2 - An Overview of The Financial System Post

Module
An Overview of the
Financial System
Khoa Tài Chính Ngân Hàng
Faculty of Finance and Banking
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Topic Objectives
 Summarize the basic function performed
by financial markets.
 Describe the different types of financial
markets.
 Describe the principal money market and
capital market instruments.
 Express why the government regulates
financial markets and financial
intermediaries.
Money, Banking and Financial Markets 2
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Topic Outline
 Function of Financial Markets
 Types of Financial Markets
 Financial Market Instruments
 Internationalization of Financial Markets
 Function of Financial Intermediaries
 Types of Financial Intermediaries
 Regulation of the Financial System
Money, Banking and Financial Markets
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Function of Financial
Markets
 Financial markets perform the essential
function of channeling funds from
economic players that have saved surplus
funds to those that have a shortage of
funds.

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Markets

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Markets
 Financial markets can do this through
 direct finance, in which borrowers
borrow funds directly from lenders by
selling them securities
 indirect finance, which involves a
financial intermediary or financial
institution that stands between the
lender-savers and the borrower-
spenders and helps transfer funds from
one to the other.
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Markets
 Financial markets promote economic
efficiency by producing an efficient
allocation of capital, which increases
production.
 They also directly improve the well-being
of consumers by allowing them to time
purchases better.

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Multiple Choice
 Which of the following requires financial
intermediaries?
A.Direct finance.
B.Indirect finance.
C.Direct purchase of retail goods.
D.All of the above.

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Multiple Choice
 Well-functioning financial markets
A.Eliminate the need for indirect finance.
B.Cause inflation.
C.Produce an efficient allocation of capital.
D.Cause financial crises.

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Multiple Choice
 Financial markets promote economic
efficiency by
A.Creating inflation.
B.Reducing investment.
C.Channeling funds from savers to
borrowers.
D.Channeling funds from borrowers to
savers.
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Debt and Equity Markets

 Funds can be obtained in two ways:
 A debt instrument is a contractual
agreement by the borrower to pay the
holder of the instrument fixed amounts of
money at regular intervals until a specified
date, when a final payment is made.
 An equity instrument which is a claim to
share in the net income and the assets of
a business.
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Debt and Equity Markets

 Funds can be obtained in two ways:
 A debt instrument is a contractual
agreement by the borrower to pay the
holder of the instrument fixed amounts of
money at regular intervals until a specified
date, when a final payment is made.
 An equity instrument which is a claim to
share in the net income and the assets of
a business.
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Primary and Secondary

Markets
 A primary market is a financial market in
which new issues of a security, such as a
bond or a stock, are sold to initial buyers
by the corporation or government agency
borrowing the funds.
 A secondary market is a financial market
in which securities that have been
previously issued can be resold.

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Multiple Choice
 A primary market is one in which
A.Newly printed money is transferred to the
banks.
B.Money market dealers make their most
important trades.
C.The central bank conducts its monetary
policy.
D.Financial assets are traded for the first time.
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Multiple Choice
 A corporation acquires new funds only when
its securities are sold in the
A.Primary market by an investment bank.
B.Secondary market by a stock exchange
broker.
C.Secondary market by a commercial bank.
D.Secondary market by an investment bank.

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Markets
 An important financial institution that
assists in the initial sale of securities in the
primary market is the investment bank.
 It does this by underwriting securities: it
guarantees a price for a corporation’s
securities and then sells them to the
public.

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Markets
 Securities brokers and dealers are crucial
to a well-functioning secondary market.
 Brokers are agents of investors who
match buyers with sellers of securities.
 Dealers link buyers and sellers by buying
and selling securities at stated prices.

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Multiple Choice
 When an investment bank ________
securities, it guarantees a price for a
corporation's securities and then sells
them to the public.
A.Underwrites.
B.Overwrites.
C.Overtakes.
D.Undertakes.
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Multiple Choice
 These are agents of investors who match
buyers with sellers of securities.
A.Borrowers.
B.Brokers.
C.Investors.
D.Dealers.

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Exchanges and Over-the-

Counter Markets
 Secondary markets can be organized in
two ways.
 One is to organize exchanges, where
buyers and sellers of securities (or their
agents or brokers) meet in one central
location to conduct trades.
 The Ho Chi Minh and Hanoi stock
exchanges are examples of organized
exchanges.
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Counter Markets
 The other method of organizing a
secondary market is to have an over-the-
counter market.
 Dealers at different locations have an
inventory of securities stand ready to buy
and sell securities “over the counter” to
anyone who comes to them and is willing
to accept their prices.

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Counter Markets
 Over-the-counter markets include those
that trade other types of financial
instruments such as
 negotiable certificates of deposit
 banker’s acceptances
 foreign exchange.

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Money and Capital Markets

 The money market is a financial market
in which only short-term debt instruments
(generally those with original maturity of
less than one year) are traded.
 The capital market is the market in which
longer-term debt instruments (generally
those with original maturity of one year or
greater) and equity instruments are
traded.
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Multiple Choice
 Financial instruments with maturities of
less than one year are traded in the
A.Equity market
B.Capital market.
C.Money market.
D.Fixed-income market.

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Multiple Choice
 Markets for newly issued financial instruments
with maturities shorter than one year are
I. money markets
II. capital markets
III. primary markets
IV. secondary markets
A.Both I and III. C. Both II and III.
B.Both I and IV. D. Both II and IV.

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Financial Market
Instruments
 Money market instruments include the
following:
 Treasury bills are short-term debt
instruments of the government issued to
finance government spending.

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Financial Market
Instruments
 A certificate of deposit (CD) is a debt
instrument sold by a bank to depositors
that pays annual interest of a given
amount and at maturity pays back the
original purchase price.
 Commercial paper is a short-term debt
instrument issued by large banks and
well-known corporations.

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Financial Market
Instruments
 Capital market instruments include the
following:
 Stocks are equity claims on the net
income and assets of a corporation.
 Mortgages are loans to households or
firms to purchase housing, land, or other
real structures, where the structure or
land itself serves as collateral for the
loans.
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Financial Market
Instruments
 Corporate bonds are long-term bonds
issued by corporations which typically
sends the holder an interest payment
twice a year and pays off the face value
when the bond matures.
 Treasury bonds are long-term debt
instruments issued by the government to
finance the deficit of the government.
 Bank loans are loans made principally
to individuals and businesses.
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Multiple Choice
 Which of the following is a money market
instrument?
A.A treasury bill.
B.A treasury bond.
C.A corporate bond.
D.A mortgage loan.

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Multiple Choice
 Which of the following is a capital market
instrument?
A.A certificate of deposit.
B.A bank loan.
C.A commercial paper.
D.A treasury bill.

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Multiple Choice
 A debt instrument sold by a bank to its
depositors that pays annual interest of a
given amount and at maturity pays back
the original purchase price is called
A.A certificate of deposit.
B.A bank loan.
C.A mortgage.
D.A treasury bond.
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Internationalization of
Financial Markets
 An important trend in recent years is the
growing internationalization of financial
markets.
 Foreign bonds are bonds sold in a
foreign country and are denominated in
that country’s currency, for example, a
bond sold by a foreign company in Ho Chi
Minh City and denominated in Vietnamese
dong.
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Financial Markets
 Eurobonds are bonds denominated in a
currency other than that of the country in
which it is sold, for example, a bond
denominated in US dollars sold in Ho Chi
Minh City.

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Financial Markets
 Eurocurrencies are foreign currencies
deposited in banks outside the home
country.
 The most important of the Eurocurrencies
are eurodollars, which are US dollars
deposited in foreign banks outside the
United States or in foreign branches of US
banks.

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Multiple Choice
 Bonds that are sold in a foreign country
and are denominated in a currency other
than that of the country in which it is sold
are known as
A.Foreign bonds.
B.Treasury bonds.
C.Eurobonds.
D.Corporate bonds.
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Multiple Choice
 Bonds that are sold in a foreign country
and are denominated in the country's
currency in which they are sold are known
as
A.Foreign bonds.
B.Treasury bonds.
C.Eurobonds.
D.Corporate bonds.
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Multiple Choice
 US dollar deposits in foreign banks
outside the US or in foreign branches of
U.S. banks are called
A.Atlantic dollars.
B.Foreign dollars.
C.Eurodollars.
D.Outside dollars.

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Intermediaries
 Financial intermediation is the process
of indirect finance using financial
intermediaries or financial institutions and
has traditionally been the primary route for
moving funds from lenders to borrowers.
 It has the following functions: (1) lower
transaction costs, (2) reduce the exposure
of investors to risk, and (3) deal with
asymmetric information problems.
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Intermediaries
1. Lower transaction costs.
 Transaction costs is the time and
money spent in carrying out financial
transactions.
 The large size of financial intermediaries
allows them to take advantage of
economies of scale, which is the
reduction in transaction costs per
currency of transactions as the size
(scale) of transactions increases.
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Intermediaries
1. Lower transaction costs.
 In addition, a financial intermediary’s low
transaction costs mean that it can
provide its customers with liquidity
services, services that make it easier
for customers to conduct transactions.

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Intermediaries
2. Reduce the exposure of investors to risk.
 Risk is uncertainty about the returns
investors will earn on assets.
 Financial intermediaries reduce risk
through the process known as risk
sharing (also called asset
transformation).

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Intermediaries
 They create and sell assets with risk
characteristics that people are
comfortable with, and the intermediaries
then use the funds they acquire by
selling these assets to purchase other
assets that may have far more risk.

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Intermediaries
 Financial intermediaries also promote
risk sharing by helping individuals to
diversify and thereby lower the amount
of risk to which they are exposed.
 Diversification means investing in a
collection (portfolio) of assets whose
returns do not always move together,
with the result that overall risk is lower
than for individual assets.
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Intermediaries
3. Deal with asymmetric information
problems.
 Asymmetric information is the unequal
knowledge that each party to a
transaction has about the other party.

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Intermediaries
problems.
 Adverse selection is the problem
created by asymmetric information
before the transaction occurs.

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Intermediaries
problems.
 Adverse selection in financial markets
occurs when the potential borrowers
who are the most likely to produce an
undesirable (adverse) outcome–the bad
credit risks–are the ones who most
actively seek out a loan and are thus
most likely to be selected.
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Intermediaries
problems.
 Moral hazard is the problem created by
asymmetric information after the
transaction occurs.

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Intermediaries
problems.
 Moral hazard in financial markets is the
risk (hazard) that the borrower might
engage in activities that are undesirable
(immoral) from the lender’s point of view,
because they make it less likely that the
loan will be paid back.

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Intermediaries
problems.
 With financial intermediaries in the
economy, small savers can provide their
funds to the financial markets by lending
these funds to a trustworthy
intermediary which in turn lends the
funds out either by making loans or by
buying securities such as stocks or
bonds.
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Intermediaries
problems.
 In addition, financial intermediaries have
high earnings because they develop
expertise in monitoring the parties they
lend to.

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Multiple Choice
 The process of indirect finance using
financial intermediaries is called
A.Direct lending.
B.Resource allocation.
C.Financial liquidation.
D.Financial intermediation.

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Multiple Choice
 Which one is not a function of financial
intermediation?
A.It deal with asymmetric information
problems.
B.It provides a safekeeping service for those
with excess funds.
C.It lower transaction costs.
D.It reduce the exposure of investors to risk.
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Multiple Choice
 Financial intermediaries lower costs by
spreading them over a large number of
customers, thereby taking advantage of
A.Moral hazard.
B.Diversification.
C.Asymmetric information.
D.Economies of scale.

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Multiple Choice
 Reducing risk through the purchase of assets
whose returns do not always move together
is
A.Diversification.
B.Disintermediation.
C.Intervention.
D.Intermediation.

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Multiple Choice
 The process where financial intermediaries
create and sell low-risk assets and use the
proceeds to purchase riskier assets is known
as
A.Risk selling.
B.Risk sharing.
C.Risk aversion.
D.Risk neutrality.
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Multiple Choice
 Asymmetric information means that
A.All parties to a transaction have the same
amount of information on the other party.
B.Information is expensive to obtain.
C.One party to a transaction has relatively
more information than another party.
D.Information is readily available for most
parties concerned in a transaction.
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Multiple Choice
 Which of the following is a problem of adverse selection?
A.Individuals use more medical services as a result of their
purchase of a health insurance plan.
B.A person takes up the hobby of bungee jumping after
purchasing health insurance.
C.The lender has a problem of distinguishing good-risk
borrowers from bad-risk borrowers.
D.The lender has a problem determining that the proceeds
from a loan are being used as the borrower stated.

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Multiple Choice
 If bad credit risks are the ones who most
actively seek loans and, therefore, receive
them from financial intermediaries, then
financial intermediaries face the problem
A.Moral hazard.
B.Adverse selection.
C.Free-riding.
D.Costly state verification.
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Multiple Choice
 If borrowers take on big risks after
obtaining a loan, then lenders face the
problem of
A.Moral hazard.
B.Free-riding.
C.Adverse selection.
D.Costly state verification.

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Multiple Choice
 Problems of ________ arise before a loan
is made; problems of _________ arise
after a loan is made.
A.Adverse selection; moral hazard.
B.Moral hazard; adverse selection.
C.Transactions costs, adverse selection.
D.Moral hazard; transactions costs.

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Multiple Choice
 Asymmetric information poses two important obstacles to the
smooth flow of funds from savers to investors. They are:
A. Adverse selection, which arises before the transaction occurs,
and moral hazard, which occurs after the transaction.
B. Adverse selection and moral hazard, both of which occur
before the transaction.
C.Adverse selection and moral hazard, both of which occur after
the transaction.
D.Moral hazard, which arises before the transaction occurs, and
adverse selection, which occurs after the transaction.

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Types of Financial
Intermediaries
 Depository institutions (or banks) are
financial intermediaries that accept
deposits from individuals and institutions
and make loans.
 Depository institutions include (1)
commercial banks, (2) savings and loan
associations and mutual savings banks,
and (3) credit unions.

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Types of Financial
Intermediaries
 Commercial banks are financial
intermediaries that raise funds primarily
by issuing checkable deposits, savings
deposits, and time deposits and then
using these funds to make commercial,
consumer, and mortgage loans and to
buy government securities.

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Types of Financial
Intermediaries
 Savings and loan associations and
mutual savings banks are depository
institutions which obtain funds primarily
through savings deposits and time and
checkable deposits and make mortgage
loans for residential housing.

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Types of Financial
Intermediaries
 Credit unions are financial institutions
organized around a particular group
(union members, employees of a
particular firm, and so forth) and acquire
funds from deposits and primarily make
consumer loans.

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Types of Financial
Intermediaries
 Contractual savings institutions are
financial intermediaries that acquire funds
at periodic intervals on a contractual basis.
 Contractual savings institutions include the
following: (1) life insurance companies and
(2) pension funds.

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Types of Financial
Intermediaries
 Life insurance companies insure
people against financial hazards
following a death and sell annuities
(annual income payments upon
retirement). They acquire funds from the
premiums that people pay to keep their
policies in force and use them mainly to
buy government bonds, corporate bonds
and stocks.

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Types of Financial
Intermediaries
 Pension funds provide retirement
income in the form of annuities to
employees who are covered by a
pension plan. Funds are acquired by
contributions from employers and from
employees. The largest asset holdings
of pension funds are corporate bonds
and stocks.

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Types of Financial
Intermediaries
 Investment intermediaries include the
following: (1) finance companies, (2)
mutual funds, and (3) money market
mutual funds.

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Types of Financial
Intermediaries
 Finance companies raise funds by
selling commercial paper and by issuing
stocks and bonds. They lend these
funds to consumers and small
businesses.

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Types of Financial
Intermediaries
 Mutual funds are financial
intermediaries acquire funds by selling
shares to many individuals and use the
proceeds to purchase diversified
portfolios of stocks and bonds.

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Types of Financial
Intermediaries
 Money market mutual funds are
financial institutions have the
characteristics of a mutual fund but also
function to some extent as a depository
institution because they offer deposit-
type accounts. They sell shares to
acquire funds that are then used to buy
money market instruments that are both
safe and very liquid.

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Types of Financial
Intermediaries
 Which of the following is a depository
financial institution?
A.A savings bank.
B.An insurance company.
C.A finance company.
D.A pension fund.

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Types of Financial
Intermediaries
 Which of the following is not a investment
intermediary?
A.Money market mutual fund.
B.Pension fund.
C.Finance company.
D.Mutual fund.

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Types of Financial
Intermediaries
 Which of the following is not a contractual
intermediary?
A.Government pension fund.
B.Life insurance company.
C.Money market mutual fund.
D.Private pension fund.

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Types of Financial
Intermediaries
 Which of the following financial
intermediaries specialize in making
mortgage loans?
A.Pension funds.
B.Savings and loan associations.
C.Finance companies.
D.Insurance companies.

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Regulation of the Financial

System
 Financial markets are regulated for two
main reasons:
 To increase the information available to
investors
 To ensure the soundness of the financial
system.

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System
 Regulations include:
 requiring disclosure of information to the
public
 restrictions on who can set up a financial
intermediary
 restrictions on what assets financial
intermediaries can hold
 limits on competition
 restrictions on interest rates.
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System
 State Securities Commission of
Vietnam is an organization under the
Ministry of Finance of Vietnam, whose
purpose is to develop capital markets,
regulate securities activities, license
market participants, and enforce
regulations.

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Multiple Choice
 Government regulation of financial
intermediaries is generally aimed at
A.Increasing the flow of information to investors.
B.Improving the central bank’s ability to control the
money supply.
C.Making intermediaries more stable and less
likely to fail.
D.All of the above.

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Module

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Debt and Equity Markets

Debt and Equity Markets

Primary and Secondary

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Primary and Secondary

Money, Banking and Financial Markets

Primary and Secondary

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Exchanges and Over-the-

Exchanges and Over-the-

Money, Banking and Financial Markets

Exchanges and Over-the-

Money, Banking and Financial Markets

Money and Capital Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets

Money, Banking and Financial Markets