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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:
Households
Business firms
Government
Foreign entities
Borrower-Spenders:
Business firms
Government
Households
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
Technology advancements in foreign exchanges.
Tighter U.S. regulations post-9/11.
Increased lawsuit risks in the U.S.
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.