Chapter 2: Overview of the Financial System  Money Market: Short-term instruments (<1 year), e.g., T-bills.

 Capital Market: Long-term instruments (>1 year) and equities.

Key Points and Examples

1. Function of Financial Markets 3. Role and Types of Financial Intermediaries

Primary Role: Channel funds from savers (those with excess funds) Indirect Finance
to borrowers (those with funding shortages), improving economic
 Functions: Reduce transaction costs, diversify risk, mitigate
efficiency.
information asymmetry.
Examples:
o Example: Banks lower per-loan costs via standardized contracts
Without financial markets, individuals might keep cash under their
(e.g., legal fees spread across loans).
mattresses, earning no return.
A carpenter borrows to buy a new saw (boosting productivity) and Types of Intermediaries
pays interest to savers.
1. Depository Institutions:
Enables young people to buy homes (intertemporal consumption).
o Commercial banks, credit unions.
o Example: HSBC in Hong Kong.
2. Contractual Savings Institutions:
2. Structure of Financial Markets
o Life insurers, pension funds.
(1) Debt vs. Equity Markets 3. Investment Intermediaries:

o Mutual funds, hedge funds, investment banks.

Debt Markets:
o Example: BlackRock’s large-scale mutual funds.
Instruments: Bonds, mortgages.
Maturity: Short-term (<1 year), medium-term (1-10 years),
long-term (>10 years).
Example: U.S. debt markets totaled $56.1 trillion in 2021. 4. Financial Regulation

Equity Markets:
Reasons for Regulation
Instruments: Common stocks (representing ownership).
Example: U.S. equity markets reached $80.1 trillion in 2021.  Enhance Investor Information: E.g., SEC-mandated corporate
disclosures.
(2) Primary vs. Secondary Markets  Ensure Institutional Soundness: Prevent bank runs.

o Examples:
Primary Market: New securities issuance (e.g., IPOs), often
underwritten by investment banks.  Hong Kong’s HK$500,000 deposit insurance post-2008 crisis.
 HSBC’s 1965 acquisition of Hang Seng Bank to avert a run.
Example: A company’s initial public offering.
Secondary Market: Trading of existing securities (e.g., NYSE,
Regulatory Models
Nasdaq).

Functions: Liquidity provision, price discovery. 1. Institutional Approach:

Example: Hong Kong raised HK46.3billionviaIPOsand HK104.4 o Regulates by entity type (e.g., Hong Kong’s dual oversight: SFC vs.
billion post-IPO in 2023. HKMA).
2. Functional Approach:
(3) Exchanges vs. OTC Markets
o Regulates by activity (e.g., U.S. SEC overseeing securities trading).

Exchanges: Centralized trading (e.g., NYSE). 3. Integrated Approach:

OTC Markets: Decentralized trading (e.g., U.S. Treasury securities). o Single regulator (e.g., Singapore’s MAS).
4. Twin Peaks Model:
(4) Money vs. Capital Markets
Separates prudential (e.g., Australia’s APRA) and conduct
regulation (e.g., ASIC).
2. Money Market Instruments

(1) Treasury Bills (T-bills)

5. Conflicts of Interest
 Features:

Investment Banks: o Issued by governments (e.g., U.S. Treasury), maturities: 4-week to

Research vs. underwriting bias (e.g., inflated ratings during the 1-year.

dot-com bubble). o Sold at a discount (e.g., 999.813for a 1,000 28-day T-bill).

Accounting Firms: o Yield Calculation:

Auditing vs. consulting (e.g., Arthur Andersen’s collapse  Discount Rate: (F−P)/F×360/n → 0.240% for the above example.

post-Enron scandal).  Investment Rate: (F−P)/P×365/n → 0.243%.

Rating Agencies:  Example:

Credit assessment vs. advisory (e.g., S&P/Moody’s role in the 2008 o 2021 U.S. T-bill auction: $2.5B issued, competitive/noncompetitive

subprime crisis). bids accepted.

(2) Federal Funds (Fed Funds)

 Features:
Summary
o Overnight loans between banks to meet reserve requirements.
Financial markets facilitate fund flows; intermediaries reduce
o Rate set by supply/demand; influenced by the Federal Reserve.
costs/risks.
 Example:
Regulation ensures transparency/stability but must balance
o $250B+ traded daily in the fed funds market.
efficiency.
Conflicts of interest remain a critical challenge in financial systems.
(3) Commercial Paper

 Features:

o Unsecured corporate debt (maturities ≤ 270 days).

Chapter 11: Money Markets
o Issued by creditworthy firms (e.g., General Motors Acceptance
Corporation).
Key Points and Examples
 Example:

o Asset-backed commercial paper (ABCP) triggered the 2008 crisis

1. Definition and Purpose of Money Markets ($1T market collapse).

Definition: (4) Negotiable Certificates of Deposit (CDs)

Wholesale markets for short-term, highly liquid securities

 Features:
(maturities ≤ 1 year).
o Bank-issued, bearer instruments (100K–100K–10M; 1–4 months
Low default risk, large denominations (e.g., $1M+).
maturity).
Purpose:
o Higher yields than T-bills but less liquid.
Investors: Park surplus funds temporarily (higher returns than
cash/banks). (5) Repurchase Agreements (Repos)
Borrowers: Access low-cost, short-term funding (e.g., corporations,
 Features:
governments).
Example: o Short-term collateralized loans (T-bills as collateral).
o Used by the Fed for monetary policy.
Apple holds $35.2B in short-term marketable securities (T-bills,
 Example:
commercial paper) for liquidity.
o 2008 crisis: Repo market froze due to counterparty risk.
(6) Banker’s Acceptances o MPF (Mandatory Provident Fund) money market funds for low-risk
investing.
Features:
 Example:
Guaranteed payment for international trade (low default risk).
o Banks like HSBC use money market instruments for liquidity
Example: Alipay’s use in cross-border transactions.
management.

(7) Eurodollars

Features:
6. Risks and Regulations
USD deposits in non-U.S. banks (e.g., LIBOR rates).
Born during the Cold War (USSR moved dollars to European  Risks:
banks). o Default Risk: Low (except ABCP in 2008).
o Inflation Risk: T-bills may not keep pace with inflation (see
1973–2021 data).

3. Participants in Money Markets  Regulations:

o SEC: Requires commercial paper issuers to register if maturity >

Participant Role 270 days.
o FDIC: Insures bank deposits but not money market investments.
U.S. Treasury Issues T-bills to fund national debt.

Federal Reserve Buys/sells T-bills to control interest rates.

Trade fed funds, issue CDs, invest in 7. Case Studies

Commercial Banks
T-bills.
 Salomon Brothers Scandal (1991): Cornered T-bill auctions,
Use commercial paper for short-term leading to rule changes.
Corporations
funding (e.g., Apple, GM).  JPEX Ponzi Scheme (2023): Promised 20% returns, highlighting

Money Market Pool small investors’ funds to buy fraud risks in unregulated markets.

Mutual Funds large-denomination securities.  Tianhong Yu’E Bao (China): Online money market fund peaked at
6% yield (2017), later regulated.

4. Comparing Money Market Securities

Summary
Instrument Liquidity Risk Typical Yield
 Money markets provide short-term liquidity with minimal risk.
T-bills High Lowest 0.24% (2024)  Key instruments include T-bills, commercial paper, and repos.
 Used by governments, corporations, and investors for cash
Commercial Paper Low Moderate 2.81% (2022)
management.
Fed Funds None Low 2.33% (2022)  Hong Kong integrates money markets into ETFs and pension
funds.
Eurodollars Low Low LIBOR-based
 Risks include inflation and regulatory gaps (e.g., Ponzi schemes).

Data Sources: Apple’s 2024 balance sheet, U.S. Treasury reports,

5. Hong Kong Money Market Federal Reserve data.

Products:
1. Capital Market Participants
Money Market ETFs (e.g., Hong Kong’s first ETF targeting 1.5%
 Bonds: Debt securities issued by governments/corporations, with
returns).
fixed payments.
 Primary issuers:
Governments: Fund operations (e.g., U.S. Treasury issues Default Case:
T-bonds).
 Washington Public Power Supply System (1983): Defaulted on
Corporations: Raise capital (e.g., Apple issues corporate bonds).
$2.25B bonds for nuclear plants.
Key investors: Individuals, institutional investors (pension funds,
insurance companies).

Example: 4. Corporate Bonds

U.S. public debt ceiling: $31.4 trillion (2023).  Features:

o Face value: $1,000 (typically).

o Credit ratings: AAA (safest) to D (default).
o Covenants:
2. Treasury Notes and Bonds
 Negative: Restrict dividends/asset sales.
Types:
 Positive: Require financial disclosures.
T-bills: <1 year.
 Types:
T-notes: 1–10 years.
o Secured: Backed by assets (e.g., mortgage bonds).
T-bonds: 10–30 years.
o Unsecured: Debentures (higher risk).
Features:
o Junk bonds: Rated below BBB (e.g., Michael Milken’s 1980s
No default risk (backed by U.S. government).
market).
Low yields (considered risk-free rate).
Innovations: Example:
TIPS (Treasury Inflation-Indexed Securities): Principal adjusts
 Huiyuan Juice (2010): Violated loan covenants → Stock
with inflation.
plunged 6%.
STRIPS: Zero-coupon bonds
(e.g., 1,000facevaluesoldat1,000facevaluesoldat800, pays no interest
until maturity).
5. China’s Debt Problem

Example:  Root cause: 2008 stimulus (bank loans to SOEs → overcapacity).

2024 Yield Curve: Upward-sloping (longer maturities = higher  Debt/GDP: 280% (2023), driven by corporate debt.

yields).  Solutions:

o Debt-to-equity swaps: Convert loans to equity (e.g., Beijing

Cement Factory).
o Securitization: Bundle bad loans into tradable securities.
3. Municipal Bonds
o Credit default swaps (CDS): Hedge against defaults.
Issued by: Local/state governments for public projects (e.g.,
schools, toll roads). Case Study:
Tax advantage: Interest is tax-exempt (attractive to high-income
 Beijing Cement Factory:
investors).
o Pre-swap: Debt ratio = 117%.
Types:
o Post-swap: Debt ratio = 30% after asset injection and equity
General obligation bonds: Backed by government’s credit.
conversion.
Revenue bonds: Backed by project income (e.g., tolls).

Example Calculation:
6. Islamic Bonds (Sukuk)
Corporate bond yield: 5% vs. Municipal bond yield: 3.5%.

For a 28% tax rate, after-tax corporate yield = 3.6% → Choose  Sharia-compliant: No interest (riba); profit-sharing instead.

municipal bond.  Structures:

o Ijarah: Lease-based (e.g., Pakistan’s airport Sukuk).

Mudarabah: Equity partnership. o Dividends: Periodic payouts (e.g., MTR Corporation’s 7.16% avg.

Global market: $1.79 trillion (2001–2022). dividend growth).

 Types:
Example: o Common stock: Voting rights + dividends (e.g., Delta Air Lines shareholder

Hong Kong: Issued USD-denominated Sukuk in 2014, 2015, voting).

2017. o Preferred stock: Fixed dividends, no voting rights.

Example:

Key Takeaways  Stock Certificate: Sapir Consolidated Airlines (1972) shows historical
paper-based ownership.
Government bonds are safest; corporate bonds offer higher
yields but carry credit risk.
Municipal bonds provide tax benefits but vary in default risk.
2. Stock Trading Venues
China’s debt crisis stems from SOE loans, addressed via
restructuring/securitization.  Organized Exchanges(e.g., NYSE, HKEx):
Sukuk comply with Islamic law, using asset-backed structures. o Centralized, auction-based trading.
o Circuit breakers: Halt trading during extreme volatility (e.g., S&P 500
Case Studies:
dropped 7% in March 2020).
U.S. T-bonds vs. inflation (1973–2022).  Over-the-Counter (OTC) Markets(e.g., NASDAQ):
Beijing Cement Factory: Successful debt-to-equity swap. o Dealer-driven, electronic trading (e.g., 3,000+ NASDAQ-listed securities).
Pakistan’s Sukuk: Funded infrastructure via Ijarah leases.  Alternative Trading Systems (ATSs):

o Dark Pools: Private forums for large institutional trades (e.g., Goldman
Traditional Chinese Summary (重點整理)
Sachs’ Sigma X).
債券類型： o ECNs: Electronic networks like Instinet (transparent, low-cost).
國債（無違約風險）、市政債（免稅）、公司債（高收益但風險高）。
中國債務問題： Example:

2008 年刺激計劃導致國企負債過高，解決方案包括「債轉股」（如  China’s Circuit Breaker (2016): Suspended after triggering market panic in
北京水泥廠案例）。 4 days.
伊斯蘭債券（Sukuk）：

符合伊斯蘭教法，以資產收益分紅代替利息（如巴基斯坦機場
Sukuk）。 3. Stock Valuation Models
關鍵數據：
 Dividend Discount Models (DDM):
美國國債上限：31.4 兆美元；全球 Sukuk 市場規模：1.79 兆美元。
o One-Period Model:

例子：
Price=Div1(1+ke)+P1(1+ke)(e.g., $0.16 dividend + $60 price → $53.71)
香港政府發行美元 Sukuk（2014–2017）。 .Price=(1+ke)Div1+(1+ke)P1
北京水泥廠債務比率從 117%降至 30%。 (e.g., $0.16 dividend + $60 price → $53.71).

FINA3010 Chapter 13: Stock Markets – Key Points & Examples o Gordon Growth Model:

P0=D1ke−g(assumes constant growth g<ke).P0=ke−gD1

(assumes constant growth g<ke).
1. Investing in Stocks

Ownership: Stocks represent equity ownership in a company.  P/E Ratio:

Returns: Price=PE×Earnings(e.g., PE=16 for $1.13 EPS → $18.08).Price=PE×Ea
Capital gains: Price appreciation. rnings(e.g., PE=16 for $1.13 EPS → $18.08).
Example:  Shanghai Composite: Peaked at 5,166 (June 2015), crashed to 2,927 (August
2015).
China Mobile: Supernormal growth (45%) vs. constant growth (4%).

Key Takeaways
4. Market Indexes
1. Stocksoffer ownership + returns via price growth/dividends.
Purpose: Track market performance (e.g., S&P 500, Hang Seng Index).
2. Trading Venues: Exchanges (NYSE) vs. OTC (NASDAQ) vs. ATSs (Dark
DJIA: 30 blue-chip stocks; grew from 800 (1980) to 42,992 (2024) → 9.48%
Pools).
annual return.
3. Valuation: DDM and P/E ratios are key tools.
Hang Seng Index: Covers 4 sectors (Finance, Utilities, Properties,
4. ADRsbridge global markets (e.g., Alibaba’s dual listing).
Commerce/Industry).
5. Criseshighlight risks of speculation (e.g., China’s 2015 crash).

Example:
Case Studies:
Global Indexes: Over 3 million indexes track 48,000 listed companies
 MTR Corporation: Steady dividends vs. biotech stocks (no dividends but
worldwide.
traded).
 2015 A-Share Crash: Margin calls triggered systemic sell-offs.

5. American Depositary Receipts (ADRs)

Mechanics: Foreign shares held by U.S. banks, traded as receipts (e.g., 1

Traditional Chinese Summary (重點整理)
China Mobile ADR = 5 shares).
1. 股票類型：普通股（投票權）vs. 優先股（固定股息）。
Benefits:
2. 交易市場：
Issuers: Access global capital (e.g., Alibaba’s NYSE listing).
o 交易所（NYSE）集中交易 vs. 場外市場（NASDAQ）電子交易。
Investors: Diversification + lower custody fees.
o 暗池（Dark Pools）適合機構大額交易。
Levels:
3. 估值模型：
Level I: OTC trading (minimal disclosure).
o 股息折現模型（DDM）適用穩定增長公司。
Level III: Full SEC compliance (e.g., AstraZeneca’s $39B acquisition of
o 市盈率（P/E）反映市場預期（如騰訊高 P/E 因增長潛力）。
Alexion).
4. ADR：外國公司赴美上市工具（如中國移動 ADR）。

Example: 5. 2015 年 A 股股災：槓桿交易加劇暴跌，監管介入失效。

2021 ADR Capital Raises: China/HK led with $17.3B.

例子：

 港鐵（0002.HK）股息穩定增長 vs. 生科股（無盈利仍可交易）。

 阿里巴巴雙重上市（香港+紐約）。
6. Case Study: 2015 A-Share Market Crisis

Causes: 1) When we refer to the shadow banking system, what

Overvaluation + margin trading (amplified losses). are we talking about? A) Hedge funds, investment banks,
Government intervention (e.g., suspending circuit breakers). and other nonbank financial firms that supply liquidity B)
Impact: The "underground" banking system used for illegal
1,241 firms halted trading (44% of A-shares). activities C) The subsidiaries of depository institutions D)
Mutual funds were primary "fire-sale" sellers. None of the above Answer: A
Lessons: 2) Stage Two of a financial crisis in an advanced economy
Avoid excessive leverage. usually involves a ________ crisis. A) currency B) stock
Long-term value investing > speculation. market C) banking D) commodities Answer: C

Example:
3) Corporate bonds are less risky if they are ________ diversified portfolio that reduces risk. D) do all of the
bonds and municipal bonds are less risky if they are above. E) do only A and B of the above. Answer: D
________ bonds. A) secured; revenue B) secured;
general obligation C) unsecured; revenue D) unsecured; Q1.
general obligation Answer: B
After the JPEX scandal, are you still willing to invest in
4) The security with the longest maturity is a Treasury A) cryptocurrencies? Justify with two reasons.
note. B) bond. C) acceptance. D) bill. Answer: B
I will not invest in cryptocurrencies in the future with the
5) According to the Gordon growth model, what is an
following two reasons:
investor's valuation of a stock whose current dividend is
$1.00 per year if dividends are expected to grow at a Reason 1: The JPEX scandal has exposed significant
constant rate of 10 percent over a long period of time vulnerabilities within the cryptocurrency market, revealing
and the investor's required return is 11 percent? A) $110 how easily scams can deceive investors. The inability of
B) $100 C) $11 D) $10 E) $5.24 Answer: A 2 users to withdraw their funds and the involvement of the
6) A share of common stock in a firm represents an police indicate a lack of regulation and security in the
ownership interest in that firm and allows stockholders cryptocurrency space, which makes it a high-risk investment.
to A) vote. B) receive dividends. C) receive interest
Reason 2: The growing skepticism surrounding
payments. D) only A and B of the above. Answer: D
cryptocurrencies among regulators and financial institutions
7) Which of the following is not a characteristic of a since the JPEX incident may lead to stricter regulations and
balloon loan? A) Prior to maturity, the borrower only a loss of investor confidence. This could negatively impact
pays interest (usually monthly). B) The loan is typically 10 market liquidity and the overall value of cryptocurrencies,
- 15 years in maturity. C) At maturity, the entire loan making them less appealing as an investment.
amount is due. D) All of the above are true. E) Only A and
C of the above are true. Answer: B

8) Growing-equity mortgages (GEMs) A) help the Q2.

borrower pay off the loan in a shorter time. B) have such
low payments in the first few years that the principal Please point out why the above argument is wrong and argue
balance increases. C) offer borrowers payments that are that indexing is still the best bet for investors.
initially lower than the payments on a conventional
mortgage. D) do all of the above. E) do only A and B of The argument against indexing is flawed because it
the above. Answer: A overlooks the fundamental benefits of indexing in
diversifying risk.
9) Market timing A) takes advantage of time differences
between the east and west coasts of the United States. B) Firstly, indexing inherently spreads investments across a
takes advantage of arbitrage opportunities in foreign wide array of stocks, which mitigates the risk associated with
stocks. C) takes advantage of the time lag between the investing solely in a few "Magnificent Seven" stocks. While
receipt and execution of orders. D) is discouraged by the these companies have driven gains recently, an index fund
stiff fees mutual funds charge every investor for buying will include other companies, thus reducing the impact of
and then selling shares on the same day. Answer: B any individual stock's downturn.
10) Mutual funds A) pool the resources of many small
Secondly, historical evidence shows that over the long term,
investors by selling these investors shares and using the
index funds tend to outperform actively managed funds due
proceeds to buy securities. B) allow small investors to
to lower fees and expenses. The difficulty active managers
obtain the benefits of lower transaction costs in
face in consistently beating the market is well-documented.
purchasing securities. C) provide small investors a
Therefore, simple indexing remains a more effective and less Event 3: Announcement of significant interest rate hikes by
risky investment strategy for the average investor. central banks.
Impact: Heightened borrowing costs affected consumer
spending and corporate investments, leading to widespread
sell-offs in equity markets.
Q3.
Event 4: Merger between two major tech companies.
Do you think Deepseek could be acquired by a domestic AI
Impact: Stock prices of the merging companies surged, while
giant? Justify your answer by discussing factors such as
competitors experienced downward pressure as market
market competition, financial viability, or technological
dynamics shifted.
synergies.
Event 5: Natural disaster causing substantial economic
a) I think Deepseek most likely will be acquired by Alibaba.
disruptions in key regions.
Impact: Price increases in commodities affected by the
Reason 1: Alibaba has a vested interest in the rapid
disaster led to inflationary pressures in the markets,
development of AI technologies, especially as competition
contributing to decreased consumer confidence.
intensifies in the global AI market. Acquiring Deepseek
would allow Alibaba to enhance its AI capabilities and
expand its current offerings, driving innovation within the
company. Q5.

Reason 2: Given Deepseek's cost-effective solutions, an Given the current political and economic climate in the
acquisition would provide Alibaba with strategic advantages United States with a new president, do you think more or
in terms of product development and market competitiveness. fewer non-US firms will choose to cross-list on US stock
This alignment would enable Alibaba to scale its operations exchanges? Justify your answer with two reasons.
efficiently while tapping into Deepseek's innovative
technologies. I think more non-US firms will choose to cross-list on US
stock exchanges with the following reasons.

Reason 1: A new administration may promote a favorable

Q4. business environment, instilling confidence among foreign
firms regarding regulatory frameworks. This encourages
Identify five major global events that occurred between
more non-US companies to access the larger US capital
December 2024 and February 2025 which could have had a
markets for funding.
significant impact on financial markets. For each event,
explain how it might have influenced financial markets. Reason 2: The increased visibility and credibility associated
with being listed on a US exchange may motivate companies
Event 1: Global recession fears due to rising inflation rates.
from emerging markets to seek cross-listing. This trend is
Impact: Increased volatility in stock markets as investors
driven by the potential for increased investment
sought safe-haven assets, leading to declines in equity prices.
opportunities and enhanced corporate governance standards
that US markets are known for.
Event 2: Major technological breach at a leading financial
institution.
Impact: Loss of consumer trust and increased regulatory
scrutiny, resulting in a decline in stock prices of major banks
and fintech companies.