Key content:

1. Financial markets, financial assets, financial market participants:

definitions, classification.
* Definitions Financial markets:
In the market, used to trade, commodity, bonds, stocks, assets, derivatives, CDs.
The financial market refers to the market where the sale and purchase of financial
products occurs. Such products include stocks, bonds, currencies, derivatives,
commodities, cryptocurrencies, etc. It acts as a platform for sellers and buyers to
connect and deal in their desired financial assets at a price determined by market
forces.
*Definitions Financial assets:
Financial assets are intangible assets, which represent a claim to future cash for its
holder.
Ex: A loan by bank to a student to pay tuition fees for university
A share of common stock issued by Google
A bond issued by the US Government.
+classification:
Financial assets are mainly classified in 2 ways by its characteristics
-By the nature of claims:
Debt securities: Holders are the lenders of Issuer
Equity securities: Holders share the ownership with the Issuer
-By the maturity of the financial assets
Mature in a year or less : Repurchase agreements, T-bill, commercial paper
Mature in more than a year: T-bon

*financial market participants:

+ Surplus units/ Lenders/ Fund providers/ Savers: is an economic unit with income
that is greater than or equal to expenditures on consumption throughout a period.
- Motivation of lenders: Time value of money; inflation; interest rate; etc.
+ Household/individuals:
Ex: Employees put a part of their income in a pension fund; employees keep a part of
their income in bank saving account; etc.
+ Companies:
Ex: Companies keep a part of their profit in bank; Companies who purchase other
companies’ stock or government bonds in the stock exchange;
+ Government (rarely):
Ex: Central bank buy company bonds or government bond in the stock exchange;
Central bank lend commercial banks through interbank system
+ Deficit units/ Borrowers/ Fund Seekers: is an economic group within that
economy, has spent more than it has earned over a specified measurement period.
- Motivation of borrowers: Need of capital/ shortage of fund; risk sharing; etc.
+ Household / individuals:
Ex: Students borrow fund from bank to pay for university tuition fee
+ Companies:
Ex: Company sells their stock in the stock exchange; Company borrows fund from
commercial bank for a new facility investment
+ Government:
Ex: Government sell government bond
+ Municipalities and Public corporations:
+ Intermediaries: is an entity that acts as the middleman between two parties
(surplus unit and deficit unit) in a financial transaction.
2. Commercial banks: Roles to economy, Potential issues.
* Roles to economy:
Commercial banks have significant roles to the economy:
Facilitate payment process, thus promote trading activities on both domestic scale and
international scale
Create liquidity in the market, matching the needs of fund providers and fund seekers
Through the ecosystem of depository institutions, government monetary policy is
implemented.
* Potential issues:
*Retail Banks:
Across all financial markets, retail banks face a series of key challenges:
Capital strength: Have they got enough to back their business?
Liquidity: Can they meet predictable and unpredictable cash requirements?
Risk management: Can banks and their supervisors manage risk (individual risks and
systematical risks) properly?
Executive pay: Do they pay too much?
Competition: Can they price competitively comparing to nontraditional rivals?
Cost control: Can they be efficient?
Sales of non-banking products: What products should they offer?
Use of IT: How can IT help in reducing cost in front and back office operations?
1. Capital strength:
The capital is the buffer - the money the bank can rely on if there are some default
borrowers, who cannot repay their loan to bank.
Capital ratio is relationship between capital and lending.
The capital ratio is the percentage of a bank's capital to its risk-weighted assets.
Weights are defined by risk-sensitivity ratios whose calculation is dictated under the
relevant Accord.
Basel II requires that the total capital ratio must be no lower than 8%.
2. Liquidity:
Cash outflows > Cash inflows Liquidity issue
Liquidity refers to both ability to pay short-term bills and debts and the capability to
sell assets quickly to raise cash of a bank.
3. Risk management:
Commercial banks have to deal with various types of risk in their daily operation:
Credit risk, liquidity risk, interest rate risk, market risk, operational risk, etc.
However, the biggest problem related to risk management in banks is that risks were
being understated and priced incorrectly. The causes of these issues is the failure of
The Credit Rating Agency System and The Monoline Insueres, which were revealed
through the financial crisises.
The financial crisis exposed the issues of systematic risk in financial system, which
led to multiple adjustments in the national and international financial laws and norms
(Basel II -> Basel III).
4. Executive pay:
Excessive salaries and bonus payments in the banking sector are said to have fuelled
the lending and securitization spree that culminated in the banking sector collapses
during 2007-2009 crisis.
The Walker Review (UK, 2009) highlighted that weak corporate governance
structures were likely to have been responsible for excessive risk-taking by banks and
had therefore been a cause of the crisis.
5. Competition:
The deregulation process and financial law system in many countries have led to the
growing competition in commercial bank industry with the enter of other financial
institutions, retailers, insurance companies and in-house corporate facilities.
Ex: Retailers: In Sweden, IKEA offers current account facilities. In the UK, Mark and
Spencer offer unsecured loans, mutual funds and life insurance.
6. Cost control:
In retail banking, a major cost is the branch network. In recent years, the branch
network have experience the rationalization and automation processes in many
countries.
Another major expense is the cost of processing paper payment transactions (Cheques
clearing), although there is big shiftment from cheques transaction to online banking.
M&A is considered as an effective way to cut cost in banking system.
7. Sale of non-banking products:
Nowadays, bank employees are typically set sales targets for non-bank products amd
commission from such sales is an increasing portion of teller staff remuneration. In
the UK and some other EU countries, many major banks have increased the propotion
profits from sale of non banking products, such as insurance, mutual fund, securities
broker, etc.
This led to the difficulties for the government to supervise these activities and the
potential issues of taking excessive risks by commercial banks and transferring these
risk to their depositors.
8. Use of IT:
Modern banking is unthinkable without the use of IT. Many developments and
expansion in commercial bank industry have IT at their heart.
*Wholesale banks:
The increasing market for Equity and Bonds leads to the shrinking market for bank
loans, which is the major services of wholesale banks.
Many wholesale bank expand their operation via acquisition into investment banking,
thus, potentially increase the level of risk they acquire.
Wholesale banks are increasingly dependent on financial market, not only for funding
sourcing but also for risk management, which could spread systematical risk to the
whole market.
The increasingly use of securitization.

3. Central Banks: Activities (Creating MP, Banker to other banks; Banker to

Government; Raising money for government) and issues.
* Creating Monetary Policy:
Monetary policy is a central bank's actions and communications that manage the
money supply
Two types of Monetary Policies tools are:
Borrow: by Open Market Operation
Non-borrow: Reverse Requirement & Discount Rate
Central banks intervene in financial markets, push the market efficiency and liquidity
to benefit the whole economy.
The general goal of Monetary Policy is to promote maximum employment, stable
prices and moderate long-term interest rate.
Example: State Bank of Vietnam cuts rate the second time in 2020 on May to support
the economy recovery after Covid block down.
*Central Banks Activities: Banker to other Banks:
The central bank will act as banker to the other banks in the economy.
Reserve: is the amounts of money that central bank requires other banks to deposit in
central bank.
This reserve is non-interest-bearing.
This reserve serve as an instrument of control over the money supply
Reserve is defined by central banks as a ratio of banks liabilities, based on the
economic condition, financial situation of banks, etc. and revised periodically.
*Banker to the Government:
Central bank receives revenues for taxes or other income and pays out money for the
government’s expenditures.
As taxes are paid, the government balance increases, and the commercial banks’
balances fall. When the government spends money, the opposite happens.
* Raising money for the government:
This usually involves the sale of short-term T-bills and medium- to long-term
government bonds.
The national debt is usually shown as a percentage of GDP to see whether the
situation is worsening or improving.
Central banks will not lend to the government but will help the government to borrow
money by the sales of its bills and bonds.
ISSUES.
* Trade off Issue:
Goals of monetary policies is numerous, but the direction of monetary policies is
limited.
 1. Losing/ dovish monetary policies: increase money supply by trying to reduce
interest rate, reduce reserve requirement, inject money to the market through
OMO.
2. Tighting/ hawkish monetary policies: reduce money supply by trying to
increase interest rate, increase reserve requirement, withdraw money from the
market through OMO.
However, it is often the case that one of the goals may require a monetary policies that
is inconstant with some other goal. In other words, a monetary policy that furthers
progress toward one goal may actually make attaining another either difficult or even
impossible.
* Independence Issues
The Independence toward the national government has always been an important
issue of the central banks.
The final goal of central bank is to support the long-term stable growth of the
economy, which sometime may not be in line with the political goals of the
government.
Ex: Decision of FED on Interest rate during the Economic War with China (2019)
* Measurement of Inflation
One of the key roles of the Central Bank is to control inflation.
In tradition, Inflation is measured by Consumer Price Index (CPI) and Producer Price
Index (PPI). These 2 ratios is used as measurement of the economy stability.
However, with the expansion of financial markets and the involvement of many
economic parties in financial transactions, the fluctuation of financial asset price
also dramatically impact the stability of the economy.
Although it is not the role of Central Banks to maintain stock market growth, the
excessive prices of many shares before they collapsed and the knock-on economic
effect of stock market instability is clearly of concern to central bank in this modern
days.
* Accountability Issues
Accountability is another current issue. National central bank, such as Fed, is
accountable to their governments and citizens. Therefore, Fed holds public meeting
every few months to announce their up-coming monetary policies and explain their
decision.
Unlike Fed, the ECB has less accountability to their members’ government. The ECB
president only meet European Parliament once a year to explain policy. Thus, it
maybe more difficult for the ECB to attract public support than Fed or other national
central banks.
* Systemically Important Fis (SIFIs)
The role of central bank as LLR leads to the raising of the Systemically important
financial institutions (SIFIs).
These FIs have the other name, which is Too-big-too-fail.

4. Investment Banks: Activities (Accepting BoE; Discounting BoE;

Investment management) and issues.

* Accepting BoE:
‘Accepting’ bill of exchange means signs the bill, promising to pay.
Bill of exchange: is a promise to pay a trade debt. There are bank bill (eligible bill)
and trade bill.
The bill of exchange is frequently sold at a discount.
Commercial banks will also accept bills, but historically, it is an investment bank
activity.
In some cases, the bank may be unsure of the credit status of the importer and
unwilling to discount the bill. In these cases, their would be a bank call accepting
bank (normally is the bank in importer country), who accept this bill (which mean
this accepting bank promises to pay if the importer fail to pay).
*Discounting BoE:
- Def: Discounting of bills of exchange is a financing transaction wherein a company
remits an unexpired commercial Bill of exchange to the bank in Return for an advance
of the amount of the bill, less Interest and fees.
Differences between Discounting BoE&Accepting BoE:
Accepting( based on country of the buyer): together with buyer give promise to pay
for the bill
Discounting(based on the country of seller): buy the bill at discount rate
Ex: TNG~exporter buy input material from Taiwan producer~buyer, importer
-> TNG made payment to TW producer using BoE with maturity of 3 months
-> TNG ask BIDV to accept their BoE-> BIDV is accepting bank
-> Trade bill -> Bank bill (if BIDV is on the eligible list of CB -> eligible bill)
*If TW producer need money in urgent -> discount the BoE to a bank~sell the BoE at
discount.
+Nature:
Acceptance: It involves a formal acknowledgment by the drawee to pay the bill on the
specified date.
Discounting: It involves selling the bill before maturity to get immediate funds, with
the buyer earning interest (discount) upon maturity.
+Timing:
Acceptance: Payment occurs on the maturity date specified in the bill.
Discounting: Immediate funds are received, but the discount represents the cost of
early payment.
+Involvement of Third Party:
Acceptance: Only the original parties (drawer, drawee, and payee) are involved.
Discounting: A third-party (discounting institution) is involved in the transaction.
Both acceptance and discounting provide flexibility and liquidity to the parties
involved in bill of exchange transactions, addressing the need for either immediate
funds or a formal commitment to payment at a later date.

* Investment management:
The investment funds these managers control may be the bank’s own funds or fund
from other institutions/individuals:
High-net-worth individuals: minimum sum will be stated for those people who want
to use this service.
-Corporates: may either have good cash flow and wish to pay someone else to handle
their investments or may build up a large ‘war chest’ and temporarily pay an
investment bank to handle this.
-Pension funds: are usually the biggest clients of the investment management
department in investment bank
-Mutual funds: collective investments in money market instruments, bonds or equities.
The investment bank may run its own fund and advertise its attractions to small
investors.
-war chest: fund earmarked for a specific purpose, action, or campaign, such as
acquisition. A war chest is often invested in short-term investment, which can be
accessed on-demand.
- ISSUES:
* Deregulation
Many commercial banks have investment bank subsidiaries and that universal banks
do all kinds of banking service, the investment bank also overlap commercial bank in
many activities.
Deregulatory process => blurring the barrier between commercial banks & investment
bank, the emerging of universal institutions.
Final goal of regulation: Control risk, especially systematic risk that financial
institutions, include investment bank, take
* Competition from Commercial Bank
Historically, accepting bill of exchange is strictly investment bank activity and being
the important part of investment bank profit.
Nowadays, commercial bank started to offer this service and become competitors of
investment bank due to the deregulation process.
* Vulnerable to Financial Crisis
Before Crisis, the deregulation leads to the expansion of large invesment banks toward
commercial banking to diversify their funding portfolio (seek for more source of
fund). This fueled the Crisis.
After Crisis, cause this didn’t work, since 2011-2013, investment bank started to
consolidate their activities.
* Shadow Banking
Shadow banking: typically non-bank financial institutions that undertake banking
style business but are not subject to banking regulation, for example:
 Hedge funds: lend to (usually risky) businesses, which may fail to ask
for loan in official bank
 Private equity companies: lend to the businesses they buy out
 Insurance firms: invest in securities market
 Other specialist investment firms: buy and sell securitized bank and
other assets
This sector boomed in the run-up to the 2007–8 credit crisis, fell back when the
bubble burst, but is now growing again as big banks cut back on lending.

5. Security market: Money market; Bond market; Bond market instruments;

Equity market (secondary markets; efficient markets) and issues (credit
rating agency issues, traditional stock exchange floor issues, hedge fund
issues).

* Money market:
Money market is the market for short-term funds (borrowing/lending money for 1
year or less)
Main types of money markets include:
Call market: Liquid funds lent for very short periods, usually overnight and could be
recalled at short notice (3~7 days priors).
Interbank market: the market where one bank will lend money to another at the
interbank offered rate. For example: London Interbank Offered Rate (LIBOR); Tokyo
Interbank Offered Rate (TIBOR).
Money market securities: Markets for securities, which mature in a year or less.
* Bond market:
Bond market is the market for medium (<15 years) to long-term (>15 years) financial
instruments.
Important information on bond:
+The name of the bond
+The nominal or par value in the currency of denomination
+The redemption value – usually the nominal value, but there are other possibilities,
index linking, for example
+The rate of interest, expressed as a percentage of nominal value, which is called the
‘coupon’ and in which the frequency of payment is stated.
+The redemption date.
*Bond Market Instruments:
Types of Bond are classified by its Issuer or the way they are created:
+Government bonds:
Government and public sector bonds are usually the most important
Government bonds are issued by Central bank or Ministry of Finance; sold at auction
periodically (monthly or quarterly); issued to specialist dealers or syndicate of banks;
pay interest (coupon) once or twice annually.
+Local authority/public utility bonds:
This is a type of government bond but issued by local authority (state, city, etc.) or
public sector (post office, railway, government unity fund, etc.)
+Mortgage and other asset-backed bonds (ABS):
This is securities backed by assets (car, house, real estate, facilities, etc.) and is the
result of securitization process.
In some markets, there is a big market for ABS, especially mortgage bonds or
collateralized mortgage obligations (CMOs) or commercial mortgage-backed
securities (CMBS). These securities contribute greatly to the formation and the
booming of housing bubble in financial crisis 2008-2009.
* Corporate bonds:
Bond issued by corporates and has strong market in US and EU.
Some corporate bonds may have super long-term, up to 50 years, or even, 100 years.
Bond is preferable way to obtain fund for corporate since the interest pay for
bondholder is tax deductible.
There are a number of variations on the corporate bond theme as follows:
4.1. Debentures: are corporate bonds that are backed by assets, for example, land and
buildings. If the issuer goes into liquidation, these assets must be sold to pay the
bondholders. Because they are more secure, however, the rate of interest is less
4.2. Convertible: is a bond that can be converted later, either into another type of
bond (for example convertible gilts) or into equity. The difference between the
implied conversion price of the equity and the market price is called the ‘premium’.
4.3. Exchangeable bonds: have the right to convert is into another company’s shares,
which the issuing company owns. This was a way of issuing company to reducing its
holding in a member company without directly selling the shares and moving the
price against it.
4.4. Warrants: is a bond in which the right to buy shares later at a certain price is
contained in a separate warrant. This is more flexible than the convertible in that the
warrant can be used later to buy shares more cheaply while still keeping the bond. The
warrants are often detached from the bonds and sold separately.
Sometimes, an entity that is not the company may issue warrants on the company’s
shares.
4.5. Preference shares: usually pay dividends as a fixed percentage rate. If there is
any shortage of money, their dividends must be paid out before other dividends. In the
event of liquidation, preference shareholders have priority over ordinary shareholders.
They normally have no voting rights. If the dividend cannot be paid, it is legally owed
to them. Hence they are cumulative (normally).
5. Hybrid Bond:
This type of bond has characteristics of bonds and equity. Rating agencies tend to
view them as quasi-equity, and capital can thus be raised without putting credit ratings
at risk. They are more expensive to the issuer comparing to original equity but are
treated as debt for accounting purposes and thus are tax deductible.
6. Foreign Bond:
Foreign bonds are domestic issues by non-residents. Notice that the bonds are
domestic bonds in the local currency, it’s only the issuer who is foreign. They should
not be confused with international bonds (also called Eurobonds), which are bonds
issued outside their natural market.
Foreign bonds may be subject to a different tax regime or other restrictions.
7. Junk Bonds (High-yield Debt):
Junk bonds were a phenomenon that occurred in the US domestic markets in the
1970s and 1980s. Bonds rated below BBB grade by credit rating agency were
essentially speculative. As a result, they offered a much higher rate of interest.
* Equity market:
+In Secondary Market:
Organized exchange floor: Each organized exchange has a trading floor where floor
traders execute transactions in the secondary market for their clients. However, a
major amount of organized exchange floor transactions is nowadays rely on electronic
system for matching trades.
Ex: New York Stock Exchange (NYSE), London Stock Exchange (LSE)
Over-the-counter Market: Stocks not listed on the organized exchanges are traded in
the over-the-counter (OTC) market. Unlike the organized exchanges, the OTC market
does not have a trading floor. Instead, the buy and sell orders are completed through a
telecommunications network.
Ex: National Association of Securities Dealers Automatic Quotations (Nasdaq); OTC
Bulletin Board.
+efficient markets:
Eugene Fama’s efficient market hypothesis (EMH) developed in the early 1960s.
The EMH asserts that financial markets are ‘informationally efficient’. There are three
main versions of the EMH, weak, semi-strong and strong.
-Weak-form EMH asserts that prices on any traded asset (equity, bonds, commodities,
property and so on) already reflect all past publicly available information. In this case,
the future prices of these assets cannot be predicted by analysing prices from the past.
-Semi-strong-form EMH claims that prices reflect all publicly available information
plus any new public information. In semi-strong-form efficiency, asset prices vary
according to publicly available new information very rapidly, so no excess returns can
be earned by trading on that information.
-Strong-form EMH argues that prices instantly reflect all public and private
information – even ‘insider’ information. In strong-form efficiency, no one can earn
excess returns. It should be noted that if there are various legal and other barriers to
private information becoming public, as with insider trading laws, strong-form
efficiency is impossible (apart from the case where the laws are ignored).

* and issues (credit rating agency issues, traditional stock exchange floor issues,
hedge fund issues):
+credit rating agency issues:
Investor in security market rely heavily on credit rating agency to assess and evaluate
their investment.
The higher the creditworthiness of the borrower, the lower the rate of interest
There are several companies in the credit rating business but the three most important
are:
Standard & Poor’s (McGraw-Hill)
Moody’s Investors Service (Dun & Bradstreet)
Fitch Ratings.
In general, the ratings are based, in varying degrees, on the following considerations:
1. Likelihood of default – capacity and willingness of the obligor as to the timely
payment of interest and repayment of principal in accordance with the terms of the
obligation
2. Nature and provisions of the obligation
3. Protection afforded to, and relative position of, the obligation in the event of
bankruptcy, reorganization or other arrangement under the laws of bankruptcy and
other laws affecting creditors’ rights.
However, each agency has its own model to rate credit risk, and these mechanism is
not public.
Up to 2008, 0.6% of S&P AAA and 0.5% of Moody’s corporate bonds had defaulted.
For bonds rated CCC (Caa in the case of Moody’s), the default rate was 69%. Both
Moody’s and S&P experienced an increase in default on high-yield debt during 2009
and 2010 due to the worsening economic environment.
Clearly, lower grade assets will have to pay more than higher grade assets to
compensate for higher risk.
Credit ratings are used extensively in the domestic US market and the euromarkets,
both for corporatations, financial insitutions and governments.
However, the financial crisis 2007-2008 exposed the issues of credit rating agency.
The key issues with credit rating agency problems are:
They always looking backwards and therefore regarded as too low
They have been accused of being too lenient in rating securitization transactions, that
is giving low-risk assessments to complex products, making them more marketable to
investors.
Concern about rating shopping, while agencies are paid by those whose products they
rate.
The concern is that the agencies could help reproduce the model of finance capitalism
with the formation of asset-price bubbles.

+ traditional stock exchange floor issues:

Traditional stock exchange, such as:
 New York Stock Exchange in the US
 London Stock Exchange in the UK.
These stock exchange platform have to deal with high competitiveness from other
brokers, who offer cheaper Internet trading or Electronic Communications Networks
(ECNs), such as:
 Tradepoint in the UK and EU (1995-2009)
 Posit Match
 Turquoise
 Chi-X
These networks act as mini-exchange and some time even be considered as official
trading platforms by SEC and other regulators.
These platforms have grown very fast to take over a large proportion of asset turn over
in the security market.
Example: In 2014, LSE was accounting for 23% of turnover in Europe market; Chi-X
and Turquoise accounted for 25%.
Other competition pressure comes from “Dark Pool” trading.
Dark pool trading: the system that allow the trading of large blocks of shares to be
carried out away from the public, or order book of an exchange or other type of
publicly available share trading platform.
In Europe (2014), dark pool trading also account for 10-15% of European equity
market turnover.
Reaction of Traditional Stock Exchange:
 Offer more flexibility with evening sessions
 Demutualization the ownership of the exchange platform for greater flexibility
for raising capital, greater accountability for owners, improve governance,
better competitive position, however, more vulnerable to takeover.
Originally, stock exchanges are mutually owned by member brokers. Demutualization
mean members sell their shares in IPOs.
Ex: LSE went public in 2000; NASDAQ went public in 2003; NYSE went public in
2006.
 Cut costs by merging with derivatives exchanges or other stock exchanges.
Ex: NASDAQ merge with AMEX and acquired the Instinet electronic exchange;
NYSE merged with Archipelago in 2006 to offer both floor and electronic trading.
+ Hedge fund issues
Potential Issue with Hedge Fund:
1. Regulation: hedge funds have been free of the regulation and control under
which investment banks and commercial banks operate, thus, usually be
referred as unregulated funds.
2.Risky strategy: Heavily using leverage, thus, magnifying both profit and loss. And
other absolute strategies.
Ex: Long-term Capital Management Collapse in 1998
3. Potentially put negative impacts on the movement of financial markets with short
selling activity
Ex: Some hedge fund short sale stocks of financial institutions, that engaged in MBS
trades, thus worsening the situation.
4. Potentially harm the economy with arbitrage or speculation activities.
Ex: Some hedge speculate oil, sugar, wheat on special occasions.
5. High potential of fraud
Ex: Bernard Madoff scandal

6. Financial Crisis: Macroeconomic factors, Securitization.

* Macroeconomic factors:
Global financial imbalance: large and persistent current account deficits and surpluses
that came from capital flows from capital-poor emerging market countries (Asia and
the oil-rich Gulf) to capital-rich industrial economies (particularly the US).
Long period of low real interest rates: In the US, from 2001 to 2005, the federal funds
rate was consistently below 1%. In the Eurozone, real rates were around 1% over the
same period.
Consequence
Fueled credit boom: annual credit growth ranged between 7% and 10% in the US and
the UK between 2003 and mid-2007.
Increase the present discounted value of revenue streams from earning assets
=>increase asset price
The BIS reports that real property prices in the US and UK increased by more than
30% between 2003 and mid-2007. Global equity markets rose by 90% over the same
period.
Encourages banks and other unregulated Institutions take on more risk.
* Securitization:
+Start of Securitization:
The origin of the US securitization business starts from the failure of the savings and
loans associations (S&Ls).
The crisis situation faced by the S&L sector led the US authorities to set up the
Resolution Trust Corporation, which took assets off the S&Ls’ books and sold them
on to investors and other banks.
The process outlined above, whereby S&Ls moved loans off the balance sheet and
sold them on to investors, was the first major securitization.
Banks no longer had to rely on deposits to make loans; they could make loans and
then sell them on to investors in the form of securities that finance the lending activity.
Originate-to-distribute model vs Originate and hold model of loan.
Before securitization, banks could only make a limited number of loans based on the
size of their balance sheets; however, the new form of financing allowed lenders to
sell off their loans to other banks or investors, and the funds raised could be used to
make more loans

7. Derivatives: Types of derivatives:

*Future Contracts:
Definition: A futures contract is an agreement to buy or sell an underlying asset at a
specific date in the future for a predetermined price with specific volume.
By purchasing the right to buy, an investor expects to profit from an increase in the
price of the underlying asset.
By purchasing the right to sell, the investor expects to profit from a decrease in the
price of the underlying asset.
*Option Contracts:
An option contract is a promise to keep an offer open for another party to accept
within a period of time. With an option contract, the offeror is not permitted to revoke
the offer within the stated period of time.
An option premium is the current market price of an option contract. It is thus the
income received by the seller (writer) of an option contract to buyer party.
* Forward Contracts:
A forward contract is a contract agreement to buy or sell an underlying asset at a
specific price on a specified date in the future.
The party who buys a forward contract is entering into a long position, and the party
selling a forward contract enters into a short position.
If the price of the underlying asset increases, the long position benefits.
If the underlying asset price decreases, the short position benefits.
*Swap Contract:
Swap contracts are financial derivatives that allow two transacting agents to “swap”
revenue streams arising from some underlying assets held by each party.
+Interest rate swaps allow their holders to swap financial flows associated with two
separate debt instruments.
+Currency swaps allow their holders to swap financial flows associated with two
different currencies.
+Hybrid swaps allow their holders to swap financial flows associated with different
debt instruments that are also denominated in different currencies.
Swaps are commonly used by banks, financial institutions, and institutional investors
for arbitrage or hedging purpose.

8. EAGLEs: Definition, Banking system in EAGLEs, Capital market in

EAGLEs

* Definition Emerging and Growth-Leading Economies:

Emerging and Growth- Leading Economies are defined as economies whose
contribution to world economic growth over the next few decades is expected to
exceed the average of the leading industrialized nations.
*Banking system in EAGLEs:
MIF reported in 2014, there are 7 countries achieved EAGLE status, including:
China
India
Indonesia
Russia
Brazil
Turkey
Mexico
* Capital market in EAGLEs:
 In China
The main stock exchanges are in Shanghai and Shenzhen. Shares are divided into
three main classes:
1. ‘A’ shares are quoted in renminbi and available to domestic investors, but there
is restricted access only for 71 ‘qualified’ foreign investors.
2. ‘B’ shares are quoted in hard currencies, mainly in US and Hong Kong dollars.
3. ‘H’ shares are those quoted in Hong Kong.
The stock market regulator is the China Securities Regulatory Commission (CSRC).
A key feature of Chinese markets is their extreme volatility. Typically, it is a market
characterized by booms and busts apparently unrelated to the country’s overall
economic performance.
 In India,
There are 22 stock exchanges and a National Stock Exchange (NSE) in Mumbai. The
NSE was set up in 1993 as the first debt market exchange for T-bills, government
securities and corporate bonds.
The Bombay Stock is the dominant equity market, set up in 1875, and is thus the
oldest in Asia.
There is also the Over-the-Counter Exchange of India for the listing of small and
medium-sized companies.
The regulator is the Securities and Exchange Board of India, and the market is
transparent and well-regulated

9. Key Trends in GFM: Re-regulation, Islamic Banking, Consolidation of

Banking sector, Investment trends.
* Re-regulation:
Concerns about the explosion of OTC derivatives contracts – particularly swaps and
CDS – have led to the US and the EU to call for much greater regulatory oversight of
these instruments and moves to pull them back onto exchanges where activity can be
more closely monitored.
Excessive exposures and leverage could, in theory at least, be reduced if much of this
activity was brought onto exchanges where greater transparency would ensue.
Nowadays, most derivative trading, therefore, will be undertaken through central
clearing houses and recognized exchanges and regulators, and the exchanges will
determine what should be exchange traded.
Exchange-traded derivatives are more transparent than their OTC counterparts, and
the credit risks will shift to the exchange.

* Islamic Banking:
One area of banking business that continues to be of interest and was barely affected
by the global credit crisis was Islamic finance
Islamic finance is a way to manage money that keeps within the moral principles of
Islam. It covers things like saving, investing, and borrowing to buy a home.
Conventional banking system Islamic banking system
Money is a product besides medium of Real asset is a product. Money is just a
exchange and store of value medium of exchange.
Time value is the basis for charging Profit on exchange of goods & services
interest on capital is the basis for earning profit.
The expanded money in the money Balance budget is the outcome of no
market without backing the real assets, expansion of money
results deficit financing.
Interest is charged even in case, the Loss is shared when the organization
organization suffers losses, Thus no suffers loss
concept of sharing loss.
While disbursing cash finance, running The execution of agreements for the
finance or working capital finance, no exchange of good and services is must,
agreement for exchange of goods & while disbursing funds under Murabaha,
services is made Salam & Istisna contract
Due to non existence of goods & Due to existence of good & services no
services behind the money while expansion of money takes place and thus
disbursing funds, the expansion of no inflation is created.
money takes place, which creates
inflation.
While disbursing cash finance, running The execution of agreements for the
finance or working capital finance, no exchange of goods & services is must,
agreement for exchange of goods & while disbursing funds under Murabaha,
services is made. Salam & Istisna contracts
Due to non existence of goods & Due to existence of goods & services no
services behind the money while expansion of money takes place and thus
disbursing funds, the expansion of no inflation is created
money takes place, which creates
inflation
Due to inflation the entrepreneur Due to control over inflation, no extra
increases prices of his goods & services, price is charged by the entrepreneur
due to incorporating inflationary effect
into cost of product
Bridge financing and long term loans Musharakah & Diminishing Musharakah
lending is not made on the basis of agreements are made after making sure
existence of capital goods the existence of capital good before
disbursing funds for a capital project
Government very easily obtains loans Government can not obtain loans from
from Central Bank through Money the Monetary Agency without making
Market Operations without initiating sure the delivery of goods to National
capital development expenditure Investment fund
Real growth of wealth does not take Real growth in the wealth of the people
place, as the money remains in few of the society takes place, due to
hands multiplier effect and real wealth goes
into the ownership of lot of hands
Due to failure of the projects the loan is Due to failure of the project, the
written off as it becomes non performing management of the organization can be
loan taken over to hand over to a better
management
Debts financing gets the advantage of Debts financing gets the advantage of
leverage for an enterprise, due to interest leverage for an enterprise, due to interest
expense as deductible item form taxable expense as deductible item form taxable
profits. This | causes huge burden of profits. This | causes huge burden of
taxes on salaried persons. Thus the taxes on salaried persons. Thus the
saving | and disposable income of the saving | and disposable income of the
people is effected badly. This results people is effected badly. This results
decrease in the real gross domestic decrease in the real gross domestic
product product
Due to decrease in the real GDP, the net Due to increase in the real GDP, the net
exports amount becomes negative. This exports amount becomes positive, this
invites further foreign debts and the reduces foreign debts burden and local-
local- currency becomes weaker currency becomes stronger
The successful operation of these institutions and the experiences in Pakistan, Iran,
Malaysia, Saudi Arabia, Bahrain and throughout the Islamic world demonstrate that it
can provide an alternative to Western commercial banking and finance.
Nowadays, most of the large international banks operating in the UK have Islamic
‘windows’ through which they undertake Islamic banking and finance business.
A particular attraction of Islamic banking is the more conservative lending practices of
Islamic banks as well as the greater emphasis on ethical behavior in customer
relationships.

* Consolidation of Banking sector:

Over the past decade, banking industry experienced a wave of M&A in the global
scale.
However, the track record of M&As in global banking systems does not always result
in positive outcomes.
A major motivation for M&A is the desire to boost performance – increased profits by
either increasing revenues or reducing costs and higher market valuation via share
price increases.
However, Extensive literature exists that investigates whether bank M&A leads to
performance improvements and there is limited evidence of greater market value or
improve efficiency, thus increase profit for shareholders, have been found.
Besides, researchers started looking at the so-called ‘managerial incentive’ literature.
The argument goes that managers engage in M&A in order to maximize their own
utility at the expense of shareholders.
Motivation for M&A of bank’s CEO could be:
Larger firms may be able to exert greater market power and insulate bank’s CEO from
various competitive pressures.
CEO compensation increases with changes in asset size due to mergers of large banks.
There is also evidence that where CEOs can expect to have large compensation
increases from acquisition.
* Investment trends:
SOCIAL, ENVIRONMENTAL, ETHICAL AND TRUST (SEET) ISSUES
Since the financial crisis of 2007–8, public opinion has increasingly focused on the
negative aspects associated with banking/financial markets business.
By 2013, there were 44 foreign banks operating in China, with total assets amounting
to some $300bn – around 2% of the banking sector.
Foreign banks are engaged in underwriting and also have access to the retail market in
credit cards, mortgages and savings products, particularly for the growing middle
classes.
The growing emphasis on CSR has probably had the biggest impact in the
investments arena, where there is now an asset class for investors who seek to obtain
returns from socially responsible firms.
According to the US-based Forum for Sustainable and Responsible Investment (US
SIF), sustainable and socially responsible investing (SRI) in the US continues to grow
at a faster pace than the broader universe of conventional investment assets under
professional management.