Learning outcomes General revision Exam Conclusion

Review and Exam

Dr. Andrea Lu

Lecture 12
FNCE90047: Financial Markets and Instruments

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Learning outcomes

On successful completion of this course you should be able to:

Analyse the nature of financial markets and explain the principles by

which financial markets operate.
Describe the major institutional participants and markets.
Explain the risk-return spectrum and characteristics of financial
instruments.
Describe derivatives and explain how they are used in the management of
financial risk.
Apply the theory of regulation to current markets and critically assess the
current regulatory structure.

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General Revision

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Topics covered
Week 1: The financial system and financial markets
Week 2: Regulatory authorities and the monetary policy
Week 3: Primary markets of equity
Week 4: Secondary markets of equity
Week 5: Investment funds
Week 6: Banking
Week 7: The mortgage market and securitisation
Week 8: Money markets and bond markets
Week 9: The derivatives markets
Week 10: Swap contracts and CDSs
Week 11: Foreign exchange markets
Week 12: Insurance

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Week 1: Financial System and Financial Markets

Role of the financial system
Characteristics of an effective financial system
◦ Understand the characteristics
◦ The role of Financial System Inquiry
Types of intermediaries
◦ Understand their roles
◦ Different types of financial institutions
Types of financial markets
◦ Money markets v.s. capital market
◦ Primary v.s. secondary
◦ OTC v.s. exchange traded

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Week 2: Regulatory Authorities and the Monetary Policy

Identify the players in the market and the role they play
Explain the roles and responsibilities of relevant regulators:
◦ RBA
◦ APRA
◦ ASIC
◦ and, Council of Financial Regulators.
Explain how monetary policy works and how the RBA influences interest
rates
◦ Objectives
◦ Operations
◦ Impact on the economy

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Week 3: Primary Markets of Equity

Sources of capital
◦ e.g. Angel investor, venture capital, private equity, crowd-sourced
funding, etc.
◦ Similarities and differences, size of scale, regulation, etc.

Initial Public Offerings

◦ Why go public? Advantages and costs, process, regulations, parties
involved.
◦ IPO underpricing.

Secondary equity raisings

◦ Types: private placement, rights issue, SPP, DRP.
◦ Process, regulations, changes, reasons for choices.

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Week 4: Secondary Markets of Equity

Trading arrangements
◦ Order driven, quote driven and hybrid markets
◦ Transparency and transaction costs
◦ Clearing and settlement

Global developments in exchange industry

◦ Algorithmic and high frequency trading
◦ Dark pools

Current Australian secondary markets landscape

◦ Exchanges, clearing and settlement, issuers, brokers, investors, and
data vendors.

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Week 5: Investment Funds

Managed funds
◦ Definition
◦ Type of funds: close-end v.s. open-end.
◦ Investment objectives and the strategies they take
Exchange traded funds (ETFs)
◦ Definition
◦ Advantages of ETFs
◦ Size of the ETF market
Superannuation funds
◦ Definition and regulation
◦ Defined benefit v.s. defined contribution
◦ Types of funds which one more inportant in AUS
Hedge funds
◦ Definition
◦ Strategies
◦ Industry size: globally and in Australia.
◦ Regulation
Measuring fund performance
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Week 6: Banking
Describe the ADI industry in Australia, including identifying key players.
Understand banks’ sources and uses of funds.

Discuss the performance of Australian banks in terms of sources of income

and expenses.

Describe how banks manage liquidity. asset management is always better in the LR

Describe bank capital requirements. definition calculation rationale

Understand credit and interest rate risk. howto quantify interest rate on both sides and manage

Understand differences between banks and nonbank financial institutions;

and, what roles do non-bank financial institutions play.

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Week 7: The Mortgage Market and Securitisation

The mortgage market.
◦ The difference between a mortgage and a standard loan/bond; why
households want take out a mortgage?
◦ How the mortgagor assess risks in the underwriting process.
◦ Different repayment structure and their associated risks. common between structures
◦ What risks do lenders face? how do they manage the risks

Securitization
◦ What is securitization? How does it work? What is the benefit of
securitising?
◦ MBS, Pass-through, CMO, CDO: their difference in structure.
◦ How tranching help to enhance/shift risks.
Securitisation and the GFC
◦ Securitisation; housing bubble; subprime mortgages; foreclosures;
correlated risk; the GFC.
◦ Understand how Australia is different from the US. reasons

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Week 8: Money Markets and Bond Markets

Money markets and bond markets.
◦ Understand the difference between their purposes.
◦ Instruments in each market, their cash flow structure, trading venues, and
risks.
Valuation of fixed-income assets.
◦ Valuation of zero-coupon and coupon paying bonds; PV/yield calculation.
Bond risks and risk management.
relationship with how to measure with
◦ Interest rate risk (price volatility, duration); default risk; operational risk;
liquidity risk.
◦ The role of credit rating agencies.
Term structure of interest rates.
◦ The yield curve. rationale
◦ Term structure models (ET, LPT, MST, PHT); and how they explain the
yield curve.

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Week 9: The Derivatives Markets

Forward contracts.
◦ What is a forward contract? key elements; payoff structure.
◦ Where, how and when to enter into a forward contract?
◦ Advantage and problems of a forward contract.
Futures contracts
◦ What is a futures contract? Keywords: standardized/exchange-trade,
margin requirements. how improve risk
◦ Understand how marking-to-market works.
Risks of forward/futures markets
face by AIG
◦ Basis risk; counter-party risk; liquidity risk; margin risk.
◦ Understand which ones apply to which market.
Options.
◦ Key elements: strike price, expiration date, long/short side.
◦ Different types of options: call/put, exchange-traded/OTC,
european/american.
◦ Payoff structure and how it is different from a futures contract.
Bonds with options
◦ Bonds with call options, bonds with put options, and convertible bonds.
◦ Understand: who makes the exercise decision? when to exercise? what are
the CF consequences?
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Week 10: The swaps and CDSs

The swaps
◦ What is a swap contract? equal principal, two different payment
obligations; no exchange of principal.
◦ Different types of swap contract: interest rate, currency, CDS.
Interest rate swaps
◦ The relation between interest rate swap and forward contracts.
◦ The reasons for interest rate swaps and what risks investors face?
Credit default swap (CDS)
◦ What is a CDS and what is its cash flow structure? periodic payments and
payment from the seller (when and the amount).
◦ What makes a CDS to be similar/different to/from an insurance contract?
◦ The fall of AIG.

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Week 11: Foreign Exchange Markets

Why do we need foreign exchange markets?
◦ The difficulties that Australian firms face when engaging in
international trade.
◦ Explain how foreign exchange markets operate and facilitate
international trade.

Exchange rates
◦ Definition of exchange rates and how they are quoted.
◦ Understand how are exchange rates determined under different
regimes.

Balance of payments
◦ The current account v.s. the financial account.
◦ Their relationship with exchange rates.

Explain why the Eurodollar deposit and Eurobond markets have developed
and become so important.
Discuss the globalisation of financial markets.
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Week 12: Insurance Companies

What do insurance companies do?
Types of insurance policies: 1) General; 2) Health; 3) Life; and others.
◦ Understand what protection each provides.
◦ Whether it has an investment component.
Investment income, insurance pricing and reduction of objective risk.
Understand how the insurance industry is regulated.

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Exam

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Exam Format
45 multiple choice questions
◦ 1 mark each.
◦ Answer then using the multiple choice answer sheet (MCAS M1)
Question 1: 5 + 2 + 5 = 12 marks
Question 2: 3 + 5 + 2 = 10 marks
Question 3: 2 + 4 = 6 marks
Question 4: 5 + 4 + 4 + 2= 15 marks
Question 5: 4 + 4 + 2 + 2 = 12 marks

Total 100 marks!

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Advice for Exam and Preparation

Preparation
◦ Lecture materials (lecture notes, including your own notes; textbook,
reading materials listed in the lecture notes).
◦ Workshop questions and the group assignment.
◦ Reading the financial press.

During the exam

◦ Read instructions on the exam cover sheet.
◦ Allocate your time according to marks.
◦ Be clear and concise in your answers. You may use bullet points.
◦ For application questions, write down your working, not just the final
answers.
◦ There are spare pages at the back of the exam to plan (they will not
be graded).
◦ Write the answers to multiple choice questions on multiple choice
answer sheet!
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Consultation
Additional consultation:
◦ Wednesday 5 June 3pm - 4pm.
◦ Wednesday 12 June 4pm - 5pm.
◦ Friday 21 June 3pm - 4pm.
Don’t wait until the last minute!
Email and LMS also work - but they are not viable for anything
other than very simple issues.
For fairness reasons I will not answer one-on-one questions about the
exam – so ask questions now!

Questions?

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What is finance about...

What does finance do?
“The allocation of assets and liabilities over time under conditions of
certainty and uncertainty”.
Two factors that make finance challenging
Time: a dollar today is worth more than a dollar tomorrow.
Risk: people generally dislike risk; therefore, higher risk often associates
with higher return.
Six Fundamental Principles of Finance
1 No free lunch (non-arbitrage).
2 Other things equal, individuals prefer more CFs, earlier CFs, and less risk.
3 All agents act to further their own self-interest.
4 Financial market prices shift to equalize supply and demand.
5 Financial markets are highly adaptive and competitive.
6 Risk-sharing and frictions are central to financial innovation.
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The End (.. for this course)

Thank you for taking FNCE90047!

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