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Summary Introduction to Financial Markets
This document covers and summarizes the entire slidepack of the subject (400+ slides), as well as the video classes on Blackboard.
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Introduction to Financial Markets: Class Notes1 Unit 1: The Financial System
1.1 Section 1: The Actors
Actors = Where is financial wealth stored? Who has money? à 2 Parties in the economy: Haves
and Havenots:
- Haves = Parties that possess money and can lend it out (banks, government, …) (net posi-
tion is positive).
- Havenots = Parties that have more needs than money and they will have to raise capital
(borrowers) (households, corporates, …) (net position is ‘in debt’).
à We consider the main actor in an economy to be Households (gezinnen) because they hold
the most money. These actors have a net wealth (= assets – liabilities), summarized in a house-
hold balance sheet:
= Government bonds
1.1.1 Assets
Asset = A possession that has value in an exchange transaction. In simple words, it’s everything a
household owns.
1.1.1.1 Types of assets
- Tangible assets/ real assets = Assets with a physical character and generate utility.
- Intangible assets = Assets that have a legal claim to some future benefit.
- Financial assets = Intangible assets that represent a claim to future cash.
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,1.1.1.2 Different asset classes
- Traditional assets:
o Common stock = Shares from a company that trades on the stock index
o Bonds = You don’t buy shares in a company, but you purchase a share in the bond
of assets (obligaties in NL)
§ Convertible bond = Bonds that can be converted to stocks
§ Exchangeable bond
§ High yield bond = Bonds that are in the speculative grade and are often very
risky!
§ Deferred interest bond = Bonds where the payment of interest rates is de-
layed
o Cash (and cash equivalents)
- Alternative assets:
o Real estate
o Commodities = Derivatives you can invest in (Lithium, Gold, Silver, Oil, …).
o Private equity = Investments in non-listed companies (small start-ups)
o Hedge funds = Investment opportunities for the wealthy (high minimum investment
amount) = Pool of money that is used to trade a lot of different financial products.
o Venture capital = Capital that is injected in an expanding business (often high risk)
o Currencies (forex)
1.1.2 Liabilities
Liabilities = Debt someone has towards a financial institution
1.1.2.1 Mortgage loans
Mortgage loans = A loan someone takes out to buy a house/ apartment. If you can’t repay this
loan, the bank can take control over your house and sell it back to the market.
1.1.2.2 Consumer loans
Consumer loans = A loan someone takes out to buy consumer goods (furniture, a car, …).
1.1.2.3 Tax debt
Tax debt = Money that households still owe to the government.
1.1.3 Growth in net wealth
à Households can grow/ change their net wealth in various ways:
- Value changes in assets and liabilities (e.g., A house you bought in 2000 is now worth a lot
more, stocks from a company rise in market value, debt becomes smaller, …)
- Net-income from labour, capital (income from rental properties, …), or transfers
- Inheritances and gifts
à Wealth is something that dynamically changes (through time, …) and is very relative.
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,1.1.4 Distribution of wealth and wealth inequality
à Wealth is not distributed well in the world. There is inequality between regions and within re-
gions (or countries). In the end, households in some parts of the world own lots more than others.
In general, households are the owners of all assets in the economy!
à Africa, India and Asia-Pacific are some of the regions with the smallest wealth (Bottom 10%)
à China and Latin-America have a large middle class
à Europe and North-America are some of the wealthiest regions (top 1%)
1.2 Section 2: The balance sheets of other actors
à All the other actors are (somehow) interconnected with each other, so it’s important to have a
good understanding of their respective balance sheets.
1.2.1 Corporates (companies)
Assets Liabilities
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, à What is described in this balance sheet?
- Assets are organized in order of liquidity:
o Fixed assets (vaste activa)
o Current assets (variabele activa)
o Deposits and cash
- Liabilities can be short term or long term:
o Equity = Money that is brought in by shareholders and investors at the foundation of
the company. à This equity can be increased by profits and decreased by losses.
o Debt = Loans the company took from banks/ other financial institutions. With this
money, they can gain leverage (= the profits gained by taking the loan are higher
than the cost of the loan)
- Everything is valued at market value
à Companies use leverage to grow wealth à We look at the return on Equity (ROE), the Lever-
age Multiplier (LM) and the Return on Assets (ROA):
- Return on Equity (ROE) = The return a shareholder gets on the money they put into the
business. In an ideal scenario, this should be bigger than the ROA
o Formula (Dupont Scheme): ROE = ROA x LM
- Return on Assets (ROA) = The return a company gets on assets
- Leverage multiplier = Assets/ equity ratio
1.2.2 Financial sector – Banks
Assets Liabilities
à Core of the credit institutions = Giving credit to households, corporates, … à They use A LOT
of debt!
- Deposits = Money they get from people who save their money
- Bonds (both on asset- and liability side, because they both issue bonds and buy bonds)
- Central bank financing = Money that comes from the central bank when the bank needs it
- Interbank loans = loans between banks
- Tax debt
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