BEO3446 Financial Institutions

and Monetary Theory

Unit coordinator : Sydney Lambrick
G321.
99194435
Sydney.lambrick@vu.edu.au

Students must have past either
Economic Principles OR
Macro and Micro Economics to do
this subject.
Financial Institutions and Monetary
Theory.
1. The Financial System
Focus on Australia with some reference to
Malaysia and China. Looking at general
principles as well as institutions.
Main functions and role within the economy

2. Monetary Theory and Policy
Review monetary theory.
Enhance understanding of monetary theory
from
Historical perspective
Current monetary policy

3
Assessment
One class paper on current newspaper topic. 10%

One group essay . (2000 words per person) 40%

Exam : 50%
4
Essay
Group project with 2 or 3 partners (Maximum 4)
Start thinking about partners and topics NOW.
Monday, 14
th
April you must have given me (by email)
notification of your partners and topic, and a contact phone
number for the group.
Essay due No later than 5.00pm ,Thursday
May 15
th
.
NB: Failure to comply with this
requirement will result in ineligibility to
sit the exam.
5
Class Paper.
A presentation to the class on a topic taken from a newspaper
article.

See webCt for detailed instructions.

Sign up now for which week you will present.

Students that fail to present on the agreed day wil FORFEIT all
marks for this assessment.
Chapter 1
A modern financial
systeman overview







Websites:
www.rba.gov.au
www.treasury.gov.au
www.bis.org
www.ny.frb.org
www.asx.com.au
www.ft.com/asia/

Learning objectives
Explain the functions of a financial system
Categorise the main types of financial institutions
Describe the main classes of financial instruments issued in
a financial system
Discuss the flow of funds between savers and borrowers,
and through the financial system and economy
Distinguish between various types of financial markets
according to function
Appreciate the importance of globalisation of financial
markets
Understand the effects and consequences of a financial
crisis on a financial system and economy
Web ct.

Unit guide

Seminar schedule

Essay instructions.

Class paper instructions.

Additional reading.

Links.

Exam guide (eventually)

Chapter organisation
1.1 Functions of a financial system

1.2 Financial institutions

1.3 Financial instruments

1.4 Financial markets

1.5 Flow of funds, market relationships and stability

1.6 Summary
Functions of the financial
system.
1. flow of funds. Surplus to deficit units.

2. Provision of the payments system.

3. Manage risk.
1.1 Functions of a financial system
Money
Acts as medium of exchange
Store of value
Unit of account

Allows specialisation in production
Solves the divisibility problem; i.e. where medium of exchange
does not represent equal value for the parties to the transaction
Facilitates saving
(cont.)
1.1 Functions of a financial system
(cont.)
Role of markets
Facilitate exchange of goods and services by:
bringing opposite parties together
establishing rates of exchange; i.e. prices

Surplus units
Savers of funds available for lending

Deficit units
Borrowers of funds for capital investment and consumption
(cont.)
1.1 Functions of a financial system
(cont.)
Financial instrument
Issued by a party raising funds, acknowledging a financial
commitment and entitling the holder to specified future cash
flows

Double coincidence of wants satisfied
A transaction between two parties that meets their mutual
needs
(cont.)
1.1 Functions of a financial system
(cont.)
Flow of funds
Movement of funds through the financial system between
savers and borrowers giving rise to financial instruments

Financial system
Comprises financial institutions, instruments and markets
facilitating transactions for goods and services and financial
transactions
(cont.)
1.1 Functions of a financial system
(cont.)
(cont.)
1.1 Functions of a financial system
(cont.)
Attributes of financial assets

Return or yield
Total financial compensation received from an investment
expressed as a percentage of the amount invested

Risk
Probability that the actual return on an investment will vary
from the expected return
(cont.)
1.1 Functions of a financial system
(cont.)
Attributes of financial assets (cont.)

Liquidity
Ability to sell an asset within a reasonable time at current
market prices and for reasonable transaction costs

Time-pattern of cash flows
When the expected cash flows from a financial asset are to
be received by the investor or lender
(cont.)
1.1 Functions of a financial system
(cont.)
Facilitation of portfolio restructuring
The combination of assets and liabilities comprising the desired
attributes of return, risk, liquidity and timing of cash flows

Implementation of monetary policy
Actions of a central bank taken to influence interest rate levels
to achieve certain economic outcomes
Primary target is inflation

(cont.)
1.1 Functions of a financial system
(cont.)
An efficient financial system:
encourages savings
directs savings to the most efficient users
implements the monetary policy of governments by influencing
interest rates
is a combination of assets and liabilities comprising the desired
attributes of return, risk, liquidity and timing of cash flows
(cont.)
1.1 Functions of a financial system
(cont.)
Since 2007, the financial markets have been characterised by a
great deal of volatility
What started as a liquidation of credit derivatives sparked by a fall
in house prices in the United States has become a watershed
moment in modern financial history
As nations continue to battle the economic effects of the GFC,
debate continues to rage about the regulatory response necessary
to bring stability to the system

Chapter organisation
1.1 Functions of a financial system
1.2 Financial institutions
1.3 Financial instruments
1.4 Financial markets
1.5 Flow of funds, market relationships and stability
1.6 Summary

1.2 Financial institutions
Most people have used the services of a financial institution at
some stage, even if the service was simply a basic bank account
Financial institutions may specialise in:
taking deposits, providing advice to corporate and government
clients or offering financial contracts such as insurance
Financial institutions are essential to the operation of the modern
financial system
(cont.)
1.2 Financial institutions (cont.)
Financial institutions permit the flow of funds between borrowers
and lenders by facilitating financial transactions

Institutions may be categorised by differences in the sources and
uses of funds
(cont.)
The Role of the Financial Sector
25
Flow of Funds.


.


Product
markets
FIRMS
HOUSE
HOLDS
Factor
markets
Govt.
Overseas
sector
Surplus units
Deficit units.





Financial
markets
1.2 Financial institutions (cont.)
Categories of financial institutions
Depository financial institutions
Investment banks and merchant banks
Contractual savings institutions
Finance companies
Unit trusts
Categories of financial institutions
Depository financial institutions

Mainly attract the savings of depositors through on-demand
deposit and term deposit accounts; e.g. commercial banks,
building societies and credit cooperatives

Mainly provide loans to borrowers in household and business
sectors
(cont.)
Categories of financial institutions (cont.)
Investment banks and merchant banks

Mainly provide off-balance-sheet (OBS) advisory services to
support corporate and government clients; e.g. advice on mergers
and acquisitions, portfolio restructuring, finance and risk
management

May also provide some loans to clients but are more likely to
advise on raising funds directly in capital markets
(cont.)
Categories of financial institutions (cont.)
Contractual savings institutions

The liabilities of these institutions are contracts that require, in
return for periodic payments to the institution, the institution to
make payments to the contract holders if a specified event occurs;
e.g. life and general insurance companies and superannuation
funds

The large pool of funds is then used to purchase both primary and
secondary market securities

Payouts are made for insurance claims and to retirees
(cont.)
Categories of financial institutions (cont.)
Finance companies

Funds are raised by issuing financial securities, such as
commercial paper, medium-term notes and bonds, directly into
money markets and capital markets

Funds are used to make loans and provide lease finance to
customers in the household and business sectors
(cont.)
Categories of financial institutions (cont.)
Unit trusts
Formed under a trust deed and controlled and managed by a
trustee

Funds raised by selling units to the public; investors purchase
units in the trust

Funds are pooled and invested by fund managers in a range of
asset classes specified in the trust deed

Types of unit trusts include equity, property, fixed interest and
mortgage trusts
1.2 Financial institutions (cont.)