Academy of Economic Studies

Faculty of International Business and Economics

International Finance and Payments

Course II
International Financial Markets and
Institutions
Lect. Cristian PUN
Email: cpaun@ase.ro
URL: http://www.finint.ase.ro
International Financial System - review
IFS ensures the capital transfers between the investors and financing
beneficiaries (or debtors) main function;
IFS is composed by financial markets, financial institutions and
financial instruments;
Bretton Woods Agreement is the base for actual IFS;
the evolution of IFS was determined by several factors;
EMS was an European alternative for IFS;
BP registers all the commercial and financial transactions of a country with
the rest of the World;
we use this BP to determine the need for financial resources for a country
this BP should be in equilibrium and the deficits can be reduced using
different policies;
the fixed exchange rate ensures an automatic equilibrium for a BP.

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Financial System - structure

Financial
transactions

Government Private
companies
Financial
Financial Institutions
transactions Financial
transactions
Population
Financial Markets

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Financial Markets - characteristics
FINANCIAL MARKETS

Money Markets (maturity < 1 year):
-very liquid;
- transactions with credit
instruments;
- small fluctuations for the
securities prices => low risk
Capital Markets (maturity > 1 year):
- transactions with debt and equity
securities (bonds, equities)
- higher prices fluctuations

International Credit Markets, Euromarkets

and FX Markets
-Primary market: is a financial market in which new issues of a
security are sold to initial buyers;
- Secondary market: is a financial market in which security
(previously issued) can be resold by the investors for cash.

Exchange offices (NYSE, CBOT) OTC Markets

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Financial Markets - characteristics
Characteristics Money Markets Capital Markets
Maturity Under 1 year Below 1 year
Risks Lower Higher
Instruments Credit instruments Debt and Equity instruments
Liquidity Higher Lower
Transaction volume Lower Higher

Credit instruments Debt and Equity Instruments

- Treasury bills; - Common Stocks
- Commercial Papers; - Preferred Stocks
- Bankers Acceptance; - Bonds
- DC; - Investment Funds Participations
- Credits; - Insurance Policies
- Pension Funds Policies
- Derivatives

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Financial Resources for a company
- Reinvesting the
Internal profits;
Resources - Increasing capital;
-Debt to equity
conversion;
- Amortization.
Financing
Decision

- Credits;
External
- Bond issuing;
Resources
- Equity.

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Why we should use internal resources ?
Advantages:
increase the company value;
higher autonomy from financial institutions;
lower costs (such as banking commissions and taxes);
advantages from fiscal regimes applied to reinvested profits;
small companies or new business;
leveraged companies (high debt).
Disadvantages:
Real cost for internal financial resources
opportunity costs;
taxation.
Internal resources are the most expensive
financial resources !!!

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Why we should use external resources ?
Advantages:
mature business cash-flow cows;
less costly then own financial resources;
important financial resources that can be obtained;
higher maturity;
fiscal regimes in case of the interest paid to a bank;
Disadvantages:
additional costs (taxes, commissions applied);
the dependence from the financial institutions;
the reimbursement program;
a good projection for your business development (future income and cash-
flow prediction).

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Direct Financing vs. Indirect Financing

Financial
Intermediaries

Indirect Financing

Debtor Investor or Creditor

(Beneficiary)

Direct Financing

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Direct Financing vs. Indirect Financing
Advantages for indirect financing:
a good information about capital resources;
lower risks (some institutions share or cover the financial risks);
financing consultancy;
financing facilities;
different financing alternatives;
financing condition imposed by the financial institutions;
lower transaction costs.
Disadvantages for indirect financing:
higher operational costs;
inexistence of a direct contact with financial markets;
historical relations with a financial institution.

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Services provided by financial institutions
selling and buying financial securities;
international payments;
international financing (incl. export financing);
financial consultancy;
international markets surviving (rating agencies);
insurance against financial risks;
guarantees for financial transactions;
managerial expertise;
companies surviving (competitors, clients);
portfolio management;
investment funds management.

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Financial Institutions
I. International Financial Institutions:
-International Monetary Fund;
-World Bank (IBRD, IDA, IFC, IMGA);
-EBRD;
Public
-European Investment Bank;
Financial
-Bank for International Settlements; Institutions
II. Government Institutions:
-Export Credit Agencies;
-Export Guarantee Credit Agencies;
-Export Insurance Agencies;
III. Depository Institutions:
-Commercial Banks;
-Savings and Loans Associations;
-Mutual Savings Banks;
-Credit Unions.
IV. Non depository Institutions:
-Investment Banks; Private
-Mutual Funds; Financial
-Pension Funds; Institutions
-Insurance Companies;
-Financing Companies;
-Venture Capital;
-Stock Markets Brokers and Dealers.

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Primary Assets and Liabilities of Financial Intermediaries
Type of intermediary Primary liabilities (sources of funds) Primary Assets (uses of funds)

1. Depository institutions:

- Commercial Banks Deposits Business and consumer loans,

Municipal Bonds, T-Bonds
- Savings and loan Deposits Mortgages loans
associations
- Mutual Savings Banks Deposits Mortgages loans

- Credit Unions Deposits Consumer loans

2. Contractual Savings Institutions

- Life Insurance Companies Premiums from policies Corporate Bonds and Mortgages

- Fire and casualty Insurance Premiums from policies Municipal Bonds, corporate Bonds,
Companies Treasury securities

- Pension Funds Employer and employee contributions Corporate bonds and stock

3. Investment Institutions

- Financing Companies Commercial papers, stocks, bonds Consumer and business loans

- Mutual Funds Shares Stocks, Bonds

- Money market mutual Shares Money market instruments

funds

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Type of intermediaries

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Financial Instruments
A financial instrument is a contract between lender and borrower;
This particular contract establish:
the financing mechanism;
the role of each institution / participant in the mechanism;
the amount;
the maturity;
the currency;
the financing cost (interest rate) and the payment method;
the risk allocation between the participants;
the payback of the loan;
other aspects (special clause).

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Financial Instruments
Financial Instruments

Direct Investment Indirect Investment

- Investment Funds
Participations;
Money Market: Capital Market - Insurance Policies;
Treasury Bills; - Pension Funds
Negotiable Participations.
bank certificates
of deposit;
Commercial Fixed Income Instr.: Equities: Derivatives:
papers; T-bonds; Common stocks; Futures;
Bankers Municipal Bonds. Preferred Stocks; Options;
acceptances; Corporate Bonds. GDR. Swaps;
Repurchase Caps;
Agreements; Floors;
Government Collars.
Funds.

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Money market instruments
Treasury Bills;
Negotiable bank certificates of deposit;
Commercial papers;
Bankers acceptances;
Repurchase Agreements;
Federal Funds.

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A. Treasury Bills
short term debt instruments
maturity of 3, 6 or 12 month;
have no interest payments (initially sold at a discount);
the most liquid financial instruments;
the safest financial instrument (no default risk)
can be issued in different currencies (usually are issued in local
currency)
risk free rate instruments;
B. Negotiable Bank Certificate of Deposits
debt instrument sold by a bank to depositors (one of the most important capital
source for banks);
pays annual interest;
at maturity pays back the original purchase price;
can be negotiable now
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C. Commercial Papers
short term instruments issued by banks or well known companies
a high growth rate for this instruments (2000% between 1970 1996 in US);
no interest payments (usually issued at a discount);
interest rates are related to the issuers risk

D. Bankers Acceptances
were developed in accordance with international trade development
represent banks drafts (a promise of payment similar to a check) issued by a
company for a future date and guarantee for a fee by the bank
the bank acceptance = the guarantee
these instruments are often resold on secondary market at a discount
high growth rate (250% in US between 1970 and 1996)

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E. Repurchase Agreements - repos
short term loans based on a collateral
this instruments were introduced in 1961
increase the liquidity for financial instruments
reverse repos

F. Federal Funds
overnight loans between banks and Central Bank
the banks pay an interest rate
federal funds rate (refinancing rate)

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Capital market instruments
Stocks (common stocks, preferred stock);
Mortgages;
Treasury Bonds;
Municipal Bonds;
Corporate bonds

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Financial Instruments risk classification

Level 4: High Risk Instruments

Derivatives, junk bonds

Level 3: Potential Growth Rate Instruments:

Blue chips, Mutual Funds Participations, Convertible Bonds.

Level 2: Sure Income Instruments:

T-Bills, Municipal Bonds / T-Bonds.

Level 1: Risk free rate instruments:

Cash, Deposit Certificates, Insurance Policies.

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