Study plan:
- Picture from van Horne (1978) about financial system
- what is pictured?
- what is an arrow?
- How we can simplifiy this chart?
- 4 sectors, can ignore governement
- put birth of sectors in a perspective
- Can we add anything to this chart?
- governance links
- claims vs flows
- How can one quantify this chart?
- use "Flow of Funds" statistics
- compare across geographies
- Find something new
- what is missing from a flow of funds stats
+++ Dark ages +++
Goods and services <~ Households
+++ Limited libility, birth of corporations +++
Goods and services <~ Business Firms <- Households
+++ Equity and debt +++
Goods and services <~ Business Firms <- Equity holders (business owners)
<- Debt holders (creditors)
+++ Finacial intermediaries +++
- Why they emerge?
- What is their position is stable?
<------------------------------------------- Households
Real markets <~ Business Firms
<------ Financial Intermediary <----- Households
- banks (depositary institutions)
- non-banks:
- insurance companies and pension funds
- other non-banks (funds, trust, etc)
+++ Securities markets +++
- stocks
- bonds
+++ Anything to add +++
- corporate governance
- household finances
- "net worth"
Useful skill:
- distiguish between stocks (levels, exposures), flows (transactions) and valuation changes
- roll-forward: stock t1 = stock t0 + transactions + valuation changes
- balance sheet, P&L and cashflow - which is stock and which is flow
Statistics:
-
Flow of Funds Overview of Japan, the United States, and the Euro area
-
US Flow of Funds (Z1):
-
table: https://www.federalreserve.gov/releases/z1/20210610/z1.pdf
-
EU:
What is missing from flow of funds?
- duration, term structure
- pricing information (interest rates, stock prices)
- composition by currency
- market microstructure, company names (sector-level only)
- any real-time information (this is lagging statistics)
- credit better reflected than equity
- off-balance sheet items (eg guarantees, open credit lines)
- derivatives and complex instruments
- reasons why flow change, drivers
Not meant to include:
- not well suited to display monetary transmision mechanisms
- not real economy transactions (income generation)
Book:
- Financial Market Rates and Flows Subsequent Edition by James C. Van Horne (1978), chapter 1 and 2.
- See also other free "historic textbooks" https://www.afajof.org/wp-content/uploads/files/historical-texts/
More reading:
- Economist (2016) on limited liability
- https://faculty.fuqua.duke.edu/~charvey/Research/Published_Papers/P131_The_scientific_outlook.pdf
- https://www.yardeni.com/pub/fofchrt.pdf
Learning objectives:
- identify counterparties of the largest financial flows/exposures - who owes whom how much
- distinguish between bank-based and market-based financial system
- identify and prioritise sources of finance for corporationis in non-financial sector
- estimate leverage in non-financial and financial sector
- identify information missing from flow of funds statistics
Uses:
- financial stability
- diversity of financial system (many instruments, several sectors)
- structure of financial system
- national vs foreign sectors
Excercises:
-
If you were writing a finance dictionary, what terms and concepts would you include?
-
Using flow of funds can you demonstrate US is a market-based financial system and EU is bank-based?
-
Is there any irregularity in flow of funds statistics that you find? Something that is hard to explain or unxpected?
Please put your anwers here:
