FINANCIAL
MARKETS AND
INSTITUTIONS
Prof dr. Geert Gielens, Rudy Vandorpe
Pauline Delphine Verhelst
VUB | 2020-2021
,Table of contents
Part 1: Prof. Dr. Geert Gielens ............................................................................................. 2
Introduction ........................................................................................................................... 3
Chapter 1: Money and money creation ............................................................................... 4
1.1. Origin & characteristics ............................................................................................. 4
1.2. Money supply ............................................................................................................ 6
Chapter 2: Financial institutions and intermediaries ......................................................... 10
2.0. Introduction ............................................................................................................. 10
2.1. Financial institutions ................................................................................................ 10
2.1.1. “credit Institutions” ......................................................................................... 10
2.1.2. Institutions supplying venture capital ............................................................. 10
2.1.3. Investment firms .............................................................................................. 12
2.1.4. Institutional investors = ICB’s .......................................................................... 13
2.1.5. Shadow banking............................................................................................... 15
2.1.6. Some numbers (ppt) ........................................................................................ 15
2.2. Financial intermediaries .......................................................................................... 16
2.2.1. Definition ......................................................................................................... 16
2.2.2. Explaining their existence. ............................................................................... 16
2.2.3. “Banks” ............................................................................................................ 18
2.2.3.1. Products liability side ............................................................................... 19
2.2.3.2. Products asset side (types of loans) ......................................................... 20
2.2.3.3. Off balance ............................................................................................... 22
2.2.3.4. Risks (see figure) ...................................................................................... 25
Chapter 3: Prudential regulation ....................................................................................... 26
3.1. Call for regulation .................................................................................................... 26
3.2. Types of regulation (extra information in the notes of the slides when needed) ... 28
3.3. European/ Belgian organization .............................................................................. 33
Chapter 4: Financial markets and instruments (Fixed Income) .......................................... 37
4.0. Introduction ............................................................................................................. 37
4.1. Money markets ........................................................................................................ 38
4.1.1. Interbank market (most important one) ......................................................... 39
4.1.2. Short term government paper ......................................................................... 41
4.1.3. Short term (non-government and non-bank) paper: Commercial paper (CP). 41
4.1.4. REPO ................................................................................................................ 42
4.2. Bond markets (always be able to draw the flows) .................................................. 46
1
, 4.2.1. Terminology ..................................................................................................... 46
4.2.2. Price and creation of yield curve ..................................................................... 52
4.3. Interest derivatives .................................................................................................. 57
4.3.1. Interest rate swaps (short introduction) ......................................................... 57
Part 2: Rudy Vandorpe ...................................................................................................... 59
Introduction ......................................................................................................................... 59
Chapter 1: Investing in equities ......................................................................................... 62
1.1. Characteristics ......................................................................................................... 62
1.2. Markets.................................................................................................................... 63
1.3. Valuation ................................................................................................................. 66
1.3.1. Price/book value .............................................................................................. 66
1.3.2. Price/ earnings ................................................................................................. 66
1.3.3. Dividend yield .................................................................................................. 67
1.3.4. Dividend yield/ bond yield ............................................................................... 67
1.3.5. Growth at reasonable price ............................................................................. 68
1.3.6. Dividend discount model ................................................................................. 68
1.3.7. Discounted cashflow model............................................................................. 69
1.3.8. Big difference in between discounted dividend and discounted cash flow .... 70
1.4. Equity management process ................................................................................... 70
1.4.1. Selecting the benchmark ................................................................................. 70
1.4.2. Active or passive management ........................................................................ 70
1.4.3. Passive management ....................................................................................... 71
1.4.4. Active management ......................................................................................... 71
1.5. Important rules ........................................................................................................ 74
Chapter 2: Investing in derivatives .................................................................................... 76
2.1. Futures and forwards .............................................................................................. 76
2.2. Options .................................................................................................................... 79
Chapter 3: Other instruments ........................................................................................... 90
3.1. Hybrid products ....................................................................................................... 90
3.2. Risk versus return .................................................................................................... 92
3.3. Investing private equity ........................................................................................... 94
3.4. Investing in practice ................................................................................................. 97
2
,Part 1: Prof. Dr. Geert Gielens
Introduction
- Y = C + I + G + (X – M)
o Supply = demand
o X – M = net export
o C = consumption
o I = investment
o G = government spending
o Y = income
- Y – T = C + I + G – T + (X – M)
o T = taxes
- S = savings = Y – T – C
o Savings = investments + some other stuff (we are going to ignore this)
- Financial system is always time and geography depending
o There is no unified system in the EU
o The Belgian financial system
§ Different from Germany, French, United states, …
§ There are similarities
§ Differences in approach
§ In the united states they still use checks
The Belgian financial system
- You have 2 countries that are exactly the same A and B
o You want to buy or sell stuff so there is an exchange of money
o CCP = central clearing parties
§ When you want to swap money, you need to go thru the CCP
- Central bank
- FSMA = Financial Security and Markets Authority
- EC = European Commission
- EBA = European Bank Authority
- Most of the financing in Belgium happens thru banks
3
,Chapter 1: Money and money creation
- Why is it important to discuss money?
o Not as known as you think
o What determines a good as money?
- Money = a product that is generally accepted in exchange for goods and services, it is
a means of exchange
o Something that you want to have because it permits you to get something
else
o Purchasing power
§ The trust you have that other people will accept it
o It HAS to be generally accepted
o It is an explicit or implicit agreement
§ Explicit: by law
• In Belgium it is Euros
• For example
o After the 1e world war in Germany
o Money wasn’t worth anything anymore
o People were using cigarettes for trading
§ Implicit: whatever the economic agents agree to use as means of
exchange
1.1. Origin & characteristics
Function
- Means of exchange
- Investment
- Unit of account
o Use it to express value
o Allows to calculate easily
o Allows trade
- Standard for future payments
o Interest rate
o Inflation
Characteristics of money
- Valuable in comparison to its weight
o Banknote costs $0,1 but it is worth $100
o Diamonds
§ Very small, very valuable
- Durable
o Can’t be destroyed easily
o When it is teared in half, it still has it whole value
o Burning money is forbidden by law, you cannot destroy it
o You can destroy diamonds by law, but it is hard
- Divisible
o Disadvantage for diamonds
§ It is not easy to cut them in half
o Banknotes: $5, $10, $1, …
§ Small amounts are easy
o Usable for every price you need to pay
4
, - Standardized quality
o Problem for diamonds
§ How do you know that it is real, from good quality
o Banknotes are easy to recognize, creates trust
- Easily recognizable
o $20 banknote, everybody knows what it looks like
o With diamonds you are not sure if it’s a diamond, or glass or something else
o The Romans did this also with their coins
- Stable purchasing power
o 1 euro today should be worth 1-euro next year (with stable inflation)
o Trying to keep inflation low and predictable
Evolution
- Barter trade
o Trading a sheep for 5 chickens
- Commodities used as ‘money’
- Precious metals
o Bronze
- Means of payment: coins (minted) or paper money
o 13th-14th century
o Trading between Italy, Bruges, ...
o Payments were necessary
o Letters for trade deals
- Legal tender
o Law tells you what can be used
- Fiduciary money
o Money that is worth something because of expectations
o Easy to transact with
o Money based on trust
Forms of money
- Paper money and coins
- Sight deposits
- E-money
- Alternative forms
5
MARKETS AND
INSTITUTIONS
Prof dr. Geert Gielens, Rudy Vandorpe
Pauline Delphine Verhelst
VUB | 2020-2021
,Table of contents
Part 1: Prof. Dr. Geert Gielens ............................................................................................. 2
Introduction ........................................................................................................................... 3
Chapter 1: Money and money creation ............................................................................... 4
1.1. Origin & characteristics ............................................................................................. 4
1.2. Money supply ............................................................................................................ 6
Chapter 2: Financial institutions and intermediaries ......................................................... 10
2.0. Introduction ............................................................................................................. 10
2.1. Financial institutions ................................................................................................ 10
2.1.1. “credit Institutions” ......................................................................................... 10
2.1.2. Institutions supplying venture capital ............................................................. 10
2.1.3. Investment firms .............................................................................................. 12
2.1.4. Institutional investors = ICB’s .......................................................................... 13
2.1.5. Shadow banking............................................................................................... 15
2.1.6. Some numbers (ppt) ........................................................................................ 15
2.2. Financial intermediaries .......................................................................................... 16
2.2.1. Definition ......................................................................................................... 16
2.2.2. Explaining their existence. ............................................................................... 16
2.2.3. “Banks” ............................................................................................................ 18
2.2.3.1. Products liability side ............................................................................... 19
2.2.3.2. Products asset side (types of loans) ......................................................... 20
2.2.3.3. Off balance ............................................................................................... 22
2.2.3.4. Risks (see figure) ...................................................................................... 25
Chapter 3: Prudential regulation ....................................................................................... 26
3.1. Call for regulation .................................................................................................... 26
3.2. Types of regulation (extra information in the notes of the slides when needed) ... 28
3.3. European/ Belgian organization .............................................................................. 33
Chapter 4: Financial markets and instruments (Fixed Income) .......................................... 37
4.0. Introduction ............................................................................................................. 37
4.1. Money markets ........................................................................................................ 38
4.1.1. Interbank market (most important one) ......................................................... 39
4.1.2. Short term government paper ......................................................................... 41
4.1.3. Short term (non-government and non-bank) paper: Commercial paper (CP). 41
4.1.4. REPO ................................................................................................................ 42
4.2. Bond markets (always be able to draw the flows) .................................................. 46
1
, 4.2.1. Terminology ..................................................................................................... 46
4.2.2. Price and creation of yield curve ..................................................................... 52
4.3. Interest derivatives .................................................................................................. 57
4.3.1. Interest rate swaps (short introduction) ......................................................... 57
Part 2: Rudy Vandorpe ...................................................................................................... 59
Introduction ......................................................................................................................... 59
Chapter 1: Investing in equities ......................................................................................... 62
1.1. Characteristics ......................................................................................................... 62
1.2. Markets.................................................................................................................... 63
1.3. Valuation ................................................................................................................. 66
1.3.1. Price/book value .............................................................................................. 66
1.3.2. Price/ earnings ................................................................................................. 66
1.3.3. Dividend yield .................................................................................................. 67
1.3.4. Dividend yield/ bond yield ............................................................................... 67
1.3.5. Growth at reasonable price ............................................................................. 68
1.3.6. Dividend discount model ................................................................................. 68
1.3.7. Discounted cashflow model............................................................................. 69
1.3.8. Big difference in between discounted dividend and discounted cash flow .... 70
1.4. Equity management process ................................................................................... 70
1.4.1. Selecting the benchmark ................................................................................. 70
1.4.2. Active or passive management ........................................................................ 70
1.4.3. Passive management ....................................................................................... 71
1.4.4. Active management ......................................................................................... 71
1.5. Important rules ........................................................................................................ 74
Chapter 2: Investing in derivatives .................................................................................... 76
2.1. Futures and forwards .............................................................................................. 76
2.2. Options .................................................................................................................... 79
Chapter 3: Other instruments ........................................................................................... 90
3.1. Hybrid products ....................................................................................................... 90
3.2. Risk versus return .................................................................................................... 92
3.3. Investing private equity ........................................................................................... 94
3.4. Investing in practice ................................................................................................. 97
2
,Part 1: Prof. Dr. Geert Gielens
Introduction
- Y = C + I + G + (X – M)
o Supply = demand
o X – M = net export
o C = consumption
o I = investment
o G = government spending
o Y = income
- Y – T = C + I + G – T + (X – M)
o T = taxes
- S = savings = Y – T – C
o Savings = investments + some other stuff (we are going to ignore this)
- Financial system is always time and geography depending
o There is no unified system in the EU
o The Belgian financial system
§ Different from Germany, French, United states, …
§ There are similarities
§ Differences in approach
§ In the united states they still use checks
The Belgian financial system
- You have 2 countries that are exactly the same A and B
o You want to buy or sell stuff so there is an exchange of money
o CCP = central clearing parties
§ When you want to swap money, you need to go thru the CCP
- Central bank
- FSMA = Financial Security and Markets Authority
- EC = European Commission
- EBA = European Bank Authority
- Most of the financing in Belgium happens thru banks
3
,Chapter 1: Money and money creation
- Why is it important to discuss money?
o Not as known as you think
o What determines a good as money?
- Money = a product that is generally accepted in exchange for goods and services, it is
a means of exchange
o Something that you want to have because it permits you to get something
else
o Purchasing power
§ The trust you have that other people will accept it
o It HAS to be generally accepted
o It is an explicit or implicit agreement
§ Explicit: by law
• In Belgium it is Euros
• For example
o After the 1e world war in Germany
o Money wasn’t worth anything anymore
o People were using cigarettes for trading
§ Implicit: whatever the economic agents agree to use as means of
exchange
1.1. Origin & characteristics
Function
- Means of exchange
- Investment
- Unit of account
o Use it to express value
o Allows to calculate easily
o Allows trade
- Standard for future payments
o Interest rate
o Inflation
Characteristics of money
- Valuable in comparison to its weight
o Banknote costs $0,1 but it is worth $100
o Diamonds
§ Very small, very valuable
- Durable
o Can’t be destroyed easily
o When it is teared in half, it still has it whole value
o Burning money is forbidden by law, you cannot destroy it
o You can destroy diamonds by law, but it is hard
- Divisible
o Disadvantage for diamonds
§ It is not easy to cut them in half
o Banknotes: $5, $10, $1, …
§ Small amounts are easy
o Usable for every price you need to pay
4
, - Standardized quality
o Problem for diamonds
§ How do you know that it is real, from good quality
o Banknotes are easy to recognize, creates trust
- Easily recognizable
o $20 banknote, everybody knows what it looks like
o With diamonds you are not sure if it’s a diamond, or glass or something else
o The Romans did this also with their coins
- Stable purchasing power
o 1 euro today should be worth 1-euro next year (with stable inflation)
o Trying to keep inflation low and predictable
Evolution
- Barter trade
o Trading a sheep for 5 chickens
- Commodities used as ‘money’
- Precious metals
o Bronze
- Means of payment: coins (minted) or paper money
o 13th-14th century
o Trading between Italy, Bruges, ...
o Payments were necessary
o Letters for trade deals
- Legal tender
o Law tells you what can be used
- Fiduciary money
o Money that is worth something because of expectations
o Easy to transact with
o Money based on trust
Forms of money
- Paper money and coins
- Sight deposits
- E-money
- Alternative forms
5
