Financial and Monetary Theory

Week 1

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Administration (cont’)
Textbook:
 Frederic S. Mishkin, The Economics of
Money, Banking and Financial markets, 9th
ed., 2007 (Addison-Wesley)
 Students are required to read text book
before lectures.

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Administration (cont’)
 Assessments:
 Attendance 10%
 Small test 10%
 Group project 10%
 Mid-term exam 20%
 Final exam 50%

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FINANCIAL & MONETARY
THEORY

Week 1
OVERVIEW OF FINANCIAL SYSTEM
Chapter 1, 2

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Objectives
 Introduce financial system:
 Functions
 Structure
 Financial markets
 Financial institutions
 Financial instruments
 Regulation

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Financial markets
 What are financial markets?
 The place where funds (money) are
transferred from people who have an
excess of available funds to people who
have a shortage.
 Example: stock or bond markets…

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Financial markets

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 Function of financial markets
 A channel for moving funds from savers to
spenders in order to:
Increase production of a business


 Satisfy personal needs (buying a car…)

 Promote economic efficiency and economic

welfare of everyone in the society

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Financial markets
1. Direct versus Intermediated financial
flow markets
2. Primary Markets versus Secondary
Markets
3. Wholesale versus Retail markets
4. Money Markets versus Capital Markets
5. Foreign Exchange Markets
6. Exchange vs. Over-the-counter (OTC)
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Direct vs. indirect flow
markets

X A
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 Primary vs. Secondary markets
 Primary market
The ISSUE of a NEW
Financial Instrument
 Issuers can be:
 Businesses (issue
shares, debentures)
Governments (issue T-

notes, T-bonds)
 Individuals (Mortgage)
 To raise funds to buy
goods, services or
assets
 Secondary market
The BUYING / SELLING of
EXISTING Fin
Instrument
 No direct impact on
original issuer
Transfer of ownership

from one investor to
another investor
 Provides liquidity to
owners of Fin Instrument
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 Importance of Secondary
market
 Increase the marketability and liquidity of
new instruments issued in primary market
 Savers like liquidity and don’t like risk.

 well- developed secondary markets encourage

savings and investment
 improve economic growth

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 Wholesale vs. Retail markets
 Wholesale markets  Retail markets
 Involves large
transactions
 Direct financial flow
transactions between
institutional investors
and borrowers
 Involves smaller
transactions
 Transactions mostly
conducted with
financial intermediaries
primarily by the
household and small to
medium-sized
businesses
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 Money vs. capital markets
 Money Markets  Capital Markets
 markets that trade  markets that trade debt
debt securities & equity instruments
with maturities ≤ 1 with maturities > 1
YEAR YEAR
 e. g.: CD’s, Treasury
bills, commercial paper  e. g.: shares, term loans,
 More liquid mortgages
 Less fluctuations in
prices
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Foreign Exchange Markets
 FX markets deal in trading one currency
for another (e. g. dollar for yen)

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Exchanges vs. Over-the-counter
markets (OTC)
 Exchanges: standardized market
where buyers and sellers of securities
meet in one central location to conduct
trades.
 Example:
 OTC market: dealers ready to buy and
sell securities to anyone who comes and
accepts their prices
 Example: 16
Types of Financial Institutions
 3 categories:
 Depository institutions (banks).
 Contractual savings institutions.

 Investment intermediaries.

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 Types of Financial Institutions
(cont.)
 Depository Institutions (banks):Financial
intermediaries that accepts deposits from
individuals & institutions and make loans.
 Include:
 Commercial Banks.
 Saving & Loan Associations (S&Ls).
 Credit Unions.

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Types of Financial Institutions
(cont.)
 Contractual Savings Institutions:
Financial intermediaries acquire funds at a
periodic intervals on a contractual basis and
invest primarily in long-term securities.
 Include:
 Life Insurance Companies.
 Fire & Casualty Insurance Companies (Non-
life).
 Pension Funds & Government Retirement
Funds. 19
Types of Financial Institutions
(cont.)
 Investment Intermediaries include:
 Finance Companies.
 Mutual Funds.
 Money Market Mutual Funds.
 Investment Banks. (is not a bank or a
financial intermediary in the ordinary sense)

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Principal intermediaries and their assets

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Financial Intermediaries and their
assets

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Regulation of Financial
Institutions
 More information disclosure to investors
 Ensure soundness of financial intermediaries:
Example:
 Person to set up financial intermediaries

 Reporting requirements

 What to do, what assets to hold

 Insurance for deposits

 Expansion of branches

 Interest rates

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Regulatory agencies of US
financial system
 Security and Exchange Commission
(SEC)
 Office of the Comptroller of the
Currency (OCC)
 Federal Reserve System (FED)
 Federal Deposit Insurance Corporation
(FDIC)

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Vietnam financial regulatory
authorities

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Source:tapchitaichinh.vn
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Financial instruments
 Financial Assets: An asset that entitles the owner
to future cash flows or real assets (interest
payments, principal repayments and capital gains).
Eg.: trade receivable, shares, bonds
 Financial Instruments: any contract that give rise
to a financial assets of one entity and a financial
liablility or equity instrument of another entity
Eg.: shares, bonds, commercial loan,
 Financial Securities: Financial instrument that has
an organised SECONDARY market (eg.:Bond,stock;
Bank deposits/ normal Bank loans are not securities)
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 Financial instruments
1. Equity: Shares
 Ownership of an asset (company) – No maturity
 Voting right
 Direct benefit from higher profitability and asset value
 Owners have RESIDUAL Claims:
 Claim on profits (dividend)

 Claim on assets (in liquidation case/ bankruptcy)

 Types:
 Ordinary Share

 Hybrid (or quasi-equity) security: such as Preference

Shares & Convertible Notes 28

Financial instruments
2. Debt
 Loans, Bonds, debentures, commercial bills, P notes,
overdrafts, leases …
 Contractual claim to
 Periodic interest payments

 Repayment of principal

 DEBT Claim ranks ahead of EQUITY Claim

 Can be secured or unsecured, short term or long
term, at floating rate or fixed rate, negotiable or non-
negotiable.
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Financial instruments
 Bond: debt security that promises to make
payments periodically for a specified period of
time.
Example: 5 year Treasury Bond with face
value of VND10 million, coupon rate 8% paid
semi-annually
 Maturity:
 coupon payment:
 Price:
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 Financial instruments
3. Derivatives
 Provide specific future rights in relation to a
 Physical market commodities

 Gold and oil

 Financial instruments

 Currencies, debt and equities instruments

 Purpose: + to manage price risk exposure

+ to speculate
 4 types: Futures, forwards, options & swaps
 In VN: 10/08/2017, launch Derivative market (VN30
futures, 5-year T-bond futures) 31
Financial instruments
 Short-term instruments: Money market
instruments (less than 1 year)
 Treasury bills

 Negotiable certificate of deposits

 Commercial paper

 Repurchase agreements (repos)

 Fed Funds

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Financial instruments
 Long-term instruments: Capital
markets instruments
 Stocks
 Mortgage
 Bonds: corporate, government (central,
local, authority)
 Consumer and bank commercial loans

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Financial system: summary
 Basic function is to facilitate efficient flows
of funds from savers to spenders
domestically and internationally.
 Increase production and efficiency of the
economy, wealth to consumers
 Financial markets can be classified by
different categories and by instruments,
which are traded in the markets

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Financial system: summary
 Financial intermediaries: transaction costs
and information asymmetry.
 Financial markets are integrated for easier
access and mobilization of funds
 Financial systems are heavily regulated by
governments and international standards.

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