FINM1001: Foundations of Finance

Tutorial 1 Solutions
Question One
What are the primary roles of financial markets?
The primary roles of financial markets are:
To bring together lenders and borrowers (via the money and capital markets).
In doing this, the financial markets assist in transferring funds between people
who have more than they wish to consume now (lenders) and those who have
less than they wish to consume or invest now (borrowers);
To facilitate the transference of risk (via the derivatives market); and,
To facilitate international trade (via the foreign exchange market).
Question Two
Describe the flow of funds within the financial system.
Lenders loan funds that are excess to their consumption requirements to other market
participants, namely borrowers. In exchange for doing this, they receive a positive
rate of return on funds lent from the people they lend them to.
Borrowers borrow funds that are required to meet their current consumption and / or
investment requirements. In exchange for borrowing these funds, borrowers pay a
positive rate of return on borrowed funds to the people they borrowed from.
Diagrammatically, we can depict the flow of funds as follows:

Lenders: Have surplus of funds and

are suppliers of funds

Borrowers: Have deficit of funds

and are demanders of funds

Examples of Lenders:
Individuals (foreign and domestic)
Companies (foreign and domestic)
Governments (foreign and domestic)

Examples of Borrowers:
Individuals (foreign and domestic)
Companies (foreign and domestic)
Governments (foreign and domestic)

Give $

Receive $

Receive financial
instruments

Issue financial
instruments

Financial Markets
Source: Based on a diagram from Viney, C., McGraths Financial Institutions, Instruments and Markets, 5th Edition.

FINM1001: Foundations of Finance

Question Three
What is the difference between a primary market and a secondary market?
Primary markets are those in which newly issued instruments are traded. Conversely,
the trading of existing instruments is executed in the secondary market. It is
important to note that primary market transactions raise funds for the issuer, whereas
secondary market transactions simply represent a transferring of ownership from one
holder to another. Therefore, the latter do not raise any additional funds for entity that
originally issued the instrument.
Question Four
Discuss the main differences between money markets and capital markets.
The term money markets encompasses all markets where instruments that mature in 1
year or less are traded. Conversely, the term capital markets is used to describe all
markets where instruments maturing in more than 1 year are traded.
Question Five
Name and describe the markets that are collectively referred to as capital markets.
As discussed in Question four, capital markets are all financial markets where
instruments maturing in more than 1 year are traded. More specifically, capital
markets encompass all markets that that trade in medium-to-long term debt
instruments, including corporate and government debt, and equity, including ordinary
and preference shares.
Question Six
What is the intercompany market? Is it regarded as a money market or a capital
market?
The intercompany involves direct lending between companies. The supply of funds in
the intercompany market comes from companies that have cash flows surplus to their
current requirements. The demand for funds comes from companies who do not have
cash flows sufficient to meet their current obligations. Given the nature of trading
within the market, it is regarded as an example of a money market.

FINM1001: Foundations of Finance

Question Seven
What does the term professionalism mean to you, and why is it important?
I. PROFESSIONALISM
A. Knowledge of the Law. Members and Candidates must understand and comply
with all applicable laws, rules, and regulations (including the CFA Institute Code of
Ethics and Standards of Professional Conduct) of any government, regulatory
organization, licensing agency, or professional association governing their
professional activities. In the event of conflict, Members and Candidates must comply
with the more strict law, rule, or regulation. Members and Candidates must not
knowingly participate or assist in and must dissociate from any violation of such laws,
rules, or regulations.
B. Independence and Objectivity. Members and Candidates must use reasonable care
and judgment to achieve and maintain independence and objectivity in their
professional activities. Members and Candidates must not offer, solicit, or accept any
gift, benefit, compensation, or consideration that reasonably could be expected to
compromise their own or anothers independence and objectivity.
C. Misrepresentation. Members and Candidates must not knowingly make any
misrepresentations relating to investment analysis, recommendations, actions, or other
professional activities.
D. Misconduct. Members and Candidates must not engage in any professional
conduct involving dishonesty, fraud, or deceit or commit any act that reflects
adversely on their professional reputation, integrity, or competence.

Textbook Questions
3-2 (p.22)
Which are the three major groups of players that interact in the financial markets?
Briefly describe them.

Borrowers: Those who need money to finance their purchases, including
businesses and individuals.

Lenders or investors: Those who have money to invest; principally individuals
who save money for a variety of reasons, and also firms with excess cash.

Financial intermediaries: Financial institutions and markets that help bring
borrowers and lenders together.

3-3 (p.22)
Define in a technical sense what is meant by a financial intermediary. Give an
example.
A financial intermediary is a key player that helps bring borrowers and lenders
together. Examples of financial intermediaries include: commercial banks (in
Australia: NAB, Commonwealth Bank, etc); credit unions; investment banks, etc.