Introduction To Financial Markets

CHAPTER
Introduction to
Financial Markets
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Slide 2
Week 1- intro
Class attendance encouraged F2F

 If you are permitted you are encouraged to
attend class in person
 If you are not allowed, please email lecturer at
bizzrh@nus.edu.sg (in the email in the subject
FIN3103B/FIN3703B: Financial Markets
line should clearly indicate section number and

attendance issue: B1 absence (medical/covid
etc) or B1 missing class (medical/covid etc)
Lecture: Introduction to FIs and their role in economy

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Slide 3
Week 1- intro
Class Attendance marking

 Class attendance through system, scan QR
code for each session to mark attendance, and
make sure lecturer / TA recorded your
attendance photographically as well.
 Please try not switch seats during one session

(can change for next session)

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Slide 4
Week 1- intro
Financial Markets Course

After this introduction to Financial markets, you’ll be able to :
 Differentiate across the various types of institutions,
• understand their key roles and activities in the economy and societ
 Understand the role of the different types of financial assets
• from fundraising, investment and wealth preservation perspectives
in regulated and unregulated financial markets;

 Able to identify the most suitable financial assets
• for specific financing and investment needs contingent upon
financial development and regulatory oversight;
 Critically evaluate the financial regulatory frameworks and perform
quantitative analysis on valuation, trading strategies, and risk
management for the major classes of financial assets.
For more detailed description of topic read the syllabus

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Slide 5
Week 1- intro
Brief topic outline for the course

Mishkin &
Week Topics Eakin Yeo
1 Introduction to financial markets and financial institutions, 1 & 2, 8 1,
FIs/ Ethics / Islamic finance* 8
2-4 Financial institutions: Incumbents and FinTech 7-8, 20-22 2
challengers)
4-5 Market regulations, Bank risk management 9, 17-19, 23 3
6 Interest rates & debt market, interest rate management 3-5, 11-12 4
Recess week 19/09/2021 – 26/09/2021)

7 Class discussion on monetary policies, review Extra reading
Midterm test, tentatively Wednesday 7-9 PM.
8 Equity markets, equity asset class and more 13 5
9 Forex market, currencies 15-16 6
10 New alternative assets, new currencies, hybrid assets Extra reading
11 Derivatives markets, derivative platforms 24 7
12 Term test no regular class (project video submissions due!)
Term test date is TBA on LumiNUS, tentatively Wednesday 7-9
13 Project elevator pitch presentations and Q&As

For more detailed description of topic read the syllabus
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Slide 6
Week 1- intro
Class test dates cannot be changed

 Please try to be available Wednesdays 7-9 PM in week 7 and
12. We may push test later to 7:30 but no later than that.
 I am trying to book classrooms for these timings and as
soon as possible timing is fixed.
 Why Wednesday timing?

 To help your workload to be spread more evenly. Normally many tests
are scheduled for Saturday, there are lots of conflict generally with
Saturday tests and / or students often have to take 3 tests on a same
day.
 If you cannot make these dates there are other sectionals with
different timings.
6 Lecture: Introduction to FIs and their role in economy

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Slide 7
Week 1- intro
Class Assessment
 Assessment
 Class participation (online & in class) 15%
 Term project 35%

 Midterm 20%
 Term test (or second test) 30%
Total 100%
 Plagiarism is taken seriously as well as cheating. Student will
fail class and there may be other disciplinary actions.

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Slide 8
Week 1- intro
Class participation & Group projects
 In class and online participation both expected. For each

class topic discussion threads will be posted.
 The class is big, try not to get lost in online thread, just
comment on your own, and contribute to ongoing

conversation.
 Group projects are group works. This group project
submissions have many component all group members are
expected to participate in all, or even work distribution. Group
project grades may very based on my observations on
presentation, Q&A responses and in general contribution and
peer review.

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Slide 9
Week 1- intro
Group projects links to class topics
Main class topics Linked group topics

Banks & Financial Groups 1 & and 2 about traditional banks and digital
intermediary banks, their roles in the economy, risk for the economy. –
(weeks 1-5) Traditional Banks, roles in the economy, bank failures,
regulations
Debt market, Groups 3 & 4 – Singapore government and corporate debt
interest rate, market (other Asian markets can includes ) and European /
monetary policy US markets
(weeks 6-7)
Exchanges and Groups 5-6 European, US, and Asian exchanges, asset
platforms trading offerings (two sides of economic role: fundraising and
venues (equity) investment, rise of speculation)
(week 8, 10, 11)
FOREX and new Group 7&8 – traditional currencies (FOREX), recent
assets currency issues: The rise of Crypto (currencies)
(week 9-10)

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Slide 10
Week 1- intro
Term Projects – Please make up groups

 Group 1 – Traditional Banks, roles in the economy, bank failures,
regulations
 Group 2 – Digital banks, Crowdfunding, P2P funding
 Group 3 – Singapore government and corporate debt market (both
private & public)

 Group 4 – US/European government and corporate debt market
(similar to group 3)
 Group 5 – US/European exchanges, clearinghouses, dark venues
 Group 6 – Asian exchanges, clearinghouses, dark venues
 Group 7 – FOREX market, traditional currencies
 Group 8 – Recent currency issues: The rise of Crypto (currencies)

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Slide 11
Week 1- intro
Project submission requirement

 25 minutes video + full presentation deck (submission on LumiNUS)
Friday 6 PM in, Week 12 by Nov 5. Noon .
 5 MCQ questions (with solutions) via email to Lecturer.
 In the email subject line label clearly the submission, and
provide information : B1_Group1_projectquiz
 Elevator pitch, short presentation, with summary presentation deck (in

class, in printed form, 2 slides on a page, double sided)
 Full report to be submitted on LumiNUS designated folder, Week 13,
Friday, November 12, at 6 PM (please include the elevator pitch
slides at the end in an appendix, 2 slides on 1 page format.
 Peer review in google form, make sure you describe carefully the
work allocation for each group member and give fair evaluation, by
Nov. 12, at 6 PM. https://forms.gle/w5phwG55DsoTtjF27

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Slide 12
Week 1- intro
Admin: Familiarize yourself with Examplify
Install Examplify :
 https://wiki.nus.edu.sg/display/DA/Download+and+Install+Examplify
 Step 1: Before you download Examplify, check that your laptop OS is
supported.
 Refer to Device Minimum System Requirements. (It is very important to note,

once you download a test, donot do any system update because you would not
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Saturday to make sure test is on your computer even if there is bad internet
connection.
 Step 2: Go to www.examsoft.com/nus
 Step 3: Log in under 'Exam Takers' using your NUSNET student ID and
password.

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Slide 13
Week 1- intro
Reviews and notations on the slides
 Occasionally preparation review slides, and videos are

posted. All materials posted in the weekly lecture note folder,
need to be reviewed, to be tested.
Additional online resources, with embedded link in logo :
Indicates, key financial term.
Discussion / Reflection
Topic can be continued online on LumiNUS

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Slide 14
Week 1- intro
About the slides and lecturer
 Slides are crowded, yes they are.

 I try to get content organized with colours and animation in a
way it makes sense to me. Unfortunately that may not be your
“cup of tea”. We all have our unique style. My apologies.
 More importantly, I hope you appreciate that the slides are very
extensive and cover most of the materials.
 So you do not have to stress out about note taking
 You do not have to stress out about combining lecture notes
and book info
 Please appreciate my efforts instead of criticising the
“crowded slides” 
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Slide 15
Week 1- intro
About the slides and lecturer
 The class is big, thus class discussion may be difficult.

 Please try to be understanding post online, but never hesitate
to ask question in class, especially if you did not understand
something or did not hear something.
 Lecturer may deviate from lecture notes. Try to appreciate the extra
effort and commitment, to talk about global current events.

 Even if the topic is Russia, and Thinkoff bank, there is a reason
for talking about other countries, especially when we can learn
from early digital banking experience.
 Please do not stress if in class we skip some slides. Try to
review those slides on your own, and if something not clear,
please ask in class, or online on LumiNUS or via email to
bizzrh@nus.edu.sg, or schedule consultation. If there is
anything unclear ask as soon as possible do not wait until the
midterm or the end of the term.
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Slide 16
Week 1- intro
This lecture
ADMIN issues:
Class outline, lecture dates
Missing a lecture (no-makeup, borrow notes)
Class information (primary query on LumiNUS)
Introduction to financial markets and institutions

1 Financial Assets
2 Financial Markets
3 Some Financial Institutions
3 Islamic Finance (and Ethical and Social Finance)
Next lecture: Banks, Financial regulations and Central
Banking

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Slide 17
Week 1- intro
1 Introduction – Financial Assets (1)

 Asset: any possession that has value in an exchange
 Tangible versus intangible assets
 The value of tangible assets is a function of its physical
properties (e.g. land, buildings, machineries, vehicles)
 The value of intangible assets is a legal claim to their

future benefits (cash flows).
- All financial assets/securities – such as stock
certificates, corporate bonds, and derivatives – are
intangible assets. Derivatives are structured assets,
where the value of the asset is derived from the value of
the underlying financial asset.

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Slide 18
Week 1- intro
1 Introduction – Financial Assets (2)

Real Assets (mostly tangible) Financial Assets (intangibles)
• Used to produce goods and Claims to the income generated by

services real assets or on income from the
• Difficult & expensive to store, government. Do not directly
contribute to the productive
maintenance costly
capacity of the economy
• difficult & expensive to transfer,
• Easy to store and transfer
• value stable, relatively
• sensitive to market conditions,
insensitive to exchange rate such as exchange inflation and
fluctuation and political risk political instability
• Example: land, Equipment,
• Example: Cash, bond, stock,
intellectual property (IP) derivatives
Which is your favorite investment asset and why?

What are the key characteristics you care about!

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Slide 19
Week 1- intro
1 Household Balance Sheet
What are real asset and financial

assets? Practice

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Slide 20
Week 1- intro
1 Example of Real Asset 1 (value ?)

 Gold price is measured in troy ounce, 31.1 grams

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Slide 21
Week 1- intro
1 Example of Real Asset 2


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Slide 22
Week 1- intro
1 Introduction – Financial Assets’ role

 Financial assets (legal contracts!) are used to transfer cash
from investors to banks, corporations, governments,
individuals and vice versa.
 Financial assets are used in indirect financing to facilitate the
fund allocation for “best use” with intermediaries financial

institutions.
 The role of financial assets is to facilitate the:
 Transfer of funds from surplus units to deficit units
 Relocation of scarce resources from non-productive to
productive use
 Pulling of funds, as well as risk pooling risk sharing.

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Slide 23
Week 1- intro
1 Properties of Financial Assets

 Ten properties of financial assets
1) Moneyness
2) Divisibility and Denomination
3) Reversibility – round trip costs (bid-ask spread)
4) Term to maturity (Time period for payment)

5) Liquidity – transferability into cash without sign. loss
6) Convertibility
7) Currency
8) Cash-flow and return predictability
9) Complexity
10) Tax status

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Slide 24
Week 1- intro
1 Ten properties of financial assets (1)

1) Moneyness
 Money is the medium of exchange: cash, demand deposit or
current account
 Near money instruments: saving deposits, fixed (or time)
deposits, T-Bills (very liquid instruments, what means liquid?)
2) Divisibility and Denomination (min. transaction size)

 Divisibility is desirable for investors
 Deposits: infinitely divisible
3) Reversibility or total round-trip cost
 Bid-ask spread reflects the difference between the price at which
the market (or market marker) is willing to buy and sell
 Other Costs: Commissions, stamp fee/duty, loading

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Slide 25
Week 1- intro
4) Term to maturity (time interval to final payment)

 Demand instruments (zero maturity, readily available) versus
Perpetuity or consol (UK government bonds)
 1 week/month – 30 years: T-Bills and Bonds

5) Liquidity (thickness of the market)
6) Convertibility – some financial assets can be converted into
other types of financial assets
7) Currency
 Example: US$, €, £, ¥, S$
 Foreign denomination exposes the investor to exchange rate risk

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Slide 26
Week 1- intro

8) Cash-flow predictability
 Riskiness of the asset is related to the predictability of the cash
flows (payments) to which the asset gives right
 Potential measure of risk is the volatility of the asset price
9) Complexity
 Simple assets versus complex assets, whereby complex assets
combine two or more simpler assets (e.g. convertible bond)
10) Tax status
 Taxability at (local), state, and federal level (tax implications are
complicated with double taxation, domicile, citizenship etc.)
 What is the tax liability of a Dutch, UK citizen on SGS sing$
interest payment, versus a US citizen, versus a Singaporean?

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Slide 27
Week 1- intro
2 Financial Intermediation
Ultimate Ultimate
Lenders Borrower
Those with excess Those with needs
DIRECT FINANCE
funds for funds for funds
Platforms
Markets
INDIRECT
FINANCE
Financial Intermediaries
Platforms, some CF sites

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Slide 28
Week 1- intro
2 The Market Players (Participants)
Who Demands Capital?

Firms
Who Supplies Capital? Households
could be also individuals/
households starting business, could be also firms, VCs, Google venture etc
pay off students loans etc but the ultimate lenders are the people
Price of Capital
D S
Financial Intermediaries: Pool & invest funds

• Investment Companies
• Banks
• Insurance companies
Role of Government?
Quantity of Capital Can be either borrowers or lenders

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Slide 29
Week 1- intro
2 Financial Markets and Institutions
 Nature and role of financial markets and financial institutions:

 Financial markets are arranged groups of institutions that facilitate
the transfer of funds between entities, have INTERMEDIARY such
as:
 Identifying potential surplus units to match deficit units. Help

transfer of funds from entities who lack investment
opportunities to entities who have such opportunities.
 Assisting in efficient allocation of wealth throughout the system.
• Allocate funds to best use, most efficient use, most
productive use not necessarily most profitable use
(recent trend: consider societal and welfare enhancing
use, positive sideffects)
 Supporting greater efficiency for the economy.
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Slide 30
Week 1- intro
2 Financial Markets and the Economy

 Financial markets play important roles, such as
 The Informational Role
• Capital flows to companies with best prospects
• The prospects of the company is reflected in their stock prices
• Market optimism/pessimism captured in prices (timely manner)
• In result: stock prices provide information about the potential

of a company
 Consumption Smoothing
• Individuals have high or low earnings periods, still need to have
relatively stable consumption. It is achieved with financial assets:
borrowing early for home / study, and paying off debt during high
earner middle age… (read more on link)

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Slide 31
Week 1- intro
 Allocation of Risk
• A wide variety of securities in the market allows investors to select
securities consistent with their tastes for risk
• This benefits companies who can issue securities at the best
possible price
 Separation of Ownership and Management

• No problem: if a business is owner & managers are the same
• However, due to the business scaling up (MNCs), most
businesses now employ outsiders to manage their operations
• Agency problem (AP) arises when managers pursue own interests
instead of maximizing Firmvalue. The tools to mitigate the issue:
• Compensation plans that tie managers’ income to firm success
• Monitoring by the board of directors
• Screening by the external security analysts, activists, Takeover threat

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Slide 32
Week 1- intro
 Corporate Governance and Corporate Ethics

• There will only be efficient allocation of resources if market signals
are accurate and investors are acting on accurate information
• Eg. Misleading or overly optimistic company reports may lead investors
to make the wrong investment decisions
• Other examples include:

o Accounting scandals
o Analyst Scandals
• Corporate governance rules help to eliminate such violation of

proper rules so that markets can be a more efficient avenue for
capital allocation
• Companies should also formulate policies on corporate ethics for
every employee to follow

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Slide 33
Week 1- intro
Financial Markets (Fig 1)

Classification of financial markets by type of claim
Or type of
Financial asset
FinancialMarkets
Markets
Fixed
Fixedincome
income Equity (stock)
FOREX
FOREX Derivatives
Derivatives
(Debt)
(Debt)market
market market
Debt assets National stock FOREX contracts, Derivatives,

traditionally markets where the currency traditionally traditionally trade
trade OTC, via stock IP trade OT OTC, via
broker O used to be the C, via broker dealers broker dealers, or
dealers good to trading on specialized
platform for stocks Derivative exchange

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Slide 34
Week 1- intro
Fig. 2-1 Financial Markets
Classification of financial markets

(Corporate Finance and Investment view)
PRIMARY MARKET SECONDARY MARKET
New Issues – Equity & Debt Trading of existing securities:

Banks role – Underwriting Debt and Equity
Private placement
IPO and SEO (public placements)

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Slide 35
Week 1- intro
2.2 Financial Markets (Fig 2)

Classification of financial markets by type of claim
Fixed
Fixeddollar
dollaramount
amountclaim
claim Residual
Residualor
orequity
equityclaim
claim
Debt
Debtinstrument
instrument Preferred
Preferredstock
stock Common
Commonstock
stock
Fixed
Fixedincome
incomemarket
market Equity
Equity(stock)
(stock)market
market
Currency markets or Forex market is the foundation behind

Debt
Debtmarket
market Common
Commonstock
stockmarket
market
bank loans, bonds, Common stocks (various share classes),
Commercial papers and leases Preferred stocks (could be warrants)

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Slide 36
Week 1- intro

Classification of financial markets by maturity of claim
Debt
Debtinstruments Common
instruments Common/ /Preferred
Preferredstocks
stocks
Maturity
Maturityless
lessthan
thanaayear
year Maturity
Maturitymore
morethan
thanaayear
year
Money
Moneymarket
market Capital
Capitalmarket
market

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Slide 37
Week 1- intro
Classification of financial markets
RETAIL MARKET WHOLESALE MARKET

Business and commercial banks Merchant banks or wholesale

providing retail banking services, institutions providing wholesale
in small redenomination, to retail business services (services in
customers multi-million dollar
(commercial banks are heavily denomination), such as business
regulated to protect retail loans and bond issues.
customers).
Heavily regulated market segment

To “protect” the citizens old age savings
(this is very important !)
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Slide 38
Week 1- intro
2 Financial markets current trends

Financial markets have been on a trend of internationalization
 Internationalbond market
 foreign bonds – issued outside borrower’s home country
 Eurobonds – “offshore” bonds issued in a currency outside
that currency’s home market

 Eurocurrency market
 foreign currency deposited outside of its home country
 Eurodollars are USD deposited outside the US
 World equity markets
 foreign IPOs in London, New York and Hong Kong
 depositary receipts (ADR, GDR) to get around listing problems

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Slide 39
Week 1- intro
2 Source of Financing by Asset types

Source: Mishkin Eakins 2015

Reading: 160101 KPMG - The rise of non bank credit: evolution or revolution
Grant Thornton - Capital for commerce, non-bank lending 2014
39 Lecture:
Casu Introduction
et al. – Comparative to FIs
banking and their
markets 2006 role in economy
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Slide 40
Week 1- intro
2 Financial markets – Stock markets

Exchanges are no longer “just” stock market, about this later
Source: world federation of exchanges

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Slide 41
Week 1- intro
3 Financial Institutions (1A)
 What are financial institutions (FIs)?

 Institutions or business entities which provide financial
services
 FIs are generally financial intermediaries, intermediate

between suppliers and demanders of funds by:
- Maturity intermediation
- Denomination intermediation
- Risk intermediation
- By new asset creation (investment banks, commercial
banks) or by asset pooling (mutual funds)
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Slide 42
Week 1- intro
3 Financial Institutions (1B)

Takes deposits from individuals and corporations and lends
Commercial bank
these funds to borrowers.
S&Ls, CUs, & Thrifts are similar, but more constrained in their investments
Investment bank
Finance Co. Raises money for corporations by issuing securities.
Mortgage Companies
Invests money set aside to pay future claims in securities,
Insurance company
real estate, and other assets.
Invests money set aside to pay future pensions in
Pension fund
securities, real estate, and other assets.
Invests the endowment of a nonprofit organization such as
Charitable foundation
a university.
Mutual fund Pools savings from individual investors to purchase
securities.
VCs and PE firms Pools money from individual investors and other financial
intermediaries, generally to fund relatively small, new
Fintech firms/ crowdfunding businesses or help in restructuring.

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Slide 43
Week 1- intro
3 Financial Institutions (1C)
Depository versus non-depository institutions

DEPOSITORIES NON-DEPOSITORIES
Raise funds by attracting Do not raise funds by

deposits in the wholesale and attracting deposits. The

retail markets, and use these lending activities are financed
deposits to fund new lending. with equity or borrowings
Some loans are resold as Most loans are resold as MBS
MBS in the market in the capital market
Examples: Insurance companies,

Examples: Retail banks, Finance
Pension funds, Unit trusts,
companies, building societies
Private equity firms
Detailed classification, and discussion of the different types of
depository and non-depository institutions are in weeks 2 and 3.

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Slide 44
Week 1- intro
3 Why do banks exist?
 Up until the 1980s, banks were viewed primarily as service

providers for asset transformation, and fund allocations
 In a seminal paper, Diamond (1984) reveals that banks have
important (superior) monitoring function
 Boyd and Prescott (1986) stress the cost effectiveness of

financial intermediaries in information provision
 Financial institutions are also found to be beneficial for
mitigating adverse selection problem (due to information
asymmetry). Investors are less informed about the true financial
positions and future potential of corporations and individuals in
need of funds.

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Slide 45
Week 1- intro

– Monitoring by Diamond
Diamond (1984) shows that banks endogenously exist in our

society/economy for reducing (1) monitoring costs via
economies of scales and (2) default risk via diversification
 Diamond’s model setup:

 1 borrower with N risky projects
 Each lender (m) pays monitoring cost = k
 If borrower cheats, penalty = p
 Each project needs m lenders with excess funds (total cost= mN)
 Three time periods (t=0,1,2) with payment shock at t=1

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Slide 46
Week 1- intro
– Monitoring by Diamond
Lender m2
Lender m3
Lender m1 cheating
cheating
Lender …
Information asymmetry,
Lenders are outside of the “black box”
Lender m7 Corporation (B) with

N risky projects
Lender …
A Financial Institution
monitors for a fee
Arrow – monitoring
Lender m4
Lender m6
Lender m5
Lenders stop monitoring as FI monitors for a fee → B doesn’t cheat
As m → ∞, monitoring costs (k) → 0 N project → ∞, P (FI defaulting) → 0

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Slide 47
Week 1- intro

– Boyd & Prescott (1986)
 To deal with Information asymmetry: Not all agents have the
same information. Companies withheld some information and
investors have to make investment decisions with limited
information, whatever is available in the public market.
 To address Adverse selection problem: An informed agent’s

financial decisions, based on his privately held information,
adversely impacts other uninformed agents.
Boyd & Prescott’s solution to adverse selection problem
Banks can have better access to information, much better than
individuals, and can thus take over the role of information gathering
and information provision for investors and ultimately the
monitoring of firms to align investors and management incentives.

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Slide 48
Week 1- intro
3 Financial Intermediaries, e.g. Banks
 In an economy, the flow of funds between fund suppliers

(depositors, investors) and fund users (e.g. corporations) is
likely to be low without Financial Intermediaries (because of
high search cost and high risk).
 In indirect fund transfer, the fund suppliers can benefit from lower
risk (by investing in mutual funds, or corporate bonds instead of
buying direct ownership in a corporation and taking on responsibility
for losses).
 The credit allocation efficiency can be improved as not only the
supplier of the funds but also the financial institution monitor the
company in which the investor invest via the FI.
 FIs, especially insurance companies, facilitate intergenerational
wealth transfer – FIs provide savers the ability to transfer wealth.

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Slide 49
Week 1- intro
3 Summary: Financial Intermediaries

 Financial Intermediaries are crucial in the economy, as they directly benefit
suppliers of funds by
 Denomination intermediation, and reduction of transaction and contracting
costs with economies of scales
 Maturity intermediation – FIs can better bear the risk mismatching of the
maturities of their assets and liabilities

 Reducing monitoring costs – reduce the risk for the supplier of funds and
also reduce the risk for the borrower
 Liquidity provision and price risk reduction – by allowing supplier of funds
to access their funds more flexibly and by providing liquidity, so suppliers
can trade their assets with lower price risk and invest in different assets to
diversify
 Provision of payment mechanisms (credit card services, ATMs, foreign
payment transfer, etc.), with the use of new technology, iPad banking and
phone payment

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Slide 50
Week 1- intro
3 Traditional Banks and Fintech banks
 Discuss, differences and similarities

 What do Challengers better (recall their primary role allocate
scarce resources for the best use)?
 Digital banks?
 Industrial firms with tech services?
 Do we still need traditional banks? What types of banks?
What types of financial services firms?
• What do you think, which FIs were least affected by
Fintech and why?

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Slide 51
Week 1- intro
Write your summary of discussion 


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Slide 52
Week 1- intro
3 Reflection on Failures and issues in FS

 In Financial services industry, market failures can arise for a number
of reasons. These include, among others:
 Imperfect competition (relevant much of the time)
 Stakeholders do not behave as purely rational agents,
 There are externalities. This means when there is a cost to

something that nobody pays for, such as keeping the air free of
pollution or the roads well maintained
 There are high levels of risk excessive risk taking, knowingly or
unknowingly without proper risk management
 High transaction costs, may deter optimal investment
 There are information asymmetries, such as…

© ZRHuszar
Slide 53
Week 1- intro

 Major impediment: Information asymmetry. The two most
important results of asymmetric information relevant to financial
services are known as moral hazard and adverse selection.
 Moral hazard can arise when someone's behaviour changes
based on their access to financial services, e.g., in financial

services asset manager may behave differently with when
trading with own or someone else money. Moral hazard exists
when a party to a transaction has an incentive to take unusual
business risks because he is unlikely to suffer potential
consequences.
 Adverse selection refers to the fact that it is often people
whose activities are particularly risky who take high interest
loans, or buy insurance.

© ZRHuszar
Slide 54
Week 1- intro
 Banks have to “be forced” to provide services where they

needed not only where they can get good business.
 How?
 1) Regulations, banking licences.

• Community Reinvestment Act (CRA) 1977 in the USA
and similar in other countries.
 2) “free competition”. Challengers (new fintech solutions)
come to the market, offering services neglected market
participants and later take on the incumbents.
• E.g., Stashaway, offers small mutual fund investments

© ZRHuszar
Slide 55
Week 1- intro
4 Islamic Finance And Shariah (1)
Basic Principles
 Explicitly Interest free
• Prohibition of interest, Riba, and prohibition of Usury.
• Instead of interest markup is used, the loan is paid back at a
higher price, kind of like a “repo”

 Ethically responsible
• funds can be used for Shari’ah compliant work.
 “Riskless” (Prohibition of Gharar, or excessive risk taking)
• The use of joint ventures is promoted to reduce once sided
excessive risk taking. Excessive derivative packages are
prohibited, cash flow rights have to be linked directly to a
tangible assets (infrastructure projects are preferred).

© ZRHuszar
Slide 56
Week 1- intro
4 Islamic Financial Institutions Assets

 50s & 60s: initial theoretical work, some
experimentation (Egypt was the leading
market)
 70s: DIB, IDB, petrodollars
 80s: OIC’s IFA, initiatives in Malaysia, Bahrain,

Pakistan, Sudan
 90s: Accounting and Auditing Organization for
Islamic Financial Institutions(AAOIFI) AAOIFI,
Dow Jones & FTSE indexes, growth in number
& type of funds
 00s: IFSB, IIRA, more innovation, credit cards
to hedge funds, more petrodollars

© ZRHuszar
Slide 57
Week 1- intro
4 Islamic finance application

Riba Gharar
Capital _Equity funds: business, debt & Derivatives (or at least their
Market income screening trading) largely avoided
_Sukuk: ownership of assets - Derivatives have to have
_Debt trading constrained direct CF rights to real
assets
Banking _Trade, lease, share Sales/leases of assets after

_No money borrowing/lending purchases
(use of mark-up)
Insurance / Avoid interest bearing Mutuality (risk-sharing,
Takaful investments solidarity group)
Note: Sin industries to be avoided in all cases, unless for making

a point
© ZRHuszar
Slide 58
Week 1- intro
4.1 Islamic Finance products & services (1)

 Saving Deposits (Wadiah, safekeeping)
• Money is deposited for the purpose of safe custody; no
return on savings is promised (but depositors of course
expect something extra in return). Often a hibah (gift) is
given to the depositors as return instead of cash.
 Financial Products:
– Sukuk (islamic bond) has unique structured coupon
payments, complying with the prohibition of Riba;
– Takaful (insurance contracts), in general should be
forbidden because of the excessive risk takin. To
address this Takafuls are structured with risk sharing,
very similar to the new Fintech insurance companies,
targeting wide range of borrowers to spread risk.

© ZRHuszar
Slide 59
Week 1- intro
4.1 Islamic Finance products & services (2)

 Mudaraba – Profit and loss sharing system through joint
partnerships/ ventures
 Murabaha – Sale with predetermined markup (cost plus
agreement). Money serves as a medium of exchange.
 Musharaka – Type of equity financing and the relationship between
a financial institution and a partner in business

 Istisna – Mode of financing for the sale of an asset and transfer of
its ownership before the asset comes into existence
 Ijarah – Leasing agreement between financial
institution and a client
 Takaful, Islamic insurance with risk sharing
 Sukuk (Islamic bond) with structured coupon payments, normally
used to finance infrastructure projects, booming market

© ZRHuszar
Slide 60
Week 1- intro
4 Islamic Finance – Sukuk outlook

sukuk or “Sharia-compliant bonds”, represent partial ownership in an
asset, not a debt obligation (cash flow rights to underlying asset)
Global sukuk issuance to hit US$100b in 2018: Moody's

 sukuk issuance volumes expected to continue to grow as
governments across the core Islamic finance markets shift their

financing mix towards a combination of conventional and Islamic
instruments,“
• sukuk also started trading on the Turkish stock exchange in August
2018, were supportive of the market.
• Green sukuk issuance is set to accelerate in Malaysia and Indonesia
as governments in both countries seek to promote sustainable policy
agendas by attracting private capital into low-carbon and climate-
resilient infrastructure projects, said the rating agency.

© ZRHuszar
Slide 61
Week 1- intro

© ZRHuszar
Slide 62
Week 1- intro
4 Islamic Finance – global trends

Greater participation of conventional Major advancement of IFSB
markets
• New licenses in non Muslim countries • Globally recognized institution
e.g. UK and France encompassing banking, takaful,
• Legal amendment (e.g. tax law) to capital market sectors
facilitate Islamic finance - UK, S’pore • 94 members (including IMF, World

• Tapping Islamic funds through sukuk Bank, BIS)
issuance • Globally accepted international
• Multinational corporations and regulatory and prudential
standards
multilateral agencies e.g. World
Bank
• Strong interest from Japan

© ZRHuszar
Slide 63
Week 1- intro
4 Islamic Finance: Current trends
Discussion
What do you know about
Islamic finance what is your

understanding?
We continue the discussion about Islamic finance online

on LumiNUS.

© ZRHuszar
Slide 64
Week 1- intro
UN Sustainability goals for 2030


© ZRHuszar
Slide 65
Week 1- intro
IDEA: ESG aspect 1: Environment
Animal
Welfare
Responsible Biodiversity &
Consumption & Habitat
Production Preservation
Carbon Energy Source
Emissions & Use
Climate Waste &
Control Recycling
Water
Scarcity
© ZRHuszar
Slide 66
Week 1- intro
IDEA: ESG aspect 3: People & Governance

Employee Good health & Shareholder Voting Executive Pay &

Remuneration Wellbeing Rights Remuneration
Supplier treatment Quality Educ. Innovation Stewardship

Customer Equality Diversity Board Indep.& Tax & Accounting
Management & Inclusivity Diversity Standards
Health & Safety Social Impact Regulatory Standards Culture &

Transparency

© ZRHuszar
Slide 67
Week 1- intro
IDEA of ESG: capture different aspects at
funds
Passive FTSE Active Multi- Environmental

Tracker Manager Fund Impact Fund
 Create standardized and informative ratings, Ideally
independently calculated/verified/audited

© ZRHuszar
Slide 68
Week 1- intro
Lect 1 Summary: Financial Intermediaries

 Financial Intermediaries are crucial in the economy, as they
directly benefit suppliers of funds by
 Denomination intermediation, and reduction of transaction and contracting
costs with economies of scales
 Maturity intermediation – FIs can better bear the risk mismatching of the
maturities of their assets and liabilities

 Reducing monitoring costs – reduce the risk for the supplier of funds and
also reduce the risk for the borrower
 Liquidity provision and price risk reduction – by allowing supplier of funds
to access their funds flexibly , suppliers can trade their assets with lower
price risk and invest in different assets to diversify
 Provision of payment mechanisms (credit card services, ATMs, foreign
payment transfer, etc.), with the use of new technology, iPad banking and
phone payment

© ZRHuszar
Slide 69
Week 1- intro
Lect 1 summary: Fin. markets & economy
 Informational Role
 FIs, banks are more efficient in information gathering.
Marketplaces such as (stock) exchanges enforce
information disclosure, and FIs, arbitrageurs enforce that
stocks prices reflect “true fundamental information”

 Consumptions Smoothing
 Allocation of Risk
 Separation of Ownership and Management
 Financial assets created structured by financial institutions
such as Investment banks support the managerial run firm
model
 Corporate governance, ethics

© ZRHuszar
Slide 70
Week 1- intro
Lect 1 Summary: Definitions

 Corporate governance is a system of rules, policies, and
practices that dictate how a company’s board of directors
manages and oversees the operations of a company;
 Corporate governance includes principles of transparency,
accountability, and security.
 Poor corporate governance, at best, leads to a company failing to

achieve its stated goals, and, at worst, can lead to the collapse of the
company and significant financial losses for shareholders.
 Financial intermediation – connecting ultimate lenders to
ultimate borrower to allocate funds to best (most productive)
use. And more recently, the fund should be allocated in a
socially responsible way.
 Real assets vs financial assets

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CHAPTER

PLEASE note usual IP rights apply.

Class attendance encouraged F2F

line should clearly indicate section number and

Lecture: Introduction to FIs and their role in economy

Class Attendance marking

 Please try not switch seats during one session

Lecture: Introduction to FIs and their role in economy

Financial Markets Course

in regulated and unregulated financial markets;

Lecture: Introduction to FIs and their role in economy

Brief topic outline for the course

Recess week 19/09/2021 – 26/09/2021)

Lecture: Introduction to FIs and their role in economy

Class test dates cannot be changed

 Why Wednesday timing?

6 Lecture: Introduction to FIs and their role in economy

 Term project 35%

7 Lecture: Introduction to FIs and their role in economy

Class participation & Group projects

 In class and online participation both expected. For each

comment on your own, and contribute to ongoing

8 Lecture: Introduction to FIs and their role in economy

Group projects links to class topics

Main class topics Linked group topics

9 Lecture: Introduction to FIs and their role in economy

Term Projects – Please make up groups

private & public)

10 Lecture: Introduction to FIs and their role in economy

Project submission requirement

 Elevator pitch, short presentation, with summary presentation deck (in

11 Lecture: Introduction to FIs and their role in economy

Admin: Familiarize yourself with Examplify

 Refer to Device Minimum System Requirements. (It is very important to note,

 Occasionally preparation review slides, and videos are

Additional online resources, with embedded link in logo :

Indicates, key financial term.

13 Lecture: Introduction to FIs and their role in economy

 Slides are crowded, yes they are.

 The class is big, thus class discussion may be difficult.

effort and commitment, to talk about global current events.

Introduction to financial markets and institutions

16 Lecture: Introduction to FIs and their role in economy

1 Introduction – Financial Assets (1)

 The value of intangible assets is a legal claim to their

17 Lecture: Introduction to FIs and their role in economy

1 Introduction – Financial Assets (2)

• Used to produce goods and Claims to the income generated by

Which is your favorite investment asset and why?

18 Lecture: Introduction to FIs and their role in economy

What are real asset and financial

19 Lecture: Introduction to FIs and their role in economy

1 Example of Real Asset 1 (value ?)

 Gold price is measured in troy ounce, 31.1 grams

20 Lecture: Introduction to FIs and their role in economy

1 Example of Real Asset 2

21 Lecture: Introduction to FIs and their role in economy

1 Introduction – Financial Assets’ role

fund allocation for “best use” with intermediaries financial

22 Lecture: Introduction to FIs and their role in economy

1 Properties of Financial Assets

4) Term to maturity (Time period for payment)

23 Lecture: Introduction to FIs and their role in economy