FINA3010 Financial Markets

Chris Leung, Ph.D., CFA, FRM

Email: chrisleung@cuhk.edu.hk

1
 Financial Markets
Financial Markets

Debt Equity

Money Bond Mortgage Stock FX Commodities,

Markets Markets Markets Markets Markets Derivatives etc.

The Fed
(Central Bank)

Interest Rates Rates of Returns

2
Financial Markets and Financial Intermediaries

Financial Markets
Lender- Borrower-
Matching
savers spenders
Direct Finance

Financial Intermediaries
Lender- Borrower-
FIs (e.g. Banks)
savers spenders
Indirect Finance

3
 Financial System

 Goal
 Economic Efficiency (Cost Minimization)

 Costs
 Explicit transaction costs
 Implicit transaction costs (Asymmetric
Information)

4
 Implicit transaction costs

 Asymmetric Information
 Different parties in a transaction have
different information
 Borrowers ALWAYS know more than Lenders

 Issues
 Adverse Selection
 Moral Hazard

5
Asymmetric Information
 Adverse Selection
 Before transaction
 Wrong person

 Moral Hazard
 After transaction
 Empty promise

6
 Financial Structure (8 Facts)

 Explicit transaction costs

 Economies of scale
 Economies of scope?

 Implicit transaction costs (Asymmetric

Information)
 Screening (Adverse Selection)
 Monitoring (Moral Hazard)

7
Conflict of interest

 Classic Cases
 Investment Banks
 Underwriting vs. Research
 Audit Firms
 Consulting vs. Auditing
 Rating Agencies
 Consulting vs. Credit rating
 Reduction in information quality
 Concealment, Distortion
 A factor for Financial Crises
8
 Financial Crises

Underestimation Asset Bubble/ Bubble Deterioration Uncertainty

of Risks Credit Bubble Burst in FI’s B/S (Failures, Bank Runs)

Adverse Selection
& Moral Hazard 

Credit Crunch GDP (C,I)

Financial
Innovation
Deflation
Conflict of
Interest
Long Period
of Stability