Financial flows and markets

Financial flows and Markets

Prof.C.S.Balasubramaniam

Introduction

• Financial assets is a paper claim by one economic unit on some other economic unit.

It does not provide its owner with the physical services/labour that a real /fixed asset does Financial assets are held as a store of value for the return what they are expected to provide Holding these assets (except equities) does not indicate neither direct nor indirect ownership of real assets in the economy .

Introduction

• Financial assets are interrelated to savings Savings are in the Keynesian terms Y-C = S or

current income minus current expenditures . They are held by households /joint family partnerships,NGOs, companies, government and their units . Financial assets facilitate capital formation or investment. All tangible assets such as land, buildings ,plant &machinery ,inventories constitute capital formation .

Introduction

• In the absence of financial assets , economy would not be able to function dynamically and it would not be having value over time . All economic units would be willing to lend to /borrow from each other and that constitutes interrelationships or claims . Households are saving surplus units and they lend to companies which are saving deficit units . Financial markets including banks are the intermediaries ,who facilitate this lending /borrowing between the units . Governments have set up regulatory bodies to supervise and monitor the functioning of these bodies in a coordinated and smooth manner.

Efficiency and economics in financial markets

• The purpose of financial markets is to allocate savings /financial assets efficiently across various economic units . Financial markets help in achieving balance between saving surplus units (Hh)and saving deficit units (Bu)

• Efficient financial markets are essential to assure adequate capital formation and economic growth in a modern economy and without that efficient level, the economy would be static , traditional and narrow .

Stages of economic efficiency

• In a modern economy, primary units lend their savings to financial intermediaries/markets and they constitute primary securities. Value creation happens through claims and allocation of financial assets/liabilities between the various economic units . Direct loans may not be sufficient in creating /service asset formation in each other. Brokers are financial intermediaries and they help in negotiating and assembling convenient multiple loans .

Stages of economic efficiency

• Secondary markets including stock exchanges enhance the flow of savings in an economy where existing securities are bought /sold and thus the markets become viable , flexible and efficient. Securities become marketable by having and retaining value across transactions and markets .The prices and yields reflected in this market provide a rational basis for borrowing/lending decisions in the primary market and pricing new loans and activities .

Role of financial intermediaries

• Financial intermediaries help in creating value and transactions across exchanges /markets .

• Financial intermediaries provide a variety of services – - Reduction of transaction costs - Information thru documents /agreements and

dissemination and analysis &appraisal - Divisibility &flexibility - Diversification across securities ,risks &return - Maturity - Expertise and convenience

Role of Financial intermediaries

• Financial intermediaries tailor the denomination and type of indirect securities they issue to savers and they make a profit in the transaction which makes their business viable and efficient.

Role of financial intermediaries

Spread/Net interest return

Equations

• RA +MT+L+E = S+D+IM+IE ------------(1)• S= (MT +L+E)—(IM+B+IE)+(RA-D) ----(2)• Aggregate Savings = Aggregate (RA -D )---(3)• Aggregate (MT+L+E) –Aggregate (IM +B+IE) =0• Liquidities across markets and economic units

results thru transactions and equilibrium and efficiency results in the economy . Otherwise disequilibrium and crisis happens .