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Why Study Money and Finance?
Contents:
Financial Systems are Special
1. Why Study Money and Finance 1) They constitute the heart (as well as the brain) of the
2. What is Money? market economy – pumping money (credit) from those who
have it but don’t need it, to those who need it but don’t
3. Overview of the Financial Sector have it.
4. Direct and Indirect Financing 2) Finance is a projection into the (unknowable) future.
Because of this, it is uniquely vulnerable amongst markets
5. Financial Markets to all the human frailties – fear, greed, vanity, ignorance,
6. Patterns: Institutions vs. Markets fraud…
7. Securitisation 3) Finance channels resources that are greatly susceptible to
government interference and patronage.
8. Some of the ‘Players’
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Money is: It is, of course, all of the above. But what is it that is
Precious metal? possessed by these things that give them the quality
Precious stones? of money?
Cowrie Shells? The important point to note about most of them, is
that they have value because of the social
Copper coins? arrangements each implies. And in this, money:
Paper banknotes? …unites
unites society more effectively than tyranny
Clay tables of owed and owing? or blood; for, in taking money, you deliver
yourself up to the other users of money, accept
Entries in a balance sheet? their freedom to choose, their frivolity and
Plastic cards? selfishness, their universal subjection to desire,
Bits and bytes? their humanity’.
Buchan 1997:20
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Schopenhauer made an almost identical point
‘Moneyness’ is not an intrinsic attribute, and does (1968:414):
not have a particular form – but represents the Men are often criticised in that money is the chief
ability to acquire. According to Buchan (1997:19) object of their wishes and is preferred above all else,
money is incarnate desire: but it is natural, even unavoidable. For money is an
inexhaustible Proteus, ever ready to change itself
into the present object of our changeable wishes
…money has always and will always symbolise
and manifold needs. Other goods can satisfy only
different things to different people…to one person a
one wish and one need. Food is good only for the
drink in a pub, a fairground ride, to a third a diamond
hungry…medicine for the sick, fur for the
ring, an act of charity to a fourth, relief from
winter…Money alone is the absolute good: for it
prosecution to a fifth and, to a sixth, simply the
confronts not just one concrete need, but Need in
sensations of comfort or security.
itself in abstract.
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ii) There is much hostility to finance and financiers Aristotle (c.330, Politics) – on that profit and
today ‘interest’:
But there always has been.
The love of money as a possession – as Yet, here’s the same man in 1936 (in the
distinguished from the love of money as a General Theory):
means to the enjoyments and realities of life
– will be recognised for what it is
is, a It is better that a man should tyrannise over
somewhat disgusting morbidity, one of those his bank balance than over his fellow citizens.
semi-criminal, semi-pathological propensities
which one hands over with a shudder to the
Why the hostility?
specialists in mental disease.
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Three reasons according to Ferguson (2008:2- People should always be careful in what they
3): wish for. Moneyless utopias have been
imagined throughout history. The first was
1) Debtors outnumber creditors perhaps Plato’s Republic. Some are
2) Crises and downturns have often appeared harmless (Sir Thomas More) others, perhaps,
to have a financial cause end in mass murder. The latest, the Khmer
Rouge’s
Rouge s ‘Year
Year Zero
Zero’ will undoubtedly not be
3) Finance…in many places…has been
the last.
disproportionately provided by ethnic and/or
Such hostility, however popular and endemic,
religious minorities.
is wrong-headed and, as we shall see, most
Buchan (1997:32) suggests (apropos of episodes of human achievement have a
Aristotle, a sexual taboo is at the heart). supporting financial foundation.
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Finance is BIG and, up until 2008, growing. In In 1947, the US financial system accounted
2006: for 2.3% of that country’s GDP
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Some big lessons from the history of money The role of the financial sector:
and finance: Facilitates trade by creating an efficient and
Poverty is not the result of the behaviour of secure payments system.
rapacious financiers, but the absence of finance Allows the aggregation
gg g and flow of funds from
and financial institutions. saving to investment through both financial
Finance exacerbates and exaggerates existing markets and institutions.
disparities. Creates products for the management of risk –
Financial crises are difficult to predict. futures, options, insurance contracts, etc
Ferguson 2008
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Surplus and Deficit ‘Units’. Financial Claims – the basic descriptor of
Surplus economic units (aka savers, lenders, financial assets and liabilities. We know them
investors, buyers of financial assets, suppliers of as loans, securities, investments – assets
loanable funds, etc) have more income than they and liabilities – but in the end they are
spend The financial system allocates their
spend. contractual claims of one party (surplus units)
surplus too…
over another (deficit units).
Deficit economic units (aka borrowers, users of
loanable funds, sellers of financial assets, etc) Given this, it follows that for every financial
have less income than their desired expenditure. asset their must be a matching liability, and
Such units must access the financial system to total receivables in the financial system must
match their cash inflow and outflows. match total payables.
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Note, however, that the financial system does The transfer of funds from surplus to deficit
not just match up deficit and surplus units – it units can take place directly or indirectly.
provides them with liquidity via the trading of By direct financing, we mean the situation in
financial claims in secondaryy markets. which deficit and surplus units deal with each
other directly rather than through an
intermediary, mostly through financial
markets. Deficit units issue financial claims
(securities – bonds, bills, notes, shares),
while surplus units supply funds by buying
these claims.
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Financial intermediaries (FIs) may have In Australia, the most relevant financial
efficiencies in monitoring. intermediaries in the context here are the so-
FIs may have efficiencies in transaction and called ‘Authorised Deposit-Taking Institutions’
search costs. (ADIs). These enjoy unique status and
FIs may be able to gather information more regulation under the Australian Prudential
effectively.
Regulation Authority (APRA). Such ADIs
FIs allow
allo for denominational transformation
transformation.
include; banks, building societies, credit
FIs allow for maturity transformation. unions. Performing similar intermediation
FIs allow for quality transformation. functions, but non-ADIs, are superannuation
FIs allow for currency transformation (where rel.) funds, life offices, insurance companies,
FIs allow the pooling and spreading of risk. public unit trusts, mutual funds, etc.
FIs provide a place to store or access liquidity
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Financial Markets
The detailed operations of all of these Financial markets are the areas through
INSTITUTIONS is not the focus of Econ 350 which direct financing takes place.
(it is, however, the focus of Econ 335 in Such markets may be differentiated
Semester 2!!).) according to when a security (a financial
Rather, as we shall see in coming weeks, our claim) is sold and bought.
focus in this course is on financial MARKETS The initial financing of deficit units takes
and their products. It is to briefly introduce place in primary markets. The subsequent
these, that we now turn. trade in their securities takes place in
secondary markets.
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Primary markets are critical in terms of the Another way in which financial markets are
transformation of savings into investment.
differentiated is according to the maturity of
Secondary markets are critical in providing the securities they trade.
liquidity, portfolio balancing, risk trading, and
so on. Short-term (<1 year, but often much shorter)
securities are issued and traded in what we call
Financial markets are also differentiated in the money market.
how and where trading takes place place.
Longer-term (>1 year) securities are issued and
Organised exchanges (such as the NYSE, ASX, traded in the capital (equity) and bond markets.
SFE, etc) provide a central (sometimes physical)
trading place.
Securities can also trade ‘over the counter’ (OTC).
OTC markets have no central trading place.
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The time element also enters into the picture
in differentiating between spot and futures
markets. Here the timing issue concerns Options markets are yet another variation on
delivery and payment. the theme – trading in securities that specify
Securities traded in the spot market are for conditional or contingent prices and delivery.
immediate delivery and payment.
A ‘call’ option
p is an option
p ((but not an obligation)
g )
In futures or forward markets, such delivery and to buy a security; a ‘put’ option is an option to sell.
payments are not immediate (indeed, the
Options are traded both on organised exchanges,
alternative is their purpose)
and OTC.
The difference between futures and forwards
contracts? – Futures contracts are traded in
organised exchanges, forwards ‘OTC’.
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Foreign exchange markets deal in national Up until the 2008 global financial crisis
currencies. (GFC), financial markets were increasing in
In foreign exchange markets trading takes importance in Australia (and around the
place in all variety of ways – spot,
spot forward,
forward world)) at the expense
p of financial
futures, options, etc. intermediation.
Foreign exchange markets are not, however, This was true both in terms of primary
the focus of Econ 350 (rather, they are markets and secondary markets.
covered in Econ 360). To some extent the rest of the world was
playing ‘catch up’ to the US and the UK.
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Securitisation
In the Australian context, the growth of By which we mean the financial packaging or
superannuation played a role too – on the ‘bundling’ of an income stream derived from a
‘demand side’. financial asset (of just about any type). These
Likewise it was driven here (and elsewhere)
Likewise, are then sold as asset-backed securities.
by the trend to ‘securitisation’. Examples of securitisation are legion – but
amongst the most prominent examples
include the securitisation of home mortgages,
credit card receivables, student loans, car
loans and so on.
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In Australia, the rapid growth of home- By 2004, Australia’s mortgage-backed bond
mortgage securitisation is particularly stark – market was the third largest in the world
from 5% of the total mortgage market in (behind the USA and the UK). This in turn
1996,, to around 25% byy 2007 (problems
(p had made the overall asset-backed bond
emerged soon after…). Of course, behind the market the fifth-largest in the world.
growth were some well-known brand ‘faces’ – Why the specific success of mortgage
Aussie Home Loans, Wizard Home Loans, securitisation in Aus?
Rams…etc. And behind these, were the likes
of Macquarie and other ‘investment’ banks.
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Speculators: Take positions in the market in
the hope that prices move their way. We shall
examine later the question of whether
speculation is stabilising or not (or whether it Finally – the ‘moms and pops’, the hoi polloi,
is either). Note the importance of short-selling the ‘noise traders’…the taxpayers
in the toolbox of speculators – one doesn’t who…prove very useful in a crisis!
need to ppunt jjust on rising
gpprices.
Arbitrageurs: Seek to exploit prices
differences on the same asset/asset
categories in different markets. Later we shall
see how this label is sometimes employed in
the context of traders with good information.
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