Topic 2 -2 Financial Markets Relevant to Business

Topic 2 -2 Financial Markets Relevant to Business HSC Business Studies 2009

Financial Markets “Financial systems consist of markets and institutions that enable and encourage the flow of funds throughout the economy. ” “Financial markets are made up of the individuals, institutions and systems supplying excess funds to those who require them. The term ‘financial’ relates to money, and ‘market’ indicates trading activity”

Financial markets are the means for the creation and exchange of financial assets. Financial markets can be either primary markets or secondary markets. Primary Markets: where securities such as shares, stocks and bonds are sold for the first time. Secondary Markets: where shares, stocks and bonds are resold.

Financial markets are important for businesses because they provide: – Access to funds – Investment opportunities and contacts in fund management – Expertise in financial market dealing.

There are four main financial markets in Australia which are: • The Share or Equity Market: where ownership shares in companies are issued and exchanged. • The Debt Market: Split into the fixed-interest (bond) and shortterm money market. Also referred to as Cash and Securities markets. • The Derivatives Market: buying and selling of securities that are based on other securities, e. g. share options and futures. Includes financial instruments that can be interchanged and altered to suit needs of participants. This is the market where the 2008 financial crisis originated. • The Foreign Exchange Market (Forex) : where currencies of different countries are traded for each other.

Major Participants in Financial Markets

Financial Intermediaries receive money from those with excess funds and makes it available to those who want to borrow money. Financial intermediaries include: – Banks – Finance companies – Merchant Banks – Building Societies – Insurance Companies – Superannuation Funds. – Mutual Funds – Companies – Stockbrokers

Banks are the largest form of financial institution in Australia. They are the major operators in financial markets and a key source of funds for business. Most of the funds provided through financial markets come through banks. They have been diversifying their operations with subsidiaries in superannuation, mutual and other funds. Australia’s banking market is dominated by four main banks; – – ANZ CBA NAB Westpac

Finance Companies Finance and insurance companies are non-bank financial intermediearies (NBFIs). They specialise in smaller commercial finance. Finance companies do not take deposits. The acquire the funds to make loans by issuing promissory notes, debt securities and asset-backed securities. Finance companies provide loans to businesses and individuals through hire purchase loans, personal loans and secured loans to businesses. Some finance companies specialise in factoring or cash-flow financing, and they are the major providers of lease finance to business. Finance companies also raise cash through the issue of debentures. These are a loan to a company for a fixed term and carry a fixed rate of interest. In the event of the company being liquidated, lenders have priority security over the firm’s assets.

Insurance companies (ICs) ICs guarantee the assets of their policy holders in return for a fee. They provide loans to the corporate sector through receipts of insurance premiums, which provide funds for investment. The funds received as premiums, called reserves, are held by law in trust funds which invest in financial assets including shares, property and debt. Life insurance offices are able to make long-term investments as the mortality rates of their premium holders are predictable when measured according to age cohorts. Life insurance companies manage funds for other investors such as superannuation funds.

Merchant Banks or Investment Banks

Merchant Banks are one of the fastest growing sectors in the Australian financial sector. They – Trade money, securities and financial futures – Arrange long term finance for company expansion – Provide working capital and arrange project finance – Advise clients on foreign exchange cover, arrange overseas finance – Advise on mergers and takeovers – Provide portfolio investment management service – Underwrite corporate and semi-government issues of securities – Operate trust funds and property trusts

Superannuation • Have grown rapidly in recent decades • Invest funds in the corporate sector • Able to invest in long-term securities such as company shares, government and company debt

Mutual Funds (Unit Trust) Operate in the same way as superannuation funds, except that the funds used are voluntary savings and can be withdrawn at any time. Take funds from a large number of small investors. Invest in financial assets such as short-term money market, mortgages and public securities. In recent years have been investing in resources such as gold and oil.

Public and Private Companies • Companies can acquire funds by issuing equity or debt securities, or simply borrowing. • Manage funds so as to insulate themselves from risks such as interest rate rises. • Invest excess funds in financial markets and in corporate shares • Deal in foreign currencies and commodities • Issue securities on the primary market and buy and sell marketable securities • Borrow money to fund their operations

Stockbrokers • Key intermediaries in financial system • Trade equities and financial assets • Trade on behalf of individuals, companies or themselves • Provide investment service and advice for clients.

Government Prior to deregulation of the financial industry in the 1980 s, the RBA was the major regulator of the financial system. Under the new structure there are three major regulators which are: • Reserve Bank of Australia • Australian Prudential Regulation Authority • Australian Securities and Investment Commission (ASIC)

Reserve Bank of Australia • Government departments and statutory authorities operate in financial markets through RBA and financial intermediaries • RBA acts as banker and financial agent to federal government • Supervises financial system and manages monetary policy to achieve certain economic goals such as inflation rates between 2 -3% • Holds portfolio of government securities and foreign currencies which it trades in financial markets.

Australian Prudential Regulation Authority (APRA) Responsible for the supervision and regulation of all deposit-taking institutions, insurance companies and superannuation funds. Australian Securities and Investment Commission (ASIC) Responsibility for corporate regulation, consumer protection and oversight of financial services products.

Australian Stock Exchange • A listed company • Provides a marketplace for trading in shares • Assists companies raise funds from the public through share issues and trade in debt instruments • Operates secondary market for existing shares and securities • All companies listed on ASX must comply with its rules.

ASX rules relate to • • • Continuous disclosure Election of directors Dividends Executive powers and share options Members off-market transactions Preference shares Prospectuses Reductions of capital. Rights issues Takeovers Voting rights

Influences on Financial Markets Financial markets are influenced by factors in the domestic and foreign markets. Domestic Market Influences Employment Patterns Level of Economic Growth Competing Demand for Funds Inflation Rate Changes in Government Policy Demographic Trends

• Fluctuations in business cycle requires continuous monitoring of market trends • Changes in market size – e. g. population decline and aging • Changes in interest rates impact on cost of borrowing and investment • Rising economic growth levels will raise incomes and demand for goods and services • Government policy in regard to deregulation of markets • Rising inflation rates will depress economic growth in the long run and cause interest rates to rise • Changes in the strategies of competitors • Superannuation policy • Privatisation and corporatisation

Overseas Market Influences Interest Rate Differentials Government Policies Regarding Market Regulation Foreign Exchange Rates World Events and Political Risks Accounting Regulations in Different Countries Different Tax Laws in Different Countries

Derivatives • Financial instruments used to hedge against risk by businesses that have to deal with uncertain prices for their own products or purchases. • Assist in managing risk and provide for participants in financial markets.

Trends in Financial Markets • Volume of activity on financial markets grew at a very high rate until the crash in 2008. • Many new trading instruments were developed to suit the needs of businesses but some of them have contributed to the crisis now afflicting financial markets. • The rate of change is being partly generated by technological innovation so that more people are now able to participate in financial markets. However, many jobs will have been lost by end of 2008. • Financial markets are becoming ever more globalised and competitive.