure and implement other policies such as
monetary policy, labour market policy, and market
regulations.

For financial market stability specifically, the
Treasury provides advice to the government about
regulatory settings for financial markets, corporate
practices and consumer protection.