FINANCIAL INSTITUTIONS AND

INVESTMENT MANAGEMENT

COURSE INSTRUCTOR : Biruk Ayalew (PhD)

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CHAPTER ONE
PART I

OVERVIEW OF FINANCIAL SYSTEM

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 QUESTION TIME
Which One Is Not The Features Of Financial System?

A. Provides An Ideal Linkage Between Depositors and

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Introduction
● It is through a country’s financial system that entities with funds allocate
those funds to those who have potentially more productive ways to
deploy those funds, potentially leading to faster growth for a country’s
economy.
● A financial system makes possible a more efficient transfer of funds by
overcoming the information asymmetry problem between those with
funds to invest and those needing funds.

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 QUESTION TIME
Financial Instruments That Have The Characteristics Of
Both Debt and Equity Instrument?

A. Debt Instruments
B. Equity Instruments
C. Preferred stock Instruments
D. CREDITS:
All Of The Above
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Definition of Financial system
● Financial system is a system that aims at establishing and providing a
regular, smooth, effective and efficient linkage between depositors and
investors.
● Financial system is a set of complex and closely connected institutions,
agents, practices, markets, transactions, claims and liabilities relating to
financial aspects of an economy.
● Financial system is a system that comprises the interaction between
financial institutions, financial market and participant in an
attempt to transfer funds from savers to borrowers using
financial instrument.

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Features of Financial System
● Financial system provides an ideal linkage between depositors and
investors. →It encourages savings and investment.
● Financial system facilitates expansion of financial markets over space and
time.
● Financial system promotes efficient allocation of financial resources for
socially desirable and economically productive purposes.
● Financial system influences both the quality and the pace of economic
development.

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Financial Concepts
● An understanding of the financial system requires an understanding of the
following important concepts.
o Financial asset / financial instruments
o Financial intermediaries
o Financial market

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[Link] Assets
● Financial assets are claims against the assets or resources of other
economic units and are held as a store of value and for the return that is
expected.
● A financial asset is a claim on a stream of income and/or a claim on a
particular asset.
● The entity (or the economic unit) that offers the future cash flows is the
issuer of the financial instrument; and the owner (holder) of the security is
the investor.

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Kinds/Classification of Financial Assets
● Although the diverse kinds of securities created and/or issued whenever
money is borrowed and lent in the financial system constitute what we call
financial assets, there are three basic forms within which all of these
instruments can be categorized. These are:
1. money
2. equity, and
3. debt securities.

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Characteristics of Financial Assets
● They are promises to future returns to their owners.
● They serve as a store of value/store of purchasing power.
● They cannot be depreciated or do not wear & tear over time. Moreover,
their physical condition is not relevant in determining their market value.

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Cont’d
● They are represented by a piece of paper that serves as a contract.
● They do have little and/or no value as a commodity.
● They do have low (or minimal) transport & storage costs relative to their
value.
● They are fungible, that is, easily changed inform

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Debt vs. Equity Instruments
● A financial instrument can be classified by the type of claims that the
investor has on the issuer.
● A financial instrument in which the issuer agrees to pay the investor
interest plus repay the amount borrowed is a debt instrument.
● The interest payments that must be made by the issuer are fixed
contractually. The key point is that the investor in a debt instrument can
realize no more than the contractual amount. For this reason, debt
instruments are often referred to as fixed income instruments.

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Cont’d
● In contrast to a debt obligation, an equity instrument specifies that the
issuer pay the investor an amount based on earnings, if any, after the
obligations that the issuer is required to make to investors of the firm’s
debt instruments have been paid.
● Some financial instruments fall into both categories in terms of their
attributes. Preferred stock and convertible bonds are an example. These
financial instruments have the characteristics of both debt and equity
instrument.

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Role of Financial Asset
● Financial assets serve two principal economic functions.
1. They allow the transference of funds from those entities who have surplus
funds to invest to those who need funds to invest in tangible assets.
2. Risk diversification

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DISCUSSION POINT
● Discuss the what financial system mean and
Features of Financial System?

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THANK YOU!

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