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Page 1: Course Information

• Course Title: Financial Systems, Markets and Instruments

• Semester: Semester B 2024/2025

• Week: 1

• Instructor: Dr. Andrew Wong

• Institution: City University of Hong Kong (香港城市大學)

Page 2: Overview of the Financial System

• Topic focuses on understanding the financial system, its markets, and instruments.

Page 3: Importance of Financial Markets

• Scenario: Starting a business manufacturing a household cleaning robot but lacking funds.

• Contrast: Walter wants to invest for retirement.

• Need: A connection between lender (Walter) and borrower (entrepreneur) is necessary to meet both financial needs.

Page 4: Financial Markets and Intermediaries

• Significance: Highlights the importance of financial markets and intermediaries in the economy.

• Need for understanding structure and operation to appreciate their roles in economic functioning.

Page 5: Examination of Financial System Roles

• Analyze the role of financial systems in advanced economies.

• Learn about their effects on the economy, structure, and operations.

• Topics Include:

  • Function of Financial Markets

  • Structure of Financial Markets

  • Internationalization of Financial Markets

  • Function of Financial Intermediaries (Indirect Finance)

  • Types of Financial Intermediaries

  • Regulation of the Financial System

Page 6: Function of Financial Markets

• Primary Role: Channels funds from ‘Lender-Savers’ to ‘Borrower-Spenders’.

• Economic Impact: Improves economic efficiency.

Page 7: Fund Transfer Agents

• Lender-Savers:

  1. Households

  2. Business firms

  3. Government

  4. Foreign entities

• Borrower-Spenders:

  1. Business firms

  2. Government

  3. Households

  4. Foreign entities

Page 8: Segments of Financial Markets

• Direct Finance: Borrowers directly obtain funds from lenders by issuing financial instruments.

• Indirect Finance: Involves financial intermediaries who aggregate loans from lenders to offer them to borrowers.

Page 9: Funds Flow in Financial Systems

• Chart displaying flow of funds through:

  • Lender-Savers

  • Borrower-Spenders

• Two routes: direct finance (selling securities) and indirect finance (via intermediaries).

Page 10: Importance of Financial Markets

• Example illustrating the lack of returns without financial markets.

• Highlights how funds can be used productively (e.g., carpenter buying a saw).

Page 11: Efficient Capital Allocation

• Financial markets facilitate:

  • Efficient allocation of capital.

  • Improved consumer welfare, allowing better timing of purchases.

Page 12: Financial Markets Structure

• Dimension Definitions: Financial markets can be defined by various dimensions.

Page 13: Debt and Equity Markets

• Debt Markets:

  • Short-Term: Maturity < 1 year

  • Long-Term: Maturity > 10 years

  • Intermediate-Term: Maturity in between

  • Total represented $56.1 trillion in 2021.

• Equity Markets:

  • Ownership claims with dividends, theoretically perpetual.

  • Total value was $80.1 trillion in 2021.

Page 14: Primary vs. Secondary Markets

• Primary Market: New securities sold to initial buyers, often involving underwriters.

• Secondary Market: Previously issued securities traded; crucial for liquidity and pricing.

Page 15: Functions of the Secondary Market

• Provides liquidity for securities.

• Establishes prices for securities aiding company valuations.

Page 16: Types of Secondary Markets

• Exchanges: Central locations for trades (e.g., NYSE, HKSE).

• Over-the-Counter: Trading by dealers in different locations (e.g., Treasury Securities).

Page 17: Classification by Maturity

• Money Market: Short-term securities (maturity < 1 year).

• Capital Market: Long-term securities (maturity > 1 year) plus equities (no maturity).

Page 18: Internationalization of Financial Markets

• Trend: U.S. dominance declines with the rise of international markets.

  • Eurobonds: Larger than U.S. corporate bond market; >80% of new bonds.

Page 19: Eurocurrency Market

• Definition: Foreign currency deposits outside home country.

  • Example: Eurodollars are dollars deposited in foreign countries.

Page 20: Foreign Stock Market Indexes

• Major indices:

  • DJIA: 30 largest U.S. companies.

  • S&P 500: 500 largest U.S. companies.

  • FTSE 100: 100 largest UK companies.

  • DAX: Top 30 German companies.

  • CAC 40: 40 largest French companies.

  • Hang Seng: Leading companies in Hong Kong.

Page 21: U.S. Capital Market Decline

• Evidence of lost dominance in various industries and financial markets.

• Competition from London and Hong Kong emerging.

Page 22: Factors for Decline

1. Technology advancements in foreign exchanges.

2. Tighter U.S. regulations post-9/11.

3. Increased lawsuit risks in the U.S.

4. Impact of Sarbanes-Oxley Act on costs for U.S. companies.

Page 23: Role of Financial Intermediaries

• Discussion on indirect finance and the role of intermediaries in fund movement.

Page 24: Function of Financial Intermediaries

• Intermediary obtains funds from savers; lends to borrowers.

Page 25: Financial Intermediation

• Main source of finance; more prominent than securities markets.

• Addresses transactions costs, risk sharing, asymmetric information.

Page 26: Transactions Costs Reduction

• Intermediaries profit by minimizing transactions costs, leveraging expertise and scale.

Page 27: Liquidity Services by Financial Intermediaries

• Examples of liquidity services, like checking accounts for easy transactions.

Page 28: Global Relevance of Financial Intermediaries

• Firms in developed nations prefer funds from intermediaries over capital markets.

• Specific examples: Germany and Japan have higher dependency on intermediaries.

Page 29: Risk Sharing by Financial Intermediaries

• Process of asset transformation, making risky assets safer for investors.

Page 30: Diversification Opportunities

• Financial intermediaries enable individuals and businesses to diversify holdings through pooled assets.

Page 31: Asymmetric Information in Finance

• Adverse Selection and Moral Hazard: Reducing investor exposure to risks via intermediaries.

Page 32: Adverse Selection Explained

• Occurs before transactions, with borrowers unlikely to be honest candidates seeking loans.

Page 33: Moral Hazard Explained

• After transaction, borrowers might act immorally post-funding, risking loan repayment.

Page 34: Financial Intermediary Solutions

• Mitigate issues of adverse selection and moral hazard for profitability.

Page 35: Economies of Scope

• Cost reduction through multi-service utilization but may lead to conflicts of interest.

Page 36: Types of Financial Intermediaries

• Depository Institutions: Banks, credit unions, contract-based funding institutions.

Page 37: Asset Values of Financial Intermediaries

• Overview of value growth from 2000 to 2021 for different types of financial intermediaries.

Page 38: Depository Institutions

• Commercial Banks: Majority of financial intermediation; diversified portfolios.

Page 39: Thrifts Types

• Overview of savings and loan associations and credit unions, their funding sources, and loan types.

Page 40: Contractual Savings Institutions

• Description of life and casualty insurance, pension funding and their investment strategies.

Page 41: Further Types of Financial Intermediaries

• Covering operations and funding strategies of finance companies and mutual funds.

Page 42: Specialty Financial Entities

• Definition and operational focus of money market mutual funds and hedge funds.

Page 43: Regulatory Agencies Overview

• Major regulatory bodies governing U.S. financial markets discussed.

Page 44: U.S. Regulatory Agencies Continued

• Additional institutions regulating finance and ensuring safety and transparency.

Page 45: Regulatory Agencies in Hong Kong

• Key agencies included: HK Monetary Authority, Securities & Futures Commission, Insurance Authority.

Page 46: Financial Market Regulation

• Main purposes: Increase information and soundness of financial intermediaries.

Page 47: Investor Information Enhancement

• SEC's role in mandating information disclosure to mitigate risks and increase market efficiency.

Page 48: Impact of Regulation on Information

• Importance of regulation in curbing adverse selection and moral hazard issues.

Page 49: Ensuring Soundness of Financial Institutions

• Regulations necessary to prevent financial panic; safeguarding depositor trust.

Page 50: Regulatory Measures Against Financial Panics

• Overview of six regulatory types to control financial institution soundness.

Page 51: Entry Restrictions Overview

• Regulations regarding establishment of financial intermediaries to ensure credibility.

Page 52: Financial Intermediary Disclosure Requirements

• Inspections, strict accounting principles, and public information mandates.

Page 53: Asset Activity Restrictions

• Limits on risky financial activities to protect depositors and maintain overall stability.

Page 54: Investment Regulations for Safety

• Strategies to prevent intermediaries from excessive risky investments.

Page 55: Deposit Insurance System

• Protects consumer deposits against financial losses; varies between countries.

Page 56: Regulation on Competition

• Historical context on limits of competition among financial institutions.

Page 57: Interest Rate Restrictions

• The evolution of regulations governing interest rates and their effects.

Page 58: Monetary Control through Regulation

• Importance of regulation for controlling the money supply at a national level.

Page 59: Global Financial Regulation Comparison

• Other countries have financial regulations similar to the U.S., but with varying practices.

Page 60: General Summary of Financial Markets

• Overview of function, structure, internationalization, and intermediary roles.

Page 61: Continued Summary

• Focus on the operational roles of intermediaries and market internationalization.

Page 62: Types and Regulation of Financial Intermediaries

• Broad outline of various types of intermediaries and their regulatory environments.