“ International Finance and Payments ”

1. Academy of Economic Studies Faculty of International Business and Economics “International Finance and Payments” Course II “International Financial Markets and Institutions” Lect. Cristian PĂUN Email: cpaun@ase.ro URL: http://www.finint.ase.ro

2. International Financial System - review • IFS ensures the capital transfers between the investors and financing beneficiaries (or debtors) – main function; • IFS is composed by financial markets, financial institutions and financial instruments; • Bretton Woods Agreement is the base for actual IFS; • the evolution of IFS was determined by several factors; • EMS was an European alternative for IFS; • BP registers all the commercial and financial transactions of a country with the rest of the World; • we use this BP to determine the need for financial resources for a country • this BP should be in equilibrium and the deficits can be reduced using different policies; • the fixed exchange rate ensures an automatic equilibrium for a BP. Course 2: International Financial Markets and Institutions

3. Financial System - structure Financial transactions Private companies Government Financial Institutions Financial transactions Financial transactions Population Financial Markets Course 2: International Financial Markets and Institutions

4. Financial Markets - characteristics FINANCIAL MARKETS • Money Markets (maturity < 1 year): • very liquid; • transactions with credit instruments; • small fluctuations for the securities prices => low risk • Capital Markets (maturity > 1 year): • transactions with debt and equity securities (bonds, equities) • higher prices fluctuations International Credit Markets, Euromarkets and FX Markets • Primary market: is a financial market in which new issues of a security are sold to initial buyers; • Secondary market: is a financial market in which security (previously issued) can be resold by the investors for cash. Exchange offices (NYSE, CBOT) OTC Markets Course 2: International Financial Markets and Institutions

5. Financial Markets - characteristics Course 2: International Financial Markets and Institutions

6. Financial Resources for a company • - Reinvesting the profits; • - Increasing capital; • Debt to equity conversion; • Amortization. Internal Resources Financing Decision • - Credits; • - Bond issuing; • - Equity. External Resources Course 2: International Financial Markets and Institutions

7. Why we should use internal resources ? • Advantages: • increase the company value; • higher autonomy from financial institutions; • lower costs (such as banking commissions and taxes); • advantages from fiscal regimes applied to reinvested profits; • small companies or new business; • leveraged companies (high debt). • Disadvantages: • opportunity costs; • taxation. Real cost for internal financial resources Internal resources are the most expensive financial resources !!! Course 2: International Financial Markets and Institutions

8. Why we should use external resources ? • Advantages: • mature business – “cash-flow cows”; • less costly then own financial resources; • important financial resources that can be obtained; • higher maturity; • fiscal regimes in case of the interest paid to a bank; • Disadvantages: • additional costs (taxes, commissions applied); • the dependence from the financial institutions; • the reimbursement program; • a good projection for your business development (future income and cash-flow prediction). Course 2: International Financial Markets and Institutions

9. Direct Financing vs. Indirect Financing Financial Intermediaries Indirect Financing Debtor (Beneficiary) Investor or Creditor Direct Financing Course 2: International Financial Markets and Institutions

10. Direct Financing vs. Indirect Financing • Advantages for indirect financing: • a good information about capital resources; • lower risks (some institutions share or cover the financial risks); • financing consultancy; • financing facilities; • different financing alternatives; • financing condition imposed by the financial institutions; • lower transaction costs. • Disadvantages for indirect financing: • higher operational costs; • inexistence of a direct contact with financial markets; • historical relations with a financial institution. Course 2: International Financial Markets and Institutions

11. Services provided by financial institutions • selling and buying financial securities; • international payments; • international financing (incl. export financing); • financial consultancy; • international markets surviving (rating agencies); • insurance against financial risks; • guarantees for financial transactions; • managerial expertise; • companies surviving (competitors, clients); • portfolio management; • investment funds management. Course 2: International Financial Markets and Institutions

12. Public Financial Institutions Private Financial Institutions Financial Institutions • I. International Financial Institutions: • International Monetary Fund; • World Bank (IBRD, IDA, IFC, IMGA); • EBRD; • European Investment Bank; • Bank for International Settlements; • II. Government Institutions: • Export Credit Agencies; • Export Guarantee Credit Agencies; • Export Insurance Agencies; • III. Depository Institutions: • Commercial Banks; • Savings and Loans Associations; • Mutual Savings Banks; • Credit Unions. • IV. Non – depository Institutions: • Investment Banks; • Mutual Funds; • Pension Funds; • Insurance Companies; • Financing Companies; • Venture Capital; • Stock Markets Brokers and Dealers. Course 2: International Financial Markets and Institutions

13. Primary Assets and Liabilities of Financial Intermediaries Course 2: International Financial Markets and Institutions

14. Type of intermediaries Course 2: International Financial Markets and Institutions

15. Financial Instruments • A financial instrument is a contract between lender and borrower; • This particular contract establish: • the financing mechanism; • the role of each institution / participant in the mechanism; • the amount; • the maturity; • the currency; • the financing cost (interest rate) and the payment method; • the risk allocation between the participants; • the payback of the loan; • other aspects (special clause). Course 2: International Financial Markets and Institutions

16. Financial Instruments Direct Investment Indirect Investment - Investment Funds Participations; - Insurance Policies; - Pension Funds Participations. Capital Market • Money Market: • Treasury Bills; • Negotiable bank certificates of deposit; • Commercial papers; • Banker’s acceptances; • Repurchase Agreements; • Government Funds. • Derivatives: • Futures; • Options; • Swaps; • Caps; • Floors; • Collars. • Fixed Income Instr.: • T-bonds; • Municipal Bonds. • Corporate Bonds. • Equities: • Common stocks; • Preferred Stocks; • GDR. Financial Instruments Course 2: International Financial Markets and Institutions

17. Money market instruments • Treasury Bills; • Negotiable bank certificates of deposit; • Commercial papers; • Banker’s acceptances; • Repurchase Agreements; • Federal Funds. Course 2: International Financial Markets and Institutions

18. A. Treasury Bills • short term debt instruments • maturity of 3, 6 or 12 month; • have no interest payments (initially sold at a discount); • the most liquid financial instruments; • the safest financial instrument (no default risk) • can be issued in different currencies (usually are issued in local currency) • “risk free rate” instruments; B. Negotiable Bank Certificate of Deposits • debt instrument sold by a bank to depositors (one of the most important capital source for banks); • pays annual interest; • at maturity pays back the original purchase price; • can be negotiable now Course 2: International Financial Markets and Institutions

19. C. Commercial Papers • short term instruments issued by banks or well known companies • a high growth rate for this instruments (2000% between 1970 – 1996 in US); • no interest payments (usually issued at a discount); • interest rates are related to the issuer’s risk D. Banker’s Acceptances • were developed in accordance with international trade development • represent banks drafts (a promise of payment similar to a check) issued by a company for a future date and guarantee for a fee by the bank • the bank acceptance = the guarantee • these instruments are often resold on secondary market at a discount • high growth rate (250% in US between 1970 and 1996) Course 2: International Financial Markets and Institutions

20. E. Repurchase Agreements - repos • short term loans based on a collateral • this instruments were introduced in 1961 • increase the liquidity for financial instruments • reverse repo’s F. Federal Funds • overnight loans between banks and Central Bank • the banks pay an interest rate • federal funds rate (refinancing rate) Course 2: International Financial Markets and Institutions

21. Capital market instruments • Stocks (common stocks, preferred stock); • Mortgages; • Treasury Bonds; • Municipal Bonds; • Corporate bonds Course 2: International Financial Markets and Institutions

22. Level 4: High Risk Instruments Derivatives, junk bonds Level 3: Potential Growth Rate Instruments: Blue chips, Mutual Funds Participations, Convertible Bonds. Level 2: Sure Income Instruments: T-Bills, Municipal Bonds / T-Bonds. Level 1: Risk free rate instruments: Cash, Deposit Certificates, Insurance Policies. Financial Instruments – risk classification Course 2: International Financial Markets and Institutions