T2_FINANCIAL SYSTEM

DPA30063
FINANCIAL
MANAGEMENT 1

TOPIC 2
FINANCIAL SYSTEM

BY :
PN. ROSMARIA BINTI ISMAIL

DEPARTMENT OF COMMERCE

COURSE CONTENTS

FINANCIAL Banks And Financial intermediaries
SYSTEM Financial Non-financial intermediaries
Institutions
Financial Central bank/regulators
Markets Role & types

Islamic Money markets and capital markets
Finance MM & CM instruments
System Purpose and basis
Principles used
Ethical aspects
Islamic finance industry

INTRODUCTION

What is Financial System?

FS is a set of arrangements facilitating the transfer of funds between
borrowers and lenders / investors through the use of financial intermediaries.

FS is a composition of various institutions, markets, regulations and laws,
practices, money manager, analysts, transactions and claims and
liabilities.

FS functions as an intermediary and facilitates the flow of funds from
the areas of surplus to the areas of deficit.
The FIRM'S FINANCIAL SYSTEM is the set of implemented procedures
that track the financial activities of the company.
On a REGIONAL SCALE, the financial system is the system that enables
lenders and borrowers to exchange funds.
The GLOBAL FINANCIAL SYSTEM encompasses all financial institutions,
borrowers and lenders within the global economy.

BORROWERS LENDERS

Borrowers need money for Lenders have the money to
various reasons: to purchase lend, not only money in savings
a home, start a business, pay
accounts, but also money
for business expenses and deposited in other interest
fund programs. They need earning products, such as
retirement accounts and
money to spend.
certificate of deposits.

Borrowers include Lenders include individuals,
individuals, companies and companies and the
government.
the government

Individuals, companies and government can be both
borrowers and lenders.

They all do both; they both borrow and lend money.

MALAYSIAN FINANCIAL SYSTEM

Financial Institutions Financial Markets
Money Market
Banking Financial Capital Market
Intermediaries
Derivatives Market
Non-bank Financial
Intermediaries

Foreign Exchange Market

Off-shore Market

2.1
FINANCIAL INSTITUTIONS

Financial Institution

FI ensures smooth FI mobilize the Done by making use of
working of the savings of investors different financial

financial system by either directly or instruments as well as
making investors indirectly via in the process using
the services of
and borrowers financial markets. numerous financial
meet. services providers.

FI could be FI offer services to FI offer complete
categorized into organizations series of services to
the organizations who
Regulatory, looking for advises want to raise funds
Intermediaries, on different from the markets and
Non-intermediaries take care of financial
problems including assets, for example
and others. restructuring to deposits, securities,
diversification
strategies. loans, etc.

Financial Intermediation

The function of This function of New
a modern borrowing money businesses
from one source to which gain
bank/financial give it to another access to
system is to money make
bring together company that the economy
needs funding, grow and the
a pool of investment or money the
money from resources is banks earn
the general from their
public, make known as
advances and FINANCIAL lending
INTERMEDIATION operation
earn an keeps them in
income from business, as

these well.
advances.

Situation

Suppose you want to start a computer repair
business and, at the same time, a woman named
Mrs. Mya, who lives in another state, has money to
invest in a start-up business. If you and Mrs. Mya
could somehow cross paths, she could invest in
your business and you could fulfill your dream of
entrepreneurship. Since you probably would never
find Mrs. Mya on your own because she lives in
another state, there's a process called financial
intermediation that can ensure both of you meet
your goals.

The reasons

Financial Intermediation

exist

Financial Enterprises or The costs to match
intermediaries individuals which creditors and
assist in resolving need the money debtors without the
the conflict that hold better services of a
could occur information about specialized third
between lenders their financial parties (i.e. financial
and borrowers and condition and intermediaries) are
facilitate the flow prospects than the prohibitive
of funds from people or
surplus to deficit. organizations that
have the money to
lend

Banking Financial Intermediaries

Acting as a regulator & Malaysian
supervisor for the whole Banking
System
financial system Bank Negara
Malaysia

Commercial Islamic Investment Finance
Banks Banks Banks Companies

Provide the facilities & services in meeting the daily requirement of the
participants of the financial system

Malaysian Banking
System

Monetary Institution Non Monetary Institution

Principal activities involve Involves with the main activities
directly with the money of granting the loan, hire

Bank Negara Malaysia (Central purchase and other activities
Bank) i.e. issuing currency Investment banks and credit

Commercial Banks and Islamic guarantee corporation.
Banks are allowed to operate

current account.

Commercial Banks

An institution that carries on the business of banking. Under BAFIA 1989, the business of
banking is defined as the business of receiving deposits; paying or collecting cheques;
provision of finance ; and such other business as BNM, with the approval of the Minister

The only institutions that are authorized to operate current account that
provide chequing facilities, which in turn facilitate the payment system in the

country.
The only institutions that are given the authority to deal in foreign exchange to

meet the needs of corporations and to deal among themselves

Investment Banks

Responsible for stimulating a lot of activity in the market.

Provides an interface for trading equity shares, bonds and other financial
instruments.

Entities that participate in these activities are also known as ‘broker dealers’.
Manage initial public offers and advise & execute mergers, acquisitions and

divestures.

Finance Companies

Just like commercial banks, finance companies provide financial services to
business sectors and the household sectors.

Businesses and individuals have identified finance companies as an
intermediary that can provide funds for the acquisition of certain assets.

The financial services include :
(a) operating saving accounts; (b) operating fixed deposits accounts; (c) hire

purchase financing; (d) leasing financing; (e) housing loans; (f) personal &
education loans

Characteristics of finance companies :
(a) customer based, where the customers are mainly smaller businesses or
individuals, (b) they are not authorized to operate current accounts; and (c)

they are not permitted to involve in foreign exchange transactions

Banking Financial Intermediaries

Commercial Islamic Investment Finance
Banks Banks Banks Companies

Affin Bank Affin Islamic Alliance AmFinance
Alliance Bank Al Rajhi Investment Berhad
Am Bank Bank Islam Bank
CIMB Bank Muamalat AmInvestment Maybank
Citibank CIMB Islamic Bank Finance
Hong Leong Bank CIMB RHB-Delta
Bank Kuwait Finance Investment Finance
HSBC Bank House Bank
Maybank Maybank Islamic Kenangan
Public Bank Investment
RHB Bank Bank
Standard Maybank
Chartered Bank Investment
United Overseas Bank
Bank (UOB)

Non-Bank Financial
Intermediaries

To further enhance efficient Provident and pension funds
mobilization of funds in the Insurance companies
Development finance
financial system institutions
Savings institutions
Not only being supervised by
various Government departments Other non bank financial
and agencies, but also monitored by intermediaries
Central Bank of Malaysia under the

enactment of the Banking and
Financial Institutions Act 1989

(BAFIA)

Provident • Established to safeguard savings from members or
and contributors, and provide future benefits in the event of
retirement, death or disabilities.
Pension
Funds • These savings come from the monthly deduction of a
(PPF) certain % of member’s monthly income & a certain %
Insurance contributed by the employers
Companies
• Provide a significant source of financing to the government
& private sector.

• Ex : Employee Provident Fund (EPF), Pension Trust Fund,
Armed Forces Fund, Teachers Provident Fund.

• Most of the funds were used to invest in Malaysian
Government securities, equities, deposits and money
market and loans.

• Provide financial coverage to policyholders in the event of
death or loss of property,

• In order to get the coverage, a sum of money (or premium)
has to be paid by policyholders to the insurance
companies.

• This premium is considered as a form of savings by the
public.

• The insurance companies will then, besides paying out for
any claims made by the policyholders, use the pool of
funds to invest or lend it out to corporations or
government.

Development • Specialized institutions formed to promote and develop the
Finance industrial & agricultural sectors.

Institutions • DFIs not only provide medium and ling term financing but also
(DFIs) technical and managerial assistance.

• Ex : Agro Bank, Bank Pembangunan & Infrastruktur Malaysia
Berhad, Bank Industri & Teknologi Malaysia Berhad

• The sources of funds include borrowings from government and
multilateral/international agencies, deposits accepted & their own
shareholders fund.

• Majority of the funds were for loans and advances followed by
investment in government securities and share & deposits
placement.

• DFIs intermediary roles directly help in achieving the country’s
objective of promoting & assisting industrialization.

Saving • Being set up to promote and mobilize savings among
Institutions individuals especially from the lower income group.

• Also involved in the economic development by providing
loans to selected borrowers.

• Ex : Bank Simpanan Nasional
• Main source of funds are from the deposits of customers.

CENTRAL BANK

Central Bank is the entity MALAYSIA = Bank Negara Malaysia
responsible for the SINGAPORE = Monetary Authority
monetary policy of a
country. of Singapore
VIETNAM = State Bank of Vietnam

UK = Bank of England

Its primary responsibility is to Frequently termed the
maintain the stability of the “government’s bank” because it
national currency and money handles the buying and selling of

supply and thus, control inflation. government bonds and other
instruments of government

funding.

Acting as a lender of Has supervisory powers to ensure
last resort to the that banks and other financial
banking sector. institutions do not behave

recklessly or fraudulently. Thus, it
regulates the banking system.

REGULATORS

To enforce applicable laws, codes and norms & take appropriate
action in case of violation of such laws, codes & norms.

To formulate the required norms, codes of conduct, etc for the
sector

To license financial service providers to ensure that the institutions
have the capability to carry out the activities they want to undertake.

To maintain confidence in the financial system

Example (in Malaysia):
Insurance companies  Bank Negara Malaysia
Securities / tradeable instrument  Securities Commission (SC)

DPA30063
FINANCIAL
MANAGEMENT 1

TOPIC 2.2
FINANCIAL MARKET

BY :
PN. ROSMARIA BINTI ISMAIL

DEPARTMENT OF COMMERCE

COURSE CONTENTS

FINANCIAL Banks And Financial intermediaries
SYSTEM Financial Non-financial intermediaries
Institutions
Financial Central bank/regulators
Markets Role & types

Islamic Money markets and capital markets
Finance MM & CM instruments
System Purpose and basis
Principles used
Ethical aspects
Islamic finance industry

Financial Market

A financial market is a market in which Markets work by placing the two
people and entities can trade financial counterparts, buyers and sellers, at
one place so they can find each other
securities, commodities and other
fungible assets at prices that are easily, thus facilitating the deal
determined by pure supply and demand between them.

principles.

In financial market, financial assets Financial markets may be viewed as
(intangible appearance) are created or channels through which flow loanable
funds directed from a supplier who has
transferred.
an excess of assets toward a
demander who experiences a deficit of

funds.

As against a real transaction that Financial Assets or Financial
involves exchange of money for real Instruments represents a claim to the
payment of a sum of money sometime
goods or services, a financial in the future and /or periodic payment
transaction involves creation or
in the form of interest or dividend.
transfer of a financial asset.

To facilitate saving by • Offering a secure place to store money and
businesses and households earn interest

To lend to businesses and • Financial markets provide an intermediary
individuals between savers and borrowers

To allocate funds to productive • Financial markets allocate capital to where
uses the risk-adjusted rate of return is highest

To facilitate the final exchange • Such as contactless payments systems,
of goods and services foreign exchange etc

To provide forward markets in • Forward markets allow agents to insure
currencies and commodities against price volatility

To provide a market for • Allowing businesses to raise fresh equity to
equities fund their capital investment and expansion

Types of Financial
Market

FINANCIAL
MARKET

PRIMARY & DEBT, EQUITY & SPOT AND
SECONDARY DERIVATIVES FUTURE
MARKET MARKET
MARKET

PRIMARY MARKET SECONDARY MARKET

A primary market, or the so-called A secondary market, or the so-
“new issue market”, is where called “aftermarket” is the place

securities such as shares and bonds where investors purchase
are being created and traded for the previously issued securities such as
stocks, bonds, futures and options
first time without using any
intermediary such as an exchange in from other investors, rather from
issuing companies themselves.
the process.
When a private company decides to The secondary market is where the
become a publicly-traded entity, it bulk of exchange trading occurs and
issues and sells its stocks at a so-
it is what people are talking about
called Initial Public Offering. when they refer to the “stock
market”.

IPOs are a strictly regulated process It includes the Bursa Malaysia,
which is facilitated by investment NYSE, London Stock Exchange,
banks or finance syndicates of Tokyo Stock Exchange and all other

securities dealers that set a starting major exchanges.
price range and then oversee its
sale directly to the investors.

DEBT • Market where debt instruments are traded.
MARKET • They are borrowings either by the government or private

institutions.
• Ex : Treasury Bills & bonds, corporate bonds, commercial papers,

repurchase agreements.
• Interest-rate related securities as they are directly affected by the

movement in interest rates

EQUITY • Market where equities are traded.
MARKET • Many different types of equity securities. The most common one is
DERIVATIVES
MARKET common stock of a company.
• Holding of common stocks (by shareholders) represents ownership

of the firm.
• Other ex : preferred stocks, real estate investment trusts,

investment funds & exchange traded funds.

• Derivatives are securities where price is derived from one or more
underlying assets,

• It serves as a contract between two or more parties.
• The most common types of derivatives are commodities futures,

financial futures, forward contracts, options, stock, indices and
swaps.
• Derivatives play an important role in helping companies to manage
risk of the interest rates, currency exchange rates, and equity
markets.

The equity holders are the residual claimants: the firm must make
payments to its debt holders before making payments
to its equity holders.

Advantage to holders of debt Advantage to holders of equities:
instruments: • Receive larger payments when
• Receive fixed payments,
the business becomes more
regardless of whether the profitable or the value of its
borrower’s income and assets assets rises.
become more or less valuable Disadvantage to holders of
over time. equities:
Disadvantage to holders of debt • Receive smaller payments
instruments: when the business becomes
• Do not benefit from an less profitable or the value of
increase in the value of the its assets falls.
borrower’s income or assets.

SPOT MARKET FUTURE MARKET

Market where buyers & sellers Market where the contracting date
contract for the exchange of the defers from the delivery date.
assets to delivery immediately.

Sometimes, it may take more than a The terms & conditions for the
couple of days for the contract to be exchange are contracted at the t.
However, the date of delivery stated
cleared & settled. in the contract will be some time in

the future at time t + n.

Example :
Trading of the common shares of a firm is considered as an activity
in SECONDARY MARKET, the EQUITY MARKET, and the SPOT MARKET

Money & Capital Market

MONEY CAPITAL
MARKET MARKET

Only short-term debt Intermediate-term debt,
instruments are traded. long-term debt, and
equities traded.

Enables optimum liquidity Allow firms to source for
distribution among the external capital on longer

market participants to be horizons.
achieved.

 MM instruments are instruments that have time
to maturity of 1 year or shorter at the time of
issuance.

 These are call discount instruments as they do
not make interim payments, either in the form of
coupon payments or dividends.

 Investors will purchase the instrument at a
discounted price that is less than the par value.

 At maturity, they will be paid at par & hence the
return they earn will be the difference between
the par and the price at which they bought the
asset.

Example :

An investor bought 90-day T-bill for RM950. In 90
days, the T-bill will mature & he will be paid the
par of RM1,000.
So....what is the DISCOUNT YIELD??

Discount yield = [(par – price) / par] x [T/t]
= [(RM1,000 – RM950) / RM1,000] x [360 / 90]
= 20%

The investor receives an absolute return of RM50, which is 5% of the
par value of T-bill; earned over a 3-month period.
= 20% annualised return !

Money Market Instruments

Discount Windows & Fed
Funds

When member banks are in need of funds which they are not
able to source them from anywhere else, they have a last option

of borrowing from the central bank  DISCOUNT WINDOW
The Federal Reserve Bank (Fed) will lend the funds to the banks

at a discounted rate.
Bank will avoid borrowing from Central Bank  such
borrowings carry a stigma as it means that the bank is unable to
borrow from any other sources & has run out of options.
It is mandatory for the banks to maintain certain amount of cash
deposits at the Central Bank  MINIMUM CASH BALANCE

Money Market Instruments

Treasury Bills Certificate of Deposits

Short term borrowing by the central or Also called as fixed deposits, term
federal government of the country. deposits, or time deposits.
Terms on the bill can be 3, 6. 9 or 12 These are basically certificates issued
months. by banks as a documentation of cash
deposits placed in a bank.
G issues T-bills for various reasons. Such deposits are for specific maturity
horizons & carry higher interest.
Most G borrow to fund their budget
deficits. Most of CDs are non-negotiable.
T-bills are considered as the best form
of liquid assets, beside cash deposits.

G may still issue T-bills even though they do
not have any real need to borrow  as a
second buffer against sudden surge.

Money Market Instruments

Repurchase Commercial
Agreements Papers

Institutions can acquire immediately funds by selling Short term unsecured promissory notes
securities & simultaneously agreeing to repurchase issued by corporations & foreign governments.
the same or similar securities after a specified time &
at specified price.

The price is usually computed as the value of Issued by the borrowing party to the lending
the securities plus an interest. party, promising to repay the loans made to
them.

Most repos are on overnight basis. By unsecured, it means that there is no
collateral pledge for such borrowings.

Normally the ownerships of the securities are Only very reputable borrowers can have
transferred to the buyer in repo. access to such sources of funds.

However any coupon paid during the period of
repo, especially for those with longer term,
will still belong to the seller.

Capital Market Instruments

Debt Bonds Level coupon bonds
Instruments Perpetual bonds
Common Callable bonds
Equity stocks Convertible bonds
Instruments
Preference Floating rate bonds
stocks Zero coupon bonds

Investment Eurobonds
funds Asian dollar bonds

Foreign bonds
Domestic bonds

Exchange traded funds

Real estate investment trusts
(REITs)

 Capital market debt securities (bonds) pay interest
periodically.

 Bond market participants include :
 Issuers  governemnts or private institutions
 Investors  institutional or retail
 Traders

 Each bond has specific risk profile, and has returns to
match the risks & market conditions.

 New issuance of bonds are sold into primary markets &
the issuer of the bond receives the money from the selling
intermediary, i.e : investment banks.

 Investors who have acquired the bonds at issue can sell
it before maturity in the secondary markets.

LEVEL COUPON ZERO-COUPON EUROBONDS
BONDS BONDS
• Bonds issued and sold
• Have fixed coupon rates • Pure discount bond  outside the country of
do not make any coupon the currency in which
PERPETUAL payments & hence are they are denominated.
BONDS sold at a deep discount.
FOREIGN BONDS
• Have no maturity date FLOATING RATE
BONDS • Bonds which a foreign
CALLABLE BONDS issuer issued the bonds
• Have coupon rates that in the country of the
• Give the issuer the right are pegged to some currency they are
to call back the bond interest rate denominated.
before maturity. benchmarks & hence
are adjustable. DOMESTIC BONDS

CONVERTIBLE • Bonds which the market
BONDS where they issued is the
country of the currency
• Allows bondholder to they are denominated in
convert the bonds into and issuer is local firm.
common equities of the
issuing firm.

 Also known as Variable Income Market as it
deals with variable payments on dividend and
share prices.

 Can be categorized into:

 DIRECT INVESTMENT - direct investment in the
stock market (Bursa Malaysia)

 INDIRECT INVESTMENT – through fund managers
in the unit trust market

Common Stocks

Also known as ORDINARY SHARES – represent ownership of the firm
Though shareholders are owner of the firm, but they do not participate in the

daily running of the firm.
Shareholders elect the Board of Directors who will in turn watch over the

managers as the run the firm.
CS come with voting rights  CSH exercise this right once a year during the

AGM.
(1) Claims to dividends – when the firm makes a net profit, the managers can

choose to retain the profits or pay part of it to shareholder as dividend.
(2) Claims on liquidation value of the firm – equity holders are among the last

to be paid , if they get to be paid at all.

Preference Stocks

Preferred to Common Shares in terms of the order claims for both dividends
& liquidation value.

The amount of dividends payable to PSH is fixed  have to be paid to PSH
before the CSH receive any dividends.

In the event of liquidation, PSH are ranked just above the CSH in terms of
priority to claim.

PSH do not have voting rights.

Cumulative PS : unpaid dividends will be added to & paid with the following year’s
dividend

Non-cumulative PS : will not enjoy such accumulation of unpaid dividends.
Non-participative PS : will get nothing more that the stipulated preferred dividends.

Participative PS : may enjoy higher dividends than normal stipulated amount.

INVESTMENT FUNDS

Convenient way for a small retail investor to invest –pool funds from
many investors to invest in a large portfolio of financial assets.

Mutual Funds Unit Trusts

Open ended fund, managed actively by Similar to close end funds in
fund managers, these funds sell an that the no. of units of certificate
unlimited no. of shares ton investors
directly or through a brokerage firm. is fixed.

They will sell shares to & buy Once the fund is fully subscribed, the assets
shares back from investors at the invested will be placed with a trustee or a
custodian institution.
net asset value

Close ended fund – these funds sell a Normally will have either a fixed
limited no. of shares, normally through IPO. termination date or certain return target,
which when reached, the trust will dissolve
Once issued, these funds can be traded
among the investors. & the money returned to the investors.

Exchange Traded Real Estate Investment
Funds (ETFs) Trusts (REITs)

Hybrid of open-ended and Investment trust that raise
closed-ended investment capital to purchase,

funds. primarily real estate asset.
Open ended – no limit to
the no. of units bought & If more funds are needed to
purchase more assets, they will
sold have to raise it either by issuing
Closed ended – can be more shares or tap into the debt
traded like a stock in an
market.
exchange. Investors of REITs will normally
receive more dividends at more
regular intervals compared to CS
 provide more stable source of

income for investors.

DPA30063
FINANCIAL
MANAGEMENT 1

TOPIC 2.3
ISLAMIC FINANCE SYSTEM

BY :
PN. ROSMARIA BINTI ISMAIL

DEPARTMENT OF COMMERCE

COURSE CONTENTS

FINANCIAL Banks And Financial intermediaries
SYSTEM Financial Non-financial intermediaries
Institutions
Financial Central bank/regulators
Markets Role & types

Islamic Money markets and capital markets
Finance MM & CM instruments
System Purpose and basis
Principles used
Ethical aspects
Islamic finance industry

Purpose and Basis of
Islamic Finance

Islamic finance is a financial system that
operates according to Islamic law (which is
called shariah) and is, therefore, shariah-
compliant.

Just like conventional financial systems,
Islamic finance features banks, capital
markets, fund managers, investment firms,
and insurance companies.

However, these entities are governed both by
Islamic law and the finance industry rules and
regulations that apply to their conventional
counterparts.

Purpose and Basis of
Islamic Finance

Islamic economics is based on core concepts of balance,
which help ensure that the motives and objectives driving

the Islamic finance industry are beneficial to society.

Balancing material pursuits and spiritual needs: In Islam, economic activity conducted according
to sharia is, itself, an act of worship. Muslims believe they will be granted rewards or merits for
sharia-compliant economic activities just as they’re rewarded for worshipping Allah (God). The
key to achieving such rewards is to find balance between economic activities and spirituality. In

other words, a follower of the faith shouldn’t focus on business success so much that he
neglects worship, for example.

Balancing individual and social needs: A Muslim is expected to consider society
in general when enjoying the bounties granted to her by Allah. These

considerations include promoting justice in all economic activities, remembering
that all people have mutual responsibility for all others, and using the earth’s
resources wisely.

Purpose and Basis of
Islamic Finance

The modern It may seem However, while
financial that a financial Shariah may
system is based institution that not allow for
on interest is devoid of interest, it
which is interest is allows for other
forbidden in devoid of a forms of
Shariah or source of remuneration
Islamic Law. income. like profit
sharing,
leasing, etc.