Week 1 Chapter 2

Financial
Markets and
Institutions
Chapter 2 Overview of the
Financial Markets
Outlines
1. Function of Financial Markets
2. Structure of Financial Markets
3. Internationalization of Financial Markets

4. Indirect Finance – Financial Intermediaries
 Types of Financial Intermediaries
 Function of Financial Intermediaries
5. Regulation of the Financial System
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
1. Function of Financial Markets
• Produce an efficient allocation of capital, allowing funds to move
from people who lack productive investment opportunities to people
who have them.
• Facilitate mobilization of savings and puts it to the most
productive uses, thus, improves economic efficiency.
• Improve the well-being of consumers, allowing them to time
their purchases better.
• Tạo ra sự phân bổ vốn hiệu quả, cho phép tiền chuyển từ những
người thiếu cơ hội đầu tư hiệu quả sang những người có chúng.
• Tạo điều kiện huy động tiết kiệm và sử dụng có hiệu quả nhất, nâng
cao hiệu quả kinh tế.
• Cải thiện sức khỏe của người tiêu dùng, cho phép họ sắp xếp thời
gian mua hàng tốt hơn.
Importance of Financial Markets (2 of 2)
• Help in determining the price of the securities (bonds,
stocks) and exchange rates. The frequent interaction
between investors helps in fixing the price of securities and
exchange rates, on the basis of their demand and supply in
the market.
• Provide liquidity to tradable assets, by facilitating the
exchange, as the investors can readily sell their securities
and convert assets into cash.
• Save the time, money and efforts of the parties, as they
don’t have to waste resources to find probable buyers or
sellers of securities. Reduce cost by providing valuable
information, regarding the securities traded in the financial
market.
Structure of Financial Markets
Financial Markets are classified by:
• Maturity of claims
– Money/capital markets
• Trading features
– Primary/Secondary markets
• Nature of claims
– Debt/equity markets
• Timing of delivery
– Cash/future market
• Organizational structure
– Exchange traded/OTC market
• Fund channeling:
– Direct/Indirect Finances
Maturity of claim
1. Money Market:
• The market where monetary assets (debt instruments) such
as commercial paper, treasury bills, etc. which mature within
a year, are traded.
• The market for short-term funds.
• No physical market; the transactions are performed over a
virtual network, i.e. fax, platform, internet or phone.
2. Capital Market: The market where medium and long

term financial assets (both debt and equity instruments) are
traded.
Trading features (applied to capital market only)
1. Primary Market
─ New security issues sold to initial buyers (newly listed
company issues for the first time or already listed
company brings the fresh issue)
─ Typically involves an investment bank who underwrites
the offering
2. Secondary Market
─ Securities previously issued are bought and sold
─ Involves both brokers and dealers (difference?)
─ Do the firm (issuer) get any money from this market?
─ It serves two important functions:
• Provides liquidity, making it easy to buy and sell the securities of the
companies
• Establishes a price for the securities (useful for company valuation)
Nature of claims
1. Debt Markets
─ Through loans and bond issuances, pay interests and principle
1year 10 years
Short-Term Medium term Long-Term
2. Equity Markets
─ Pay dividends, in theory forever
─ Represents an ownership claim in the firm
US market:
Debt/Equity market: 60:40
VN market:
Debt/Equity market:70:30
Timing of delivery
1. Cash Market:
The market where the transaction between buyers and sellers
are settled in real time.
2. Futures Market:
Futures market is one where the delivery or settlement of
commodities takes place at a future specified date.
Organizational structure
(applied to secondary market only)
1. Exchanges
─ Trades conducted in central
locations (e.g., New York
Stock Exchange, Hanoi stock
exchange,…)
─ Organized exchanges
2. Over-the-Counter
Markets
─ Dealers at different locations
buy and sell
─ Best example is the market
for Treasury
Securities/corporation bonds
(Why?)
Structures of Financial Markets
Fund channeling
Indirect Finance Borrowers borrow indirectly from lenders via financial
intermediaries
Direct Finance Borrowers borrow directly from lenders in financial

markets Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Internationalization of Financial Markets
 Foreign bond
• is issued in a domestic market by a foreign issuer in the currency of
the domestic country.
• For example, a bond that is issued in Canada and valued in Canadian
dollars by a non-Canadian company (Maple bond). Other
examples: Samurai bond (Japan), Matador bond (Spain), Yankee bond
(US), Bulldog bond (UK), kangaroo or Matilda bonds (Australia), etc.
• Exchange rate and interest rate risks
 Eurobond is denominated in a currency other than the home currency of

the country or market in which it is issued.
• For example: Chinese bank held yen-denominated bonds issued by a
American company in US (Euroyen bond). Dollar-denominated bonds
issued in Singapore market by a Vietnamese company
 Eurocurrency Market
• Foreign currency deposited outside of home country
• Eurodollars are U.S. dollars deposited in, say, London (Gives U.S.
borrowers an alternative source for dollars).
Internationalization of Financial Markets
> FOLLOWING THE FINANCIAL NEWS
Foreign Stock Market Indexes
Foreign stock market indexes are published FTSE 100 An index of the 100 most highly
daily in newspapers and Internet sites such as capitalized UK companies listed on the London
www.finance.yahoo.com. Stock Exchange.
The most important of these stock market DAX An index of the 30 largest German
indices are: companies trading on the Frankfurt Stock
Dow Jones Industrial Average (DJIA) An Exchange.
index of the 30 largest publicly traded CAC 40 An index of the largest 40 French
corporations in the United States maintained by companies traded on Euronext Paris.
the Dow Jones Corporation. Hang Seng An index of the largest companies
S&P 500 An index of 500 of the largest traded on the Hong Kong stock markets.
companies traded in the United States Strait Times An index of the largest 30
maintained by Standard & Poor’s. companies traded on the Singapore Exchange.
Nasdaq Composite An index for all the stocks
that trade on the Nasdaq stock market, where
most of the technology stocks in the United
States are traded.
3. Indirect Finance – Financial Intermediaries
Types of Financial Intermediaries

Function of Financial Intermediaries
The top part of Figure —Indirect Finance.
Table 2.1 Primary Assets and Liabilities of Financial
Intermediaries (3 of 3)
Vietnam Financial Institution:
Banking System
• BANKS: • NON-BANK CREDIT
INSTITUTIONS: 26
- 7 state-owned banks (incl. - 16 financial

3 largest ones with major companies (10/6)
state ownership)
- 28 joint-stock banks - 11 financial
leasing
- 9 foreign-owned banks companies.(9/2)
- 2 joint-venture banks
- 2 Policy banks
- 1 Co-operative Bank.
• PEOPLE’S • MICRO
CREDIT INS.: FINANCE
• FOREIGN BANK BRANCHES: 50 1181 INS. 4
Function of Financial
Intermediaries: Indirect Finance
• More important source of finance than securities
markets (such as stocks)
– Studies show that firms in the U.S., Canada, the U.K., and other
developed nations usually obtain funds from financial
intermediaries, not directly from capital markets.
– In Germany and Japan, financing from financial intermediaries
exceeds capital market financing 10-fold.
– However, the relative use of bonds versus equity does differ by
country.
– Vietnam: source of capital from FIs more than double that from
equity market
• Why FIs are so important?
Function of Financial
Intermediaries: Indirect Finance
 Lower Transactions Costs
• FIs develop expertise and take advantage of economies of scale/scope
 Provide liquidity services

• Banks provide depositors with checking accounts that enable them to
pay their bills easily
• Depositors can earn interest on checking and savings accounts and yet
still convert them into goods and services
 Reduce the exposure of investors to risk (risk sharing)
• Diversification (invest in a collection of assets – portfolio- whose
returns do not always move together =>lower overall risk)
 Reduce the impact of asymmetric information.

• One party lacks crucial information about another party, impacting
decision-making.
Economies of Scope vs Economies of Scale
• Economy of scope and economy of scale are two

different concepts used to help cut a company's costs.
• Economies of scope focuses on the average total
cost of production of a variety of goods. Average total
cost of a company's production decreases when there
is an increasing variety of goods produced.
• Economies of scale focuses on the cost advantage
that arises when there is a higher level of production
of one good.
Economies of Scope and Conflicts of
Interest
• FIs are able to lower the production cost of

information by using the information for multiple
services: bank accounts, loans, auto insurance,
retirement savings, etc. This is called economies of
scope.
• But, providing multiple services may lead to conflicts
of interest, perhaps causing one area of the FI to
hide or conceal information from another area (or the
economy as a whole). This may actually make
financial markets less efficient!
4. Regulation of Financial System
Main Reasons for
Regulation
1. Increase
Information to
Investors
2. Ensure the
Soundness of
Financial
Intermediaries
Regulation Reason: Increase Investor
Information
• Asymmetric information in financial markets means that
investors may be subject to adverse selection and moral
hazard problems that may hinder the efficient operation of
financial markets.
• The Securities and Exchange Commission (SEC) requires
corporations issuing securities to disclose certain information
about their sales, assets, and earnings to the public and
restricts trading by the largest stockholders (known as
insiders) in the corporation.
• Such government regulation can reduce adverse selection
and moral hazard problems in financial markets and increase
their efficiency by increasing the amount of information
available to investors, pursuing illegal insider trading.
Regulation Reason: Ensure Soundness of
Financial Intermediaries (1 of 2)
• Providers of funds (depositors) to financial
intermediaries may not be able to assess whether
the institutions holding their funds are sound or
not.
• If they have doubts about the overall health of
financial intermediaries, they may want to pull their
funds out of both sound and unsound institutions,
which can lead to a financial panic.
• Such panics produces large losses for the public
and causes serious damage to the economy.
Regulation Reason: Ensure Soundness of
Financial Intermediaries (2 of 2)
• To protect the public and the economy from
financial panics, the government has implemented
six types of regulations:
─ Restrictions on Entry
─ Information Disclosure
─ Restrictions on Assets and Activities
─ Deposit Insurance
─ Limits on Competition
─ Restrictions on Interest Rates
Regulation: Restriction on Entry
• Restrictions on Entry
─ Regulators have created tight regulations as to who is
allowed to set up a financial intermediary
─ Individuals or groups that want to establish a
financial intermediary, such as a bank or an insurance
company, must obtain a charter from the state or the
federal government
─ Only if they are upstanding citizens with impeccable
credentials and a large amount of initial funds will they be
given a charter
Regulation: Disclosure
• There are stringent reporting requirements for
financial intermediaries
─ Their bookkeeping must follow certain strict principles
─ Their books are subject to periodic inspection
─ They must make certain information available to
the public
Regulation: Restriction on Assets and
Activities
• There are restrictions on what financial
intermediaries are allowed to do and what assets
they can hold
• Before you put your funds into a bank or some
other similar institution, you want to know that
your funds are safe and that the financial
intermediary will be able to meet its obligations to
you
Regulation: Restriction on Assets and
Activities (2 of 2)
• One way of doing this is to restrict the financial
intermediary from engaging in certain risky
activities
• Another way is to restrict financial intermediaries
from holding certain risky assets, or at least from
holding a greater quantity of these risky assets
than is prudent
• Basel II and CAR (Capital Adequacy Ratio): capital-
to-risk weighted assets ratio is used to protect depositors and
promote the stability and efficiency of financial systems
around the world
Regulation: Deposit Insurance (1 of 2)
• The government can insure people’s deposits to a
financial intermediary from any financial loss if the
financial intermediary should fail
• The Federal Deposit Insurance Corporation (FDIC)
insures each depositor at a commercial bank or
mutual savings bank up to a loss of $250,000 per
account
• Vietnam: Deposit Insurance of Vietnam: 75 million VND per
depositor in a bank
Regulation: Limits on Competition
• Evidence is weak showing that competition among
financial intermediaries promotes failures that will
harm the public. However, such evidence has not
stopped the state and federal governments from
imposing many restrictive regulations.
• In the past, banks were not allowed to open
branches in other states, and in some states banks
were restricted from opening additional locations.
Regulation: Restrictions on Interest Rates
• Competition has also been inhibited by regulations
that impose restrictions on interest rates that can
be paid on deposits
• These regulations were instituted because of the
widespread belief that unrestricted interest-rate
competition helped encourage bank failures during
the Great Depression
• Later evidence did not support this view, and
restrictions on interest rates have been abolished
• Vietnam: Cap on short term deposit (3 months),
one kind of limits on competition. Too many small
banks may spoil the market .
Chapter Summary
• Function of Financial Markets: the flow of funds through the
financial system and the role of intermediaries in this process.
• Structure of Financial Markets: market structure from
several perspectives, including types of instruments, purpose,
organization, and time horizon.
• Internationalization of Financial Markets: how debt and
equity markets have expanded in the international setting.
• Function of Financial Intermediaries: the roles of
intermediaries in reducing transaction costs, sharing risk, and
reducing information problems.
• Types of Financial Intermediaries: the numerous types of
financial intermediaries to be further examined in later chapters.
• Regulation of the Financial System: something that you
must be aware of when doing business because it may cost you
a fortune if you breach the law and regulations.

Week 1 Chapter 2

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Week 1 Chapter 2

Uploaded by

Copyright:

Available Formats

Financial

2. Structure of Financial Markets

3. Internationalization of Financial Markets

5. Regulation of the Financial System

2. Capital Market: The market where medium and long

Short-Term Medium term Long-Term

Direct Finance Borrowers borrow directly from lenders in financial

 Eurobond is denominated in a currency other than the home currency of

Types of Financial Intermediaries

- 7 state-owned banks (incl. - 16 financial

• Why FIs are so important?

 Provide liquidity services

 Reduce the impact of asymmetric information.

• Economy of scope and economy of scale are two

• FIs are able to lower the production cost of

You might also like