Unit 1: The Financial System
1. The Actors
1.1 types of actors: Haves or Havenots? (Macro-perspective)
The economy consists out of haves and havenots. Haves possess capital and can
lend it out (Lenders). Havenots have more needs than money and they will have
to raise capital (borrowers).
- Looking at that with a Macro perspectif => big entities:
Corporates (havenot: they have big loans)
The government (havenot: they get money from shareholders)
Households (haves: they own financial wealth) => they are crucial!
- Financial economics helps to bridge the funding from the haves to the
havenots
1.2 The Main Actor: Households
Net wealth = assets - liabilities
E.g: when a single household owns a house of 100 but at the same time
has a remaining mortgage debt of 80, its net wealth is 20.
The household balance sheet gives an overview of the assets and the liabilities of
a single household:
Real assets = everything
fysical that someone
ownes.
Financial assets = stocks
(aandelen), bonds (loan),
mutual fonds, …
Liabilities = is money you
owe to another person or
institution.
- The way how people store wealth is different around the globe:
US: more financial assets than real assets
India: almost only real assets and no financial assets
1
, 1.3 Kinds of assets
An asset is a possession that has value in an exchange transaction:
- Tangible assets or real assets derive value from their physical
character and the utility they generate.
- Intangible assets derive value from a legal claim to some future
benefit.
- Financial assets are intangible assets that represent a claim to
future cash
1.4 Asset Classes
Traditional:
- Common stock
- Bonds Cash
- Cash (and cash equivalents for example: savings account)
Alternative:
- Real estate
- Commodities
- Private equity
- Hedge funds
- Venture capital
- Currencies (forex)
1.5 Liabilities (already discussed)
- Mortgage loans
- Consumer loans
- Tax debt
1.6 Growth Drivers in Net Wealth
Different kind of sources:
- Value changes in assets and liabilities (for example a car is a bad
investment)
- Net-income from labour (paycheck), capital or transfers (pensions, social
security based income)
- Inheritances, gifts
=> Wealth change a lot during time …
2
, 1.7 Wealth Creation
=> important! Middle class is not rich! -> the real rich got assest that generate
an income on their own!
- So the goal is to own assets that generate income on is own …
1.8 Wealth Distribution
- 1. Wealth is not evenly distributed over the globe
- 2. The wealthiest people are north america and Europe => on the right
But on the left in the top corner => also a lot of poor people in Nort
America
The highest poverty is a lot on the countries on the left.
- 3. In belgium we have a developped economics and our wealth has a low
inequality. So it is good distributed over the people of the state.
1.9 Conclusion actors
Do you fully realize that households are the ultimate owners of all assets in the
economy! + also the bearers of risk within the financial system!
We know that families (household) are the most important but in economics
there are other actors with their own balancesheet. In the end household will
ownt it! but they have assets of businesses and banks. => we are gonna look to
that now…
3
, 2. How do the balance sheets of other actors look like?
2.1 Corporates
Liabilities:
- Equity is the claim of the shareholders
- Debt is the money they loan
- => the ratio is important! -> corporates like to work with lend money!
This because: when the cost of borrowing money is lower than your
profit margin => you can enjoy of a leverage!
Assets
- Fixed assets: a long term commitment
- Current assets: a shorter term commitment
2.1.1 Funding of Corporates
Companies can be funded (as we can see on the balance sheet)
- with shareholder funds (equity) consisting out of the original equity, rights
issues and the retained profit.
- debt
=> When companies use debt to finance their operations, they use leverage.
- Most companies use leverage to raise the ROE above the ROA.
ROE = return on equity i.e. profit/equity
ROA = return on assets i.e. profit/assets
2.1.2 Gearing = the ratio that shows funded by lenders versus shareholders
Leverage can be measured in different ways:
- As a Debt/Equity ratio
V&M define the gearing ratio as the ratio between long-term debt
and equity.
The net gearing ratio is often defined as the ratio of the financial
debt and the equity. Net financial debt is defined as the long term
debt + short term debt - cash - short term financial assets.
- As a Assets/Equity ratio i.e. a leverage multiplier.
The famous Dupont scheme uses the latter: ROE = ROA x LM
4
1. The Actors
1.1 types of actors: Haves or Havenots? (Macro-perspective)
The economy consists out of haves and havenots. Haves possess capital and can
lend it out (Lenders). Havenots have more needs than money and they will have
to raise capital (borrowers).
- Looking at that with a Macro perspectif => big entities:
Corporates (havenot: they have big loans)
The government (havenot: they get money from shareholders)
Households (haves: they own financial wealth) => they are crucial!
- Financial economics helps to bridge the funding from the haves to the
havenots
1.2 The Main Actor: Households
Net wealth = assets - liabilities
E.g: when a single household owns a house of 100 but at the same time
has a remaining mortgage debt of 80, its net wealth is 20.
The household balance sheet gives an overview of the assets and the liabilities of
a single household:
Real assets = everything
fysical that someone
ownes.
Financial assets = stocks
(aandelen), bonds (loan),
mutual fonds, …
Liabilities = is money you
owe to another person or
institution.
- The way how people store wealth is different around the globe:
US: more financial assets than real assets
India: almost only real assets and no financial assets
1
, 1.3 Kinds of assets
An asset is a possession that has value in an exchange transaction:
- Tangible assets or real assets derive value from their physical
character and the utility they generate.
- Intangible assets derive value from a legal claim to some future
benefit.
- Financial assets are intangible assets that represent a claim to
future cash
1.4 Asset Classes
Traditional:
- Common stock
- Bonds Cash
- Cash (and cash equivalents for example: savings account)
Alternative:
- Real estate
- Commodities
- Private equity
- Hedge funds
- Venture capital
- Currencies (forex)
1.5 Liabilities (already discussed)
- Mortgage loans
- Consumer loans
- Tax debt
1.6 Growth Drivers in Net Wealth
Different kind of sources:
- Value changes in assets and liabilities (for example a car is a bad
investment)
- Net-income from labour (paycheck), capital or transfers (pensions, social
security based income)
- Inheritances, gifts
=> Wealth change a lot during time …
2
, 1.7 Wealth Creation
=> important! Middle class is not rich! -> the real rich got assest that generate
an income on their own!
- So the goal is to own assets that generate income on is own …
1.8 Wealth Distribution
- 1. Wealth is not evenly distributed over the globe
- 2. The wealthiest people are north america and Europe => on the right
But on the left in the top corner => also a lot of poor people in Nort
America
The highest poverty is a lot on the countries on the left.
- 3. In belgium we have a developped economics and our wealth has a low
inequality. So it is good distributed over the people of the state.
1.9 Conclusion actors
Do you fully realize that households are the ultimate owners of all assets in the
economy! + also the bearers of risk within the financial system!
We know that families (household) are the most important but in economics
there are other actors with their own balancesheet. In the end household will
ownt it! but they have assets of businesses and banks. => we are gonna look to
that now…
3
, 2. How do the balance sheets of other actors look like?
2.1 Corporates
Liabilities:
- Equity is the claim of the shareholders
- Debt is the money they loan
- => the ratio is important! -> corporates like to work with lend money!
This because: when the cost of borrowing money is lower than your
profit margin => you can enjoy of a leverage!
Assets
- Fixed assets: a long term commitment
- Current assets: a shorter term commitment
2.1.1 Funding of Corporates
Companies can be funded (as we can see on the balance sheet)
- with shareholder funds (equity) consisting out of the original equity, rights
issues and the retained profit.
- debt
=> When companies use debt to finance their operations, they use leverage.
- Most companies use leverage to raise the ROE above the ROA.
ROE = return on equity i.e. profit/equity
ROA = return on assets i.e. profit/assets
2.1.2 Gearing = the ratio that shows funded by lenders versus shareholders
Leverage can be measured in different ways:
- As a Debt/Equity ratio
V&M define the gearing ratio as the ratio between long-term debt
and equity.
The net gearing ratio is often defined as the ratio of the financial
debt and the equity. Net financial debt is defined as the long term
debt + short term debt - cash - short term financial assets.
- As a Assets/Equity ratio i.e. a leverage multiplier.
The famous Dupont scheme uses the latter: ROE = ROA x LM
4
