Chapter 9_ARA_13_14.pdf

7/27/2019 Chapter 9_ARA_13_14.pdf

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7/27/2019 Chapter 9_ARA_13_14.pdf


! Basic concepts about the financial system

! Analize the financila decisions of the company

! Understand the financial structure of thecompany

! Understand what financial assets (securities)

are, financial markets and agents.

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! In this module we´ll start with the big picturefirst, making sure we know what finance is in

the context of a diagram describinginvestment cash flow in our economy.

! Next we´ll define the different agents of the

financial system and their activities/responsabilities…

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! 9.1 Financial director

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Two main roles

• FINANCE: providing financial sources (funds) minimizing or at least reducing

the costs.

• INVEST arranging the best possible way the borrowed money whilst at thesame time ensuring the returns are high. (maximizing profits).

Secondary roles:

• Find external funds.• Set up the financial structure of the firm

• Define the dividends policy

• Manage the liquidity

• Report on the trend of the company and the financial and economical structure

• Distribute the funds between departments or alternatives of investment

• Do research about possible alternatives of investment• Rank the investments

• Analyze and make decisions of alternatives of investment

(Select if the debts are wanted in the short or in the long run)

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! Internal sources: Traditionally, the major sources of finance for alimited company were internal sources.

! Retained earnings or profit

! Depreciation

! External sources: debenture, loans, stocks…

Loss of value of my assets over time.

Selling bonds or stocks, asking for loans.

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Sources of finance

Amortización = Amortization or Payback (depending on the meaning) Obligaciones, bonos = Bonds ( depending on the time)

Short run Long run

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Goals of the financial system: • Promote the private savings

• Efficient allocation of the financial funds

• To guarantee the institutions, the financial tools and marketshave flexibility to adapt to the new changes that promote the

private sector saves and the efficient allocation of financialfunds.

• Economic agents or economic units of expenditure: • Families: domestic economies or households

• Private sector: corporations, firms, businesses

• Public sector

• Countries

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! The F.S. channels household savings to the corporate sector andallocate investment funds among firms;

! It allows intertemporal smoothing of consumption by householdsand expenditures by firms; they enable households and firms toshare risks.

! The agents: produce, consume, save and invest.

! Features of a financial tool (stock, bond…):cost, the maturity (life),volume and risk

Specialized agent. Direct allocation.

Financial Intermediaries. Indirect allocation

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PYMESBanco de España

CNM

8+('(4+'- +($#19#)+'1+#":

CNM Comision Nacional Mercado de valores

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Broker: A broker is a party that mediates between a buyer and a seller of securities

• Don´t assume any risk; the buyers and/or sellers assume all risks.

• Don´t influence the price. They assume the market price, “fair value”

• They usually charge a commission once the trade is ended.

• They act on behalf of a third party. They don’t increase the supply or demand of the market.

• They work in Brokerage Firms (and Stock Markets) , supervised by the National Banking and

Securities Commission. They usually need a license and own capital about 901,518.16".

Dealers: they buy and/or sell securities on behalf of a third party. They can work on commission ormanage their own portfolio. If an agent works as a “broker” or as a “dealer” is an important issueand has to be reported.

• They get gains from managing their own portfolios and /or commissions

• It is more complex than a broker

•

They assume the risk of managing their own portfolios but they don't influence prices

• They can act on their own behalf

• They can act on behalf of a third party.

• They can increase the supply or demand

• They are allocated in Securities Firms, corporations that need a minimum amount of owner'sequity of 4,507,590.78 "

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! Market makers: dealers specialized on a kind of financial instrument. They are

companies, or individuals, that quote both a buy and a sell price in a financial instrument

or commodity, hoping to make a profit on the bid-offer spread.

! A brokerage or bank that maintains a firm bid and ask price in a given security by

standing ready, willing, and able to buy or sell at publicly quoted prices (called making a

market).

! These firms display bid and offer prices for specific numbers of specific securities, and ifthese prices are met, they will immediately buy for or sell from their own accounts.

! Market makers are very important for maintaining liquidity and efficiency for the

particular securities that they make markets in.

! At most firms, there is a strict separation of the market-making side and the brokerage

side, since otherwise there might be an incentive for brokers to recommend securities

simply because the firm makes a market in that security

! They work on public debt markets and also on derivative markets (options and futures).

! For avoiding monopoly there is a market maker for each stock/bond but they have

to keep a spread between buy and sell to prevent from war of prices.

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! These are institutions acting as mediators forthose who want to receive funds and thosewho want to invest them, thus transformingmaturities, amounts, and risks, and therebyreducing costs, (adapting them to theinvestors)

! Two kind:! Belonging to the Banking System/sector.

! Out of the banking system

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Financial intermediaries provide 3 major functions:

! Maturity transformation: Converting short-term liabilities to longterm assets (banks deal with large number of lenders and borrowers,and reconcile their conflicting needs).

! Risk transformation: Converting risky investments into relativelyrisk-free ones. (lending to multiple borrowers to spread the risk).

! Convenience denomination: Matching small deposits with large loansand large deposits with small loans.

Their profit comes from the difference of rate of interest they applyto the agents with surplus of liquidity (savers) and the borrowers(investors). As consequence of the minor difference between rates,the intermediaries have opted for applying commissions in order toincrease their gain/loss.

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Banking System:

! Banks can be private or public ones. A bank connects customers with capitaldeficits to customers with capital surpluses. Usually public ones lend loansand credits.

! Savings and loan institutions facilitate access to credit for their members andpromote public saving and lending, grant financing for small and medium-sized business, and, in general, foster economic and social improvement, as

well as the well-being of their members and the communities in which theyoperate. Part of their gains is derived in social actions.

! Credit cooperatives: Credit unions are public companies that facilitate fortheir members the investment of resources to support the productiveactivities and/or services they perform. Credit unions can operate only in thesectors in which their members perform their activities.

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Not banking systems:Two kind:

! Those whose main goal is to finance the savers:

Financial groups

Insurance firms

Pension fundsRetirement Savings Administrators

Special-purpose non-bank financial institutions

Joint Ventures

! Those that are financial credit institutions:

Credit firms (they finance long term operationsbut they do not capture deposits)

Mortgaging companies

Financial leasing companies

Factoring companies

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Banking System

! Banks: can be private or public ones. A bank connects customers with capitaldeficits to customers with capital surpluses. Usually public ones lend loansand credits.

! Savings and loan institutions: facilitate access to credit for their members andpromote public saving and lending, grant financing for small and medium-sized business, and, in general, foster economic and social improvement, as

well as the well-being of their members and the communities in which theyoperate. Part of their gains is derived in social actions.

! Credit unions: Credit unions are public companies that facilitate for theirmembers the investment of resources to support the productive activitiesand/or services they perform. Credit unions can operate only in the sectors inwhich their members perform their activities.

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! Financial groups: are financial intermediaries managed by asole controlling entity. They consist of a controlling companyand some of the following financial entities: pawnbrokers,financial leasing companies, factoring companies, foreignexchange firms, bonding companies, insurance companies,

brokerage firms, universal banks.! Investment companies they have their own regulation. They

seek to acquire and sell assets for the purpose of investment,with funds that come from the placement of shares with publicinvestors, who are the companies' owners. The shares of thesecompanies are part of their portfolios. For obtaining a return of

the portfolio, the shares have to be sold when they haveincrease their value. In an Investment company the shares haveto be sold in the Stock Market.

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! Insurance companies are required to cover damages, directlyor indirectly, equivalent to a certain amount of money when afuture, unforeseen event occurs, as preordained by theparties, in exchange for a specified payment called apremium. Insurance operations are classified as life, property,and medical and hospitalization and illness.

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! Retirement Savings Administrators :dedicated exclusively toadministering the individual accounts of workers, channelingthe funds to sub-accounts constituted according to the socialsecurity laws.

! They also administer investment companies specialized inretirement funds.

! Investment companies specialized in retirement funds. Theirmain purpose is to invest, exclusively, the resources from theworkers' accounts they receive, according to the socialsecurity

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! Corporate Venture Capital: Corporate venture capital (CVC) isthe investment of corporate funds directly in external start-up companies.

! CVC is defined by the Business Dictionary as the "practice

where a large firm takes an equity stake in a small butinnovative or specialist firm, to which it may also providemanagement and marketing expertise; the objective is to gaina specific competitive advantage

! The definition of CVC often becomes clearer by explaining

what it is not. An investment made through an external fundmanaged by a third party, even when the investment vehicleis funded by a single investing company, is not consideredCVC.

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! A financial claim on an asset that is usually documented by some

type of legal representation.! Examples include bonds and shares of stock but not tangible assets

such as real estate or gold.

! They are submitted by agents looking for financial sources(investors) and are acquired by agents with surplus of liquidity(an investment= expecting a return).

! They are channels of transferring funds between agents and alsotransferring risks.

! They suppose to be a liability for the issuer and an asset for theinvestor

! The most important assets issued by firms are: stocks (variable

return) and bonds (fixed return)! Basic features of a financial asset:

! Liquidity: ease to cash

! Return: economic profit/gains yield

! Risk: solvency and guaranty

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! The oscillations of the securities that quote in the StockMarket is called volatility.

! The risk is measured by the variance:! The greater variance: the greater volatility

! The risk of an asset can divide into:

! The specific risk of the asset. If we diversify our portfolio wecan minimize this risk.

! The market risk or systematic risk: depends on the market noton the issuer of the asset. The ! coefficient is used to estimatethe sensitivity of a security return to any change of the marketreturn (measured by an index, as the IBEX 35)

! The rational investor prefers the return rather than the risk

! The higher the return of a security, the higher the risk

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! Financial market: related to the place, mechanism or systemthat allows the trade of the financial assets between theagents.

! The price (market value, “fair value”, providing liquidity.

Roles

! Meeting point of demand and supply

! Determine “fair value” of the assets: supply=demand

! Liquidity

! Reduce the costs and the intermediaries

! Efficiency, better return-risk features. Improve conditions oftrading (less commissions, cutting costs)

! Institutional Features : transparency, freedom of access tobuyers and sellers

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28

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29

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30

Public

Debt

BondsConvertible

bonds

Common

Stocks

Options

Bank

Deposits

Preferredstocks

Investement

s funds

Assets:Real

Estate, Art,Gold

Futures

Risk

Expected return

Securties

free of

risk

Rf

Market securties

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31

Return of a secutiry

(%)

Market

Return (%)

4040

10

30

20

-20

-10

-30

-10

-40

-30 -20 10-40 3020 40

SecurityA

Characteristic line A

Security B

Characteristic line B

! A= slope = 1,27

!B= slope = 0,85

r A = " + 3 + 1,27 * r m

r B = " -11 + 0,85 * r m

Security A shows higher risk than B

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RD7D L'#%#2'%) 5%63*$,

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! Classification of the markets:! By the level of transformation of the assets:

! Direct markets! Intermediated markets

! By the level of trading of the assets:! Primary markets

! Secondary markets! By the features of the asset:

! Cash markets! Capital markets! Currency markets

! By the level of formality :! Organized Markets

! Non organized Markets! By the maturity or conditions:

! Spot Markets

! Markets of futures! Market of options

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! In Spain there are 4 Stock Markets: Madrid, Barcelona, Bilbao andValencia. Private Institutions.

! The law of the Stock Markets set up the arbitrage and thecontinuous market.

! The net: (SIBE: Sistema de Interconexión Bursátil) ease the unique

trade.! Bolsas y Mercados Españoles, is a society that regulates the markets

of securities and financial systems in Spain: Stocks Markets ofBilbao, Madrid, Valencia and MF (Financial Markets and Iberclear)

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! The official financial markets are:! Stock Markets

! The Public Debt Market

! The futures and options Market

! The Stock Markets in Spain are the official secondary markets

for trading stocks and securities.! The derivatives Markets are managed by the MEFF (Spanish

Market of Financial Futures)

! MEFF manages the trade of options and futures

! The traded securities in the Public Debt Market are bonds,

obligations, Treasure Bills and debt issued by PublicInstitutions or Authorities.

! Those national or state markets that accomplish with therequirements and are authorized by Law

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! IBERCLEAR: manages the liquidity and thecompensation of traded securities in theStock Market

! The MEF manages the liquidity of the tradesof the market! The CNMV (National Commission of the Stock

Market) audits and regulates the Stock Market! The Public Debt Market of the Spanish Central

Bank is supervised directly by the SpanishCentral Bank.

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Documents

Chapter 9_ARA_13_14.pdf