UTS16657 Chap.1 The Australian Financial System
The Australian Financial System
The financial system exists to solve one problem: savings sit in one set of hands and investment opportunities in another. It moves funds from surplus units to deficit units and attaches a price and a set of enforceable rights to the transfer, and the price of using someone else's funds is the interest rate.
Its three limbs are institutions, markets and instruments, and the functions it performs are settling transactions in cash, promoting the flow of funds, managing the risk of default or unfavourable returns, overcoming information asymmetry, resolving incentive problems and pooling funds to support equity raising.
Markets are sorted on one axis and then cut in two.
The money market covers arrangements completing within twelve months and the capital market everything beyond a year, and term is the only test: a treasury note and a five-year bond from the same borrower sit in different markets purely because of maturity.
Within each, the primary tier is where new instruments are issued and the cash reaches the issuer, while the secondary tier is investors trading claims that already exist, where the issuer receives nothing at all.
The second tier still matters to the issuer, because liquidity there is what makes anyone willing to buy in the first.
Instruments are financial claims: a paper agreement giving its holder a right, as against a real asset that its holder physically owns and uses. That distinction is the ancestor of everything the subject later says about direct compared with indirect property investment.
Several money-market securities are priced at a discount rather than paying explicit interest, so the return is the gap between the price paid and the face value collected.
On the institutional side, the conduct regulator polices market behaviour and investor protection, the prudential regulator supervises the solvency of deposit takers, insurers and superannuation funds, the central bank runs monetary policy and oversees stability and payments, and a coordinating council brings them together with Treasury.
What this chapter covers
- 01
The functions the financial system performs, stated as jobs
- 02
Money market against capital market and the twelve-month line
- 03
Primary issuance against secondary trading, and why both are needed
- 04
Financial assets against real assets
- 05
The five money-market securities and what each is for
- 06
Pricing a security sold at a discount
- 07
Conduct regulation against prudential regulation
Finding the yield hidden inside a discount security
- +1Find the discount, because that is the entire return on an instrument that pays no coupon: 500,000 − 487,500 = $12,500.
- +1Express it as a return on the capital actually committed, which is the price and not the face value: 12,500 ÷ 487,500 = 0.025641, or 2.5641% over the ninety days.
- +1Annualise on the 365-day convention used for Australian money-market instruments: 0.025641 × 365 ÷ 90 = 10.40% per annum, as a simple yield with no reinvestment assumed.
- +1Compare and qualify. The bill beats the deposit by 0.60 percentage points, so on yield it wins; before committing, weigh the credit standing of the accepting bank and whether the money is genuinely idle for the full term, since exiting a bill early means selling it at whatever the market pays.
Key terms
- Money market
- The part of the financial market where arrangements are completed within twelve months, covering treasury notes, commercial paper, certificates of deposit, commercial bills and repurchase agreements.
- Capital market
- The part of the financial market where funds are committed beyond one year, covering mortgages, longer-dated bonds, corporate debt, debentures and ordinary shares.
- Primary market
- The tier where an instrument is sold by its issuer to investors for the very first time, so the capital raised actually reaches the issuer. New corporate bonds and initial public offerings are primary transactions.
- Secondary market
- The tier where investors trade already-issued securities among themselves. The issuer receives no cash, but the liquidity created here is what makes primary issuance cheap.
- Financial asset
- A paper agreement conferring a right of claim in an investment or transaction. Its holder owns the right rather than the underlying thing, unlike a real asset whose holder physically owns and occupies it.
- Repurchase agreement
- A short-term loan created by selling a security with a binding agreement to buy it back later at a higher price, so the price difference functions as interest, often overnight.
The Australian Financial System FAQ
Is Week 1 material examinable in the final?
No, and it is still not optional. The subject states that every one of the sixteen final questions is drawn from Week 5 through Week 11. Week 1 is, however, the whole field for the Week 3 online quiz along with Week 2, and the quiz topics are named as the Australian financial system, equity and debt, and risk and return.
The vocabulary here is also used without explanation from Week 5 onward, and the pricing of short-term discount instruments returns directly as examinable material in that week.
How do I tell a money-market instrument from a capital-market one?
Look only at the term. Anything that settles within twelve months belongs to the money market and anything running longer belongs to the capital market, regardless of who issued it or how creditworthy they are. A treasury note and a five-year Commonwealth bond come from the same borrower and sit on opposite sides of the line for that reason alone.
Which regulator deals with which kind of failure?
Sort it by what is being protected. A misleading disclosure, unsuitable advice or manipulative trading is a conduct matter for the conduct and markets regulator, which protects investors from being misled. A lender holding too little capital to keep its promises is a prudential matter for the prudential regulator, which protects depositors and the system.
A firm can be sound and dishonest, or scrupulous and undercapitalised, so the two questions are genuinely separate.
Exam move
Learn this chapter as vocabulary rather than as theory, because everything in it is definitional and almost none of it involves calculation. Build two one-page maps: one placing every instrument on the twelve-month line, and one attaching each regulator to the job it does.
Then work the discount-security arithmetic until dividing by the price rather than the face value is automatic, since that calculation reappears as examinable material in Week 5.
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