FINANCIAL MARKETS AND
INSTITUTIONS
Prof. Dr. Geert Gielens & Rudy Vandorpe
Axel Gosez
2024–2025
,Table of Contents
PRACTICALITIES .................................................................................................................. 6
INTRODUCTION ....................................................................................................................... 6
TYPECASTING THE BELGIAN FINANCIAL SYSTEM .................................................................................... 7
CHAPTER 1: MONEY AND CREATION OF MONEY ................................................................... 8
1.1 ORIGIN AND CHARACTERISTICS ............................................................................................. 8
DEFINITION .................................................................................................................................. 8
FUNCTION.................................................................................................................................... 8
CHARACTERISTICS ......................................................................................................................... 9
EVOLUTION ................................................................................................................................ 10
FORMS OF MONEY ........................................................................................................................ 11
1.2 SUPPLY OF MONEY.............................................................................................................12
DEFINITION ................................................................................................................................ 12
BASE MONEY .............................................................................................................................. 14
MONEY MULTIPLIER ...................................................................................................................... 15
FRACTIONAL RESERVE SYSTEM: WORKING – SIMPLE EXAMPLE ................................................................................... 15
FRACTIONAL RESERVE SYSTEM: WORKING – MORE REALISTIC EXAMPLE ....................................................................... 16
WHAT INFLUENCES THE MONEY MULTIPLIER? ....................................................................................................... 17
FACTORS DETERMINING THE PREFERENCE FOR CASH ............................................................................................. 18
FACTORS INFLUENCING THE RESERVE COEFFICIENT ............................................................................................... 19
RELATIONSHIP BETWEEN THE MULTIPLIER AND INTEREST RATES ................................................................................. 19
SOME NUMBERS .......................................................................................................................... 19
1.3 BELGIAN MONETARY HISTORY ...............................................................................................20
CHAPTER 2: FINANCIAL INSTITUTIONS AND INTERMEDIARIES ..............................................21
2.1 FINANCIAL INSTITUTIONS ....................................................................................................21
CREDIT INSTITUTIONS.................................................................................................................... 21
INSTITUTIONS SUPPLYING VENTURE CAPITAL ....................................................................................... 21
VENTURE CAPITALISTS ................................................................................................................................... 22
HOLDINGS ................................................................................................................................................. 22
INVESTMENT COMPANIES ............................................................................................................... 22
STOCKBROKERS ........................................................................................................................................... 22
PORTFOLIO MANAGEMENT AND INVESTMENT ADVICE COMPANIES .............................................................................. 22
INSTITUTIONAL INVESTORS ............................................................................................................. 23
INSURANCE COMPANIES ................................................................................................................................ 23
COLLECTIVE INVESTMENT UNDERTAKINGS AKA FUNDS ........................................................................................... 24
SHADOW BANKING ....................................................................................................................... 24
SOME NUMBERS .......................................................................................................................... 25
COLLECTIVE INVESTMENT UNDERTAKINGS ........................................................................................................... 25
PENSION FUNDS .......................................................................................................................................... 25
SHADOW BANKING ....................................................................................................................................... 26
2.2 FINANCIAL INTERMEDIARIES.................................................................................................27
DEFINITION ................................................................................................................................ 27
REASONS FOR EXISTENCE .............................................................................................................. 27
1
,1. EXTERNAL FINANCING ................................................................................................................................ 27
INDIRECT EXTERNAL FINANCING – BANK INTERMEDIATION. ...................................................................................... 29
INDIRECT EXTERNAL FINANCING – CAPITAL MARKETS ............................................................................................. 29
2. REDUCING MARKET IMPERFECTIONS .............................................................................................................. 30
– ADVERSE SELECTION.............................................................................................................................. 30
– DUPLICATED SCREENING ........................................................................................................................ 31
– MORAL HAZARD .................................................................................................................................... 32
3. ASSET TRANSFORMATION ............................................................................................................................ 32
4. TRANSPARENCY........................................................................................................................................ 33
BANKS....................................................................................................................................... 34
PRODUCTS LIABILITIES SIDE (FUNDING) .............................................................................................................. 35
PRODUCTS ASSET SIDE: CORPORATIONS............................................................................................................. 37
PRODUCTS ASSET SIDE: RETAIL......................................................................................................................... 39
OFF-BALANCE ............................................................................................................................................. 39
RISKS ........................................................................................................................................................ 41
CHAPTER 3: PRUDENTIAL REGULATION ...............................................................................42
3.1 WHY REGULATION? ...........................................................................................................42
EFFECTIVENESS OF DEPOSIT GUARANTEE SYSTEM ................................................................................ 44
3.2 TYPES OF REGULATION........................................................................................................45
ZOOM ON BASEL III ...................................................................................................................... 47
PILAR I ...................................................................................................................................................... 47
PILLAR II .................................................................................................................................................... 48
PILLAR III ................................................................................................................................................... 48
ZOOM ON LIQUIDITY ..................................................................................................................... 49
LCR ......................................................................................................................................................... 50
NSFR ....................................................................................................................................................... 50
OTHER TYPES .............................................................................................................................. 50
CRISIS MANAGEMENT.................................................................................................................... 51
DOOM LOOP ............................................................................................................................................... 52
3.3 ORGANIZATION IN EUROPE/BELGIUM .....................................................................................52
SINGLE SUPERVISORY MECHANISM ................................................................................................................... 53
SINGLE RESOLUTION MECHANISM.................................................................................................................... 54
CHAPTER 4: FINANCIAL INSTRUMENTS AND FIXED INCOME CAPITAL MARKETS ....................56
4.1 BOND MARKETS ................................................................................................................56
A BOND ..................................................................................................................................... 57
SENIORITY .................................................................................................................................. 58
PARI PASSU ................................................................................................................................................ 59
THE PRICE .................................................................................................................................................. 59
CLASSIFICATION ACCORDING TO INITIAL MATURITY .............................................................................. 60
FACTORS THAT DETERMINE THE INTEREST RATE OF A BOND: .................................................................... 60
CREDIT QUALITY:.......................................................................................................................................... 60
MATURITY .................................................................................................................................................. 62
LIQUIDITY ................................................................................................................................................... 62
RELATIONSHIP BETWEEN INTEREST RATE AND CREDIT QUALITY & MATURITY................................................. 63
EXAMPLE: INFORMATION OF A BOND AND PRICE OF A BOND ................................................................... 63
PRICE AND CREATION OF A YIELD CURVE ............................................................................................ 64
4.3 MONEY MARKETS ..............................................................................................................66
2
, MONEY MARKETS: INTERBANK MARKET .............................................................................................. 66
MONEY MARKETS: SHORT TERM GOVERNMENT PAPER............................................................................ 68
MONEY MARKETS: SHORT TERM PAPER (NON-GOVERNMENT & NON-BANK) ................................................ 68
MONEY MARKETS: REPO ............................................................................................................... 69
CHAPTER 5: INVESTING IN EQUITIES ...................................................................................71
INTRODUCTION ......................................................................................................................71
EQUITIES CAN BE VOLATILE ............................................................................................................. 72
BUT THEY DO OUTPERFORM ............................................................................................................ 72
ON AVERAGE AND IN THE LONG RUN EQUITIES PERFORM WELL ................................................................ 73
EQUITIES ..............................................................................................................................74
CHARACTERISTICS ....................................................................................................................... 74
MARKETS ................................................................................................................................... 74
STOCK MARKET ORGANIZATION: PARTIES INVOLVED ............................................................................................... 75
STOCK MARKET ORGANIZATION: DIFFERENCE SELL SIDE – BUY SIDE ............................................................................ 75
VALUATION ................................................................................................................................. 76
PRICE/BOOK VALUE ...................................................................................................................................... 76
PRICE/EARNINGS (& EARNINGS YIELD) ............................................................................................................... 77
DIVIDEND YIELD ........................................................................................................................................... 79
DIVIDEND YIELD/BOND YIELD .......................................................................................................................... 80
GROWTH AT REASONABLE PRICE ...................................................................................................................... 82
DIVIDEND DISCOUNT MODEL ........................................................................................................................... 83
EXAMPLE EXERCISES ..................................................................................................................................... 84
DISCOUNTED CASH FLOW MODEL..................................................................................................................... 86
DCF MODEL: CALCULATION OF THE WACC........................................................................................................ 86
DCF IN CLOSE UP: COLRUYT .......................................................................................................................... 87
FCF YIELD (A BETTER?) ALTERNATIVE VALUATION METHOD ...................................................................................... 87
EQUITY MANAGEMENT PROCESS: HOW TO MANAGE/SELECT EQUITY? ....................................................... 88
SELECTING THE BENCHMARK ........................................................................................................................... 88
PASSIVE MANAGEMENT.................................................................................................................. 88
ACTIVE MANAGEMENT ................................................................................................................... 89
TOP DOWN ................................................................................................................................................. 89
STYLE ROTATION .......................................................................................................................................... 92
SECTOR ROTATION ........................................................................................................................................ 92
TECHNICAL ANALYSIS .................................................................................................................................... 93
BOTTOM UP ................................................................................................................................................ 93
RISK MANAGEMENT ....................................................................................................................................... 94
DIVERSIFICATION ......................................................................................................................................... 94
LIMIT YOUR UNIVERSE! ................................................................................................................................... 95
WATCH OUT FOR ACQUISITIONS ....................................................................................................................... 95
OTHER POTENTIAL DANGER: FRAUD ................................................................................................................ 95
CHAPTER 6: INVESTING IN DERIVATIVES ..............................................................................96
FUTURES ..............................................................................................................................96
MARKETS ................................................................................................................................... 96
EXAMPLE OF HOW A FUTURE IS DEFINED ............................................................................................................. 97
FORWARDS ...........................................................................................................................97
VALUATION ................................................................................................................................. 98
EXAMPLE EXERCISE – FUTURE ON BOND ............................................................................................................. 98
3
INSTITUTIONS
Prof. Dr. Geert Gielens & Rudy Vandorpe
Axel Gosez
2024–2025
,Table of Contents
PRACTICALITIES .................................................................................................................. 6
INTRODUCTION ....................................................................................................................... 6
TYPECASTING THE BELGIAN FINANCIAL SYSTEM .................................................................................... 7
CHAPTER 1: MONEY AND CREATION OF MONEY ................................................................... 8
1.1 ORIGIN AND CHARACTERISTICS ............................................................................................. 8
DEFINITION .................................................................................................................................. 8
FUNCTION.................................................................................................................................... 8
CHARACTERISTICS ......................................................................................................................... 9
EVOLUTION ................................................................................................................................ 10
FORMS OF MONEY ........................................................................................................................ 11
1.2 SUPPLY OF MONEY.............................................................................................................12
DEFINITION ................................................................................................................................ 12
BASE MONEY .............................................................................................................................. 14
MONEY MULTIPLIER ...................................................................................................................... 15
FRACTIONAL RESERVE SYSTEM: WORKING – SIMPLE EXAMPLE ................................................................................... 15
FRACTIONAL RESERVE SYSTEM: WORKING – MORE REALISTIC EXAMPLE ....................................................................... 16
WHAT INFLUENCES THE MONEY MULTIPLIER? ....................................................................................................... 17
FACTORS DETERMINING THE PREFERENCE FOR CASH ............................................................................................. 18
FACTORS INFLUENCING THE RESERVE COEFFICIENT ............................................................................................... 19
RELATIONSHIP BETWEEN THE MULTIPLIER AND INTEREST RATES ................................................................................. 19
SOME NUMBERS .......................................................................................................................... 19
1.3 BELGIAN MONETARY HISTORY ...............................................................................................20
CHAPTER 2: FINANCIAL INSTITUTIONS AND INTERMEDIARIES ..............................................21
2.1 FINANCIAL INSTITUTIONS ....................................................................................................21
CREDIT INSTITUTIONS.................................................................................................................... 21
INSTITUTIONS SUPPLYING VENTURE CAPITAL ....................................................................................... 21
VENTURE CAPITALISTS ................................................................................................................................... 22
HOLDINGS ................................................................................................................................................. 22
INVESTMENT COMPANIES ............................................................................................................... 22
STOCKBROKERS ........................................................................................................................................... 22
PORTFOLIO MANAGEMENT AND INVESTMENT ADVICE COMPANIES .............................................................................. 22
INSTITUTIONAL INVESTORS ............................................................................................................. 23
INSURANCE COMPANIES ................................................................................................................................ 23
COLLECTIVE INVESTMENT UNDERTAKINGS AKA FUNDS ........................................................................................... 24
SHADOW BANKING ....................................................................................................................... 24
SOME NUMBERS .......................................................................................................................... 25
COLLECTIVE INVESTMENT UNDERTAKINGS ........................................................................................................... 25
PENSION FUNDS .......................................................................................................................................... 25
SHADOW BANKING ....................................................................................................................................... 26
2.2 FINANCIAL INTERMEDIARIES.................................................................................................27
DEFINITION ................................................................................................................................ 27
REASONS FOR EXISTENCE .............................................................................................................. 27
1
,1. EXTERNAL FINANCING ................................................................................................................................ 27
INDIRECT EXTERNAL FINANCING – BANK INTERMEDIATION. ...................................................................................... 29
INDIRECT EXTERNAL FINANCING – CAPITAL MARKETS ............................................................................................. 29
2. REDUCING MARKET IMPERFECTIONS .............................................................................................................. 30
– ADVERSE SELECTION.............................................................................................................................. 30
– DUPLICATED SCREENING ........................................................................................................................ 31
– MORAL HAZARD .................................................................................................................................... 32
3. ASSET TRANSFORMATION ............................................................................................................................ 32
4. TRANSPARENCY........................................................................................................................................ 33
BANKS....................................................................................................................................... 34
PRODUCTS LIABILITIES SIDE (FUNDING) .............................................................................................................. 35
PRODUCTS ASSET SIDE: CORPORATIONS............................................................................................................. 37
PRODUCTS ASSET SIDE: RETAIL......................................................................................................................... 39
OFF-BALANCE ............................................................................................................................................. 39
RISKS ........................................................................................................................................................ 41
CHAPTER 3: PRUDENTIAL REGULATION ...............................................................................42
3.1 WHY REGULATION? ...........................................................................................................42
EFFECTIVENESS OF DEPOSIT GUARANTEE SYSTEM ................................................................................ 44
3.2 TYPES OF REGULATION........................................................................................................45
ZOOM ON BASEL III ...................................................................................................................... 47
PILAR I ...................................................................................................................................................... 47
PILLAR II .................................................................................................................................................... 48
PILLAR III ................................................................................................................................................... 48
ZOOM ON LIQUIDITY ..................................................................................................................... 49
LCR ......................................................................................................................................................... 50
NSFR ....................................................................................................................................................... 50
OTHER TYPES .............................................................................................................................. 50
CRISIS MANAGEMENT.................................................................................................................... 51
DOOM LOOP ............................................................................................................................................... 52
3.3 ORGANIZATION IN EUROPE/BELGIUM .....................................................................................52
SINGLE SUPERVISORY MECHANISM ................................................................................................................... 53
SINGLE RESOLUTION MECHANISM.................................................................................................................... 54
CHAPTER 4: FINANCIAL INSTRUMENTS AND FIXED INCOME CAPITAL MARKETS ....................56
4.1 BOND MARKETS ................................................................................................................56
A BOND ..................................................................................................................................... 57
SENIORITY .................................................................................................................................. 58
PARI PASSU ................................................................................................................................................ 59
THE PRICE .................................................................................................................................................. 59
CLASSIFICATION ACCORDING TO INITIAL MATURITY .............................................................................. 60
FACTORS THAT DETERMINE THE INTEREST RATE OF A BOND: .................................................................... 60
CREDIT QUALITY:.......................................................................................................................................... 60
MATURITY .................................................................................................................................................. 62
LIQUIDITY ................................................................................................................................................... 62
RELATIONSHIP BETWEEN INTEREST RATE AND CREDIT QUALITY & MATURITY................................................. 63
EXAMPLE: INFORMATION OF A BOND AND PRICE OF A BOND ................................................................... 63
PRICE AND CREATION OF A YIELD CURVE ............................................................................................ 64
4.3 MONEY MARKETS ..............................................................................................................66
2
, MONEY MARKETS: INTERBANK MARKET .............................................................................................. 66
MONEY MARKETS: SHORT TERM GOVERNMENT PAPER............................................................................ 68
MONEY MARKETS: SHORT TERM PAPER (NON-GOVERNMENT & NON-BANK) ................................................ 68
MONEY MARKETS: REPO ............................................................................................................... 69
CHAPTER 5: INVESTING IN EQUITIES ...................................................................................71
INTRODUCTION ......................................................................................................................71
EQUITIES CAN BE VOLATILE ............................................................................................................. 72
BUT THEY DO OUTPERFORM ............................................................................................................ 72
ON AVERAGE AND IN THE LONG RUN EQUITIES PERFORM WELL ................................................................ 73
EQUITIES ..............................................................................................................................74
CHARACTERISTICS ....................................................................................................................... 74
MARKETS ................................................................................................................................... 74
STOCK MARKET ORGANIZATION: PARTIES INVOLVED ............................................................................................... 75
STOCK MARKET ORGANIZATION: DIFFERENCE SELL SIDE – BUY SIDE ............................................................................ 75
VALUATION ................................................................................................................................. 76
PRICE/BOOK VALUE ...................................................................................................................................... 76
PRICE/EARNINGS (& EARNINGS YIELD) ............................................................................................................... 77
DIVIDEND YIELD ........................................................................................................................................... 79
DIVIDEND YIELD/BOND YIELD .......................................................................................................................... 80
GROWTH AT REASONABLE PRICE ...................................................................................................................... 82
DIVIDEND DISCOUNT MODEL ........................................................................................................................... 83
EXAMPLE EXERCISES ..................................................................................................................................... 84
DISCOUNTED CASH FLOW MODEL..................................................................................................................... 86
DCF MODEL: CALCULATION OF THE WACC........................................................................................................ 86
DCF IN CLOSE UP: COLRUYT .......................................................................................................................... 87
FCF YIELD (A BETTER?) ALTERNATIVE VALUATION METHOD ...................................................................................... 87
EQUITY MANAGEMENT PROCESS: HOW TO MANAGE/SELECT EQUITY? ....................................................... 88
SELECTING THE BENCHMARK ........................................................................................................................... 88
PASSIVE MANAGEMENT.................................................................................................................. 88
ACTIVE MANAGEMENT ................................................................................................................... 89
TOP DOWN ................................................................................................................................................. 89
STYLE ROTATION .......................................................................................................................................... 92
SECTOR ROTATION ........................................................................................................................................ 92
TECHNICAL ANALYSIS .................................................................................................................................... 93
BOTTOM UP ................................................................................................................................................ 93
RISK MANAGEMENT ....................................................................................................................................... 94
DIVERSIFICATION ......................................................................................................................................... 94
LIMIT YOUR UNIVERSE! ................................................................................................................................... 95
WATCH OUT FOR ACQUISITIONS ....................................................................................................................... 95
OTHER POTENTIAL DANGER: FRAUD ................................................................................................................ 95
CHAPTER 6: INVESTING IN DERIVATIVES ..............................................................................96
FUTURES ..............................................................................................................................96
MARKETS ................................................................................................................................... 96
EXAMPLE OF HOW A FUTURE IS DEFINED ............................................................................................................. 97
FORWARDS ...........................................................................................................................97
VALUATION ................................................................................................................................. 98
EXAMPLE EXERCISE – FUTURE ON BOND ............................................................................................................. 98
3
