Corporate finance chapter 02 the financial system

Chapter 2: The Financial System Objective Understanding the workings of the financial system Determining rates of return... The Flow of Funds Diagram Markets Intermediaries... Fund Fl

Chapter 2: The Financial

System

Objective

Understanding the workings of

the financial system Determining rates

of return

Chapter 2 Contents

• 1 What is a Financial System

• 2 The Flow of Funds

• 3 The Functional Perspective

• 4 Financial Innovation & the

“Invisible Hand”

• 5 Financial Markets

• 6 Financial Market Rates

• 7 Financial Intermediaries

• 8 Financial Infrastructure

and Regulation

• 9 Governmental & Quasi-Governmental Organizations

The Flow of Funds Diagram

Markets

Intermediaries

Fund Flows via Market

Markets

Intermediaries

Fund Flows via Intermediary

Markets

Intermediaries

Fund Flows via Intermediary

and Market

Markets

Intermediaries

Funds Flow via Markets and Intermediaries

Markets

Intermediaries

Funds Flow: Disintermediation

Markets

Intermediaries

Markets

Intermediaries

Funds Flow: Secured Credit

Markets

Intermediaries

Poor Credit Risk

Six Key Financial Functions:

– Transferring Resources Across Time & Space – Managing Risk

– Clearing and Settling Payments

– Pooling Resources and Subdividing Shares – Providing Information

– Dealing with Incentive Problems

Exchange Rate Example

15000 ¥

15260 ¥

15450 ¥

£100

£109

Time

3% ¥/¥ (direct)

1.73% ¥/£/£/¥

•150 ¥/£

9%£/£

140 ¥/£

Exchange Rate Example

15000 ¥

16241 ¥

15450 ¥

£100

£109

Time

3% ¥/¥ (direct)

8.27% ¥/£/£/¥

150 ¥/£

9%£/£

149 ¥/£

Exchange Rate Example

15000 ¥ (borrowed)

15450 ¥

15450 ¥

Repaid

£100 Invested

£109 Matures

Time

3% ¥/¥ (direct)

3% ¥/£/£/¥

150 ¥/£

9%£/£

Forward ¥/£

US Treasury Yiled Curve, Jan 97

4.50

5.00

5.50

6.00

6.50

7.00

7.50

Years to Maturity

Yield Comparisons

April '95 US Corporate Corporate

Treasury High Quality Med Quality

1 - 10 Years 6.92% 7.57% 7.86%

10 ++ Years 7.65% 8.15% 8.55%

Computation of Return

% 10 10

.

0 100

$

5

$ )

100

$ 105

($

) (

















Return

StartPrice

nd CashDivide StartPrice

EndPrice Return

Security Returns

-60.00

-40.00

-20.00

0.00

20.00

40.00

60.00

1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995

Year

Bills Bonds Stocks Inflation

Consolidated Indicies

10.0000

100.0000

1000.0000

Bills_Index Bonds_Index Stocks_Index Inflation_Index

Frequency of Returns

0 10 20 30 40 50 60 70

-50 -40 -30 -20 -10 0 10 20 30 40 50

Percent

Freq_Bills Freq_Bonds Freq_Stock Freq_Inflation

Nominal to Real

ate InflationR

ate InflationR e

NominalRat RealRate

ate InflationR RealRate

e NominalRat

















1

) 1

(

* ) 1

( ) 1

(