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Financial Introduction Notes

Economics Notes > Financial and Business Systems Notes

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LECTURE 1 - Introduction Assets Tangible means value is based on physical properties e.g. buildings, land, machinery etc. Intangible means claims to future income generated by tangible assets e.g. financial assets which include loans, gov bonds, corporate bonds, common/preferred/foreign stock etc. PRICE OF FINANCIAL ASSET AND RISK Price/value of a financial asset = present value of all expected cash flows. Expected rate of return and risk of expected cash flow. Other investment risks include;

* Purchasing power risk = inflation risk

* Default risk = credit risk

* Exchange rate risk = currency risk ROLE OF FINANCIAL ASSETS They transfer funds from those with more money than projects to those with more projects than money. Share unavoidable risk associated with cash flows like inflation risk (for equity holders), default risk (for debt holders) and exchange risk. Debt v Equity fixed dollar payments examples ike loans and bonds. Equity claims where dollar payment is based on earnings, residual (varying) claims e.g. common stock, partnership share. Role of (Financial) Markets Provide liquidity; buyers and sellers in one pace. Price discovery - efficient resource allocation. Reduce transaction costs; search and information costs. Participants include households, firms, government agencies, international organizations and regulators. MARKETS It is easier for investors to move capital internationally because of deregulation of financial markets (e.g. currency controls), technological advances and increased role of institutional investors (economies of scale). CLASSIFICATION OF GLOBAL FINANCIAL MARKETS Internal (national) market - domestic market: issuers domiciled in that country
-foreign market: issuers domiciled abroad. External (international, offshore) market - securities offered outside single jurisdiction to investors in multiple countries. Motivation to use such markets comes from limited funds in internal markets (esp. poorer nations), reduced cost of funds and diversifying funding sources (portfolio reduces risk) to reduce reliance on domestic investors. DERIVATIVES MARKET Derivatives value depends on underlying financial asset. In future or forward contracts - parties agree to buy sell at an agreed price and date. In options contracts there are rights not obligations to buy/sell at an agreed price on/by an agreed date. Advantages of derivative instruments include possible lower transaction costs, faster transactions than cash market, greater liquidity and greater scope for financial innovation. FOUNDATIONS OF FINANCIAL MARKETS AND INSTITUTIONS, notes, chapters 1 and 2

1.1 financial assets An asset is any possession that has a value in exchange. Financial assets are intangible the typical benefit/value is a claim to future cash. The issuer is the person has agreed to make future cash payments, the investor is the owner of the financial asset.

1.2 debt vs. equity instruments The claim the holder of the financial asset has can be a fixed dollar amount or a varying amount. Financial assets can be referred to as a debt instrument. An equity instrument/residual claim makes the issuer of the financial asset to pay the holder an amount based on earnings e.g. common stock. Some securities are both e.g. preferred stock and are called fixed-income instruments.

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