FIN3103B/3703B

Financial Markets
01: Introduction and Financial Institutions

Dr. YUE Ling

1 Sem2 AY2020/21
Introduction and Financial Institutions
Introduction:
1. What are financial assets?
2. What are financial markets?

Financial Institution:
1. Depository institutions
2. Non-depository institutions

2 Sem2 AY2020/21
What is finance?
• Definition (from Google):
• monetary support for an enterprise;
• the management of large amounts of money.

• Functions:
• .
• .

3 Introduction
Why study financial markets?
• Crucial to our economy: channel funds from surplus spending
units to deficit spending units, promoting economic efficiency

• Well-functioning financial markets are nowadays key factors in

producing high economic growth

• Market activities affect personal wealth, firms business, and

economic development
Basic definitions
• Financial assets are legal claims to future benefits which have
monetary values.

• Financial markets are structures where financial assets are

traded.

• Financial institutions are institutions or business entities which

provide financial services.

7 Introduction
Introduction and Financial Institutions
Introduction:
1. What are financial assets?
2. What are financial markets?

Financial Institution:
1. Depository institutions
2. Non-depository institutions

8 Sem2 AY2020/21
Assets
Assets: Any possession that has value in an exchange

• Tangible assets: value is based on physical properties

• Examples: land, buildings, machineries, vehicles

• Intangible assets: legal claims to future benefits

• Examples: financial assets: stocks and bonds

9 Introduction – 1. Financial Assets
Roles of financial assets:
• Helps in fulfilling the function of finance
• Efficient pooling of funds
• Efficient distribution of ownership
• Limited liability
• Management of risk

10 Introduction – 1. Financial Assets
Types of financial assets
• Debt: Fixed payment
• Bank loans
• Government bonds
• Corporate bonds

• Equity: Payment is based on earnings

• Common stock
• Preferred stock

• Others: Combination or derivation of the above two

• Convertible securities, e.g., convertible bonds
• Derivatives, e.g., futures, options, swaps

11 Introduction – 1. Financial Assets
Properties of financial assets
• Money or near money
• Money: medium of exchange:
• cash or check (demand deposit or current account)
• Near money (quasi-money):
• saving deposits, fixed (or time) deposits, NCDs
• Under MAS definition:
• M1 = currency in active circulation
• M2 = M1 + Near (or Quasi) money

12 Introduction – 1. Financial Assets
Properties of financial assets
• Divisibility: minimum size for liquidation or exchange for money
• Deposits: (almost) infinitely divisible
• Lots of shares:
• US: 100 shares (round lot 100 shares, odd lot <100
shares)
• Singapore: 100 shares from Jan 2015 (previously 1,000)
• Why reduce?
• T-bills and bonds: US$1,000 or S$1000

13 Introduction – 1. Financial Assets
Properties of financial assets
• Reversibility or round-trip cost (cost of getting in and out)
• Bid-ask spread
• Difference between the price where the market (or market
marker) is willing to buy and sell
• Function of risk

Market: ____ ____

Bid Ask

$9.00 $9.50

Trader: ____ ____

14 Introduction – 1. Financial Assets
Properties of financial assets
• Reversibility or round-trip cost (cost of getting in and out)
• Bid-ask spread
• Difference between the price where the market (or market
marker) is willing to buy and sell
• Function of risk
• Commission or brokerage fee
• Stamp fee/duty
• Loadings

17 Introduction – 1. Financial Assets
Properties of financial assets
• Term to maturity (time interval to final payment)
• Demand instruments: Payment at anytime
• eg. checking (demand) and savings account deposits
• Infinite time to maturity:
• eg. perpetuities, consol (government), equities
• Short term: T-bills
• Long term: Bonds

19 Introduction – 1. Financial Assets
Properties of financial assets
• Liquidity (thickness of the market)
• Loss due to immediate liquidation
• Depends on the number of ready buyers and sellers
• Affects the bid-ask spread

• Currency
• Example: US$, €, £, ¥, S$
• Exchange rate exposure and risk

21 Introduction – 1. Financial Assets
Properties of financial assets
• Risk
• Some define risk as probabilistic and uncertainty as not
• Measure of risk: Example, price risk
• Variance, standard deviation, beta, etc

• Convertibility
• Convertible bonds, convertible preferred stocks

• Tax status
• Capital gain tax, dividend tax, etc.

23 Introduction – 1. Financial Assets
Introduction and Financial Institutions
Introduction:
1. What are financial assets?
2. What are financial markets?

Financial Institution:
1. Depository institutions
2. Non-depository institutions

24 Sem2 AY2020/21
What are financial markets?
Financial markets:
• Structures where financial assets are exchanged or traded

Role of financial markets:

• Provision of liquidity
• Provide a place of gathering of willing buyers and sellers

• Price discovery process

• Determination of price or return of financial assets
• Influence by many factors (eg. liquidity, risk, information,
transaction process)

• Reduction of transaction costs

• Reduce search time and cost
• Reducing contracting cost and risk

25 Introduction – 2. Financial Markets
Types of financial markets
1. Primary and secondary
2. Asset class
3. Money and capital
4. Exchange and OTC
5. Spot and forward, future

26 Introduction – 2. Financial Markets
Types of financial markets
1. Primary and secondary
• Primary:
• New issue of securities
• IPO and SEO
• Private placement
• Secondary:
• Trading of issued assets

2. Asset class
• Debt
• Equity
• Foreign exchange
• Derivatives

27 Introduction – 2. Financial Markets
Types of financial markets
3. Money and capital
• Money market
• Short-term: 1 year or less
• Discount windows
• Federal funds
• Certificates of deposits (negotiable and nonnegotiable)
• T-bills
• Repurchase agreement (repo): selling securities and
simultaneously agreeing to repurchase the same after a
specified time at a given price
• Commercial papers: short-term unsecured promissory
notes issued by corporations and foreign governments

28 Introduction – 2. Financial Markets
 Types of financial markets
3. Money and capital
• Money market
• Repurchase agreement (repo): selling securities and
simultaneously agreeing to repurchase the same after a
specified time at a given price

________ ________

Time = t Time = t+1
Borrower Lender Borrower Lender

________ _________

29 Introduction – 2. Financial Markets
Types of financial markets
3. Money and capital
• Capital market
• Long-term: More than 1 year
• Stocks and bonds

4. Exchange or OTC
• Exchange
• Trade, clear, and settle in and by an exchange (or its clearing
house)
• Products traded on the exchange must be well standardized.
• OTC
• Over-the-counter (or off-exchange)
• Trade is done directly between two parties, without the
supervision of an exchange.
• The price is not necessarily publicly disclosed.
• Counterparty risk: what is it?

32 Introduction – 2. Financial Markets
Types of financial markets
5. Spot or forward, future
• Spot: Immediate delivery
• Future or forward: Future delivery

33 Introduction – 2. Financial Markets
 Structure of financial markets: summary
Classification methods
Stage Primary market (issuing) Secondary market (trading)

Instrument Equity market Debt market

Time to maturity Money market (1 year or  Capital market (longer than 1 
less, e.g., T‐bills, fed funds,  year, e.g., corporate stocks, 
discount windows,  corporate bonds, government 
commercial papers) bonds)
Trading Exchange Over‐the‐counter (OTC) market
Delivery Spot market Forward market

35 Introduction – 2. Financial Markets
Introduction and Financial Institutions
Introduction:
1. What are financial assets?
2. What are financial markets?

Financial Institution:
1. Depository institutions
2. Non-depository institutions

36 Sem2 AY2020/21
 Flow of funds through the financial system

Source: Mishkin and Eakins (2018) Figure 2.1 
37 Financial Institutions
Roles of financial institutions
• Financial institutions are institutions or business entities which
provide financial services.

• Roles:
• Economy of scale
• Risk sharing
• Alleviate problems caused by asymmetric information
• Economy of scope
• But, there could be conflict of interests. This is why the
financial services industry is heavily regulated in most
countries.

38 Financial Institutions
Category of financial institutions

Primary Assets Primary Liabilities
(uses of funds) (sources of funds)

Financial assets that could  Deposits
include loans, bonds, stocks,  Depository institutions
money market instruments,  Examples: commercial 
foreign currencies, and  banks, S&Ls, credit unions
many other assets

(same as above) Something other  Non‐depository 

than deposits institutions
Examples: insurance 
companies, pension funds

39 Financial Institutions
Introduction and Financial Institutions
Introduction:
1. What are financial assets?
2. What are financial markets?

Financial Institution:
1. Depository institutions
2. Non-depository institutions

40 Sem2 AY2020/21
1. Depository institutions
Institutions that accept deposits from individuals and institutions and
make loans.
• Often referred to as “banks” for simplicity
• Different types (charters/licenses) based on the scope of permitted
deposits, loans, and/or other activities.

Types:
• Commercial banks
• Saving banks
• Finance companies (Singapore)
• Savings and loan associations (US)
• Credit Unions (US)

41 Financial Institutions – 1. Depository
Commercial banks
Institutions that accept deposits, make loans, and offer related
services.

• Deposits: checking accounts, savings accounts, time deposits,

certified deposits, etc.

• Loans: corporation loans, consumer loans, mortgages, etc.

• Services: payment, transfer, (wealth management?), etc.

• Profit sources: interest margins, fees, commissions, off-balance-

sheet (OBS) activities, etc.

42 Financial Institutions – 1. Depository
Balance Sheet of U.S. Commercial Banks
(items as a percentage of the total, 2016)

Source: Mishkin and Eakins (2018). Table 17.1

43 Financial Institutions ‐ 1. Depository
Commercial banks in Singapore
• Full banks: whole range of banking business
• Local banks: DBS, OCBC, UOB, Bank of Singapore
• Foreign banks, some with Qualifying Full Bank (“QFB”)
privileges

• Wholesale banks: limited S$ retail banking activities

• Directory of financial institution: https://eservices.mas.gov.sg/fid/

44 Financial Institutions ‐ 1. Depository
Changing landscape of commercial banks in
Singapore

• Savings bank in the past: Post Office Savings Bank (POSB)

• Oldest financial institution in Singapore, from 1 Jan 1877
• Became a statutory corporation in 1972
• DBS acquired POSB in Nov 1998

• Offshore banks in the past: more restricted than wholesale banks,

separation between S$ and foreign currency businesses
• License stopped in April 2016, existing ones converted to
wholesale banks over time

45 Financial Institutions ‐ 1. Depository
Depository institutions other than
commercial banks
• Finance companies in Singapore
• Take deposit
• No checking account
• Restricted (capital > $100 m) dealing in foreign currency, gold or
other precious metal
• Loan size: 0.5% of capital funds per borrower
• Total unsecured loans < 25% of capital funds
Note that the meaning of the term “finance company” varies across
countries. In the US, finance companies are companies who raise
funds not by taking deposits, but by issuing commercial papers, bonds,
and stocks, and lend these funds to consumers and small businesses.

• Thrifts in the US
• Savings and loan (S&L) associations, mutual savings banks, credit
unions
46 Financial Institutions ‐ 1. Depository
Credit Unions (US)
• No corporate stock ownership
• Owner by members: mutuals
• Deposits => shares
• Membership limited to groups having a common bond of
occupation or association

48 Financial Institutions ‐ 1. Depository
Introduction and Financial Institutions
Introduction:
1. What are financial assets?
2. What are financial markets?

Financial Institution:
1. Depository institutions
2. Non-depository institutions

50 Sem2 AY2020/21
2. Non-Depository institutions
• Insurance companies
• Pension funds
• Investment banks (US) and merchant banks (Singapore)
• Investment companies
• Mutual funds, Unit trusts
• Hedge funds
• Private equity funds
• Sovereign wealth funds (SWF)

51 Financial Institutions – 2. Non‐Depository
Insurance companies
• Insurance products
• human, property, liability, etc.
• transfer the risk to an entity (typically insurance company) that
pools the risk of loss and provides payment if a loss occurs.

• Revenue and cost

• Initial premium income is invested
• Payments to the insured are contingent on potential future
events

• Risk
• Timing and magnitude of payments are uncertain (the
randomness of natural disasters)
• Long lag between receipts and payments need assets
management

52 Financial Institutions – 2. Non‐Depository
Pension funds
Retirement plans set up by corporations, governments, or labour
unions for their employees

• DC vs DB plans:
• Defined contribution (DC) plans specify the amount (or the
percentage) contributed by employer and employees. The
amount payable at retirement is not guaranteed but depends
on the results of the investment.
• Defined benefit (DB) plans specify the amount payable.

• Insured versus non-insured: whether the pension fund is

insured by an insurance company

• Portable versus non-portable: whether the employee will lose

the benefits if s/he leaves the company

53 Financial Institutions – 2. Non‐Depository
Pension funds
• Singapore: The CPF
• Compulsory for Singapore citizens and permanent residents
• Defined contribution plan
• Contributions: Cap at $6,000 of ordinary wages (from Jan
1, 2016)
• Portable

54 Financial Institutions – 2. Non‐Depository
Investment banks (US) or merchant banks
(Singapore)
• Merchant bank is a traditional form, a used-to-be British term, and
a narrow definition of today’s investment bank.

• Legislation changes in the US

• Glass Steagall Act 1933 separates commercial banking from
investment banking. Why?
• Gramm Leach Bliley Act 1999 allows universal banking
(meaning a financial institution can provide both commercial
banking and investment banking, as well as insurance
services).

55 Financial Institutions – 2. Non‐Depository
Investment banks or merchant banks
• Main function: Securities Underwriting
• Help corporations to raise funds
• IPOs: Helping companies to issue equity shares to the general
public for the first time
• Private placement: Sell (or place) securities to selected
investors
• Merges and Acquisitions:
• Help sellers to find buyers and vice versa
• Valuation
• Advice on method of payment: cash, shares, both

57 Financial Institutions – 2. Non‐Depository
Investment banks or merchant banks
• Creation and trading of financial products
• Options, futures, swaps, etc.
• Asset securitization: how does it work?
• Issue securities backed by a pool of assets
• Everything can be securitized: mortgages, credit card debts,
auto loans, etc.
• Securities Trading:
• Making the market
• Arbitrage: riskless and risky
• Speculation
• Provide research

58 Financial Institutions – 2. Non‐Depository
Investment companies
• Definition
• Pool money from investors (therefore “shareholders”)
• Invest money on behalf of the shareholders
• Hold securities of other companies for investment purpose

• Types
• Mutual funds, Unit trusts
• Hedge funds
• Private equity funds

Note that the usage of terms used to vary across countries. For
example, by the UK classification, both mutual funds and unit
trusts are called unit trusts.

59 Financial Institutions – 2. Non‐Depository
Mutual funds (I): open-end
Open-end mutual funds constantly offer and redeem shares.

• An unlimited number of shares directly or through brokerage firms

• Shares are bought and sold at net asset value (NAV)

• Funds are required to redeem shares any time upon shareholders’

request

• Assets size changes due to

• (1) the change of the price of securities held;
• (2) flows of money in and out of the funds.

60 Financial Institutions – 2. Non‐Depository
Mutual funds (II): closed-end
Closed-end mutual funds offer a limited number of shares once,
which can be traded subsequently.

• No money flow in and out of funds after the inception and before
the termination

• Termination/open-end is decided by the fund management and

boards of directors

• Shares are traded at premium or discount: Closed-end discount

puzzle

61 Financial Institutions – 2. Non‐Depository
Unit trusts
• Fixed number of unit certificates (similar to closed-end mutual
funds)

• Securities held are specific and not managed (fixed) after the
inception

• Assets are placed with trustee

• Termination date is fixed

62 Financial Institutions – 2. Non‐Depository
Private equity funds
• Private partnership
• General Partner: a private equity firm holding the control power
• Limited Partner: institutions or wealthy individuals (passive
partners)

• Equity investments of different types

• Venture capital: major stake in less mature firms
• Growth capital: minor stake in more major firms
• Buy-outs (including LBOs): buying a controlling equity stake

• Big names: Blackstone Group, Carlyle Group, Goldman Sachs, TPG,

KKR, Bain Capital, Apollo Global Management
• The Blackstone Group is now listed in NYSE ($4 billion IPO) on
July 22, 2007
• KKR later listed in Euronext, transferred listing to NYSE in July
15, 2010
• Many more has gone public

63 Financial Institutions – 2. Non‐Depository
Hedge funds
• Overview
• Partnership structure, similar to private equity funds
• Operate through private placement to rich individuals and
institutions
• Investment techniques
• Short overvalued & long undervalued, “hedge”
• Use leverage to amplify returns
• Involve a lot of derivatives trading
• Compare to mutual fund
• Investors: Accredited investor?
• Regulations: tough/lax?
• Redemption: lock-in period?
• Transparency: high/low?

64 Financial Institutions – 2. Non‐Depository
Hedge funds
• Hedge Funds Hall of fame:
• LTCM: Merton and Scholes
• Bear Stearns: High-Grade Structured Credit Fund and
Stearns High-Grade Structured Credit Enhanced Leveraged
Fund (June 2007)

67 Financial Institutions – 2. Non‐Depository
Sovereign wealth funds
• State-owned investment companies
• Sources of funding
• Oil and gas exports
• Non-commodity: transfer of assets from official foreign
exchange reserves, government budget surpluses, or
privatisation revenue
• Largest SWFs are from Norway, China, Singapore (Temasek and
GIC), and Middle Eastern countries such as Qatar, Kuwait, and
the United Arab Emirates.
• Total assets-under-management (AUM) at end 2020 is US$9.1
trillion (according to Global SWF)

69 Financial Institutions – 2. Non‐Depository
Sovereign wealth funds
• Gain attention lately due to high profile purchase amid the credit
crisis
• Investments example: Citibank, UBS, Morgan Stanley, Merrill
Lynch, Chrysler Tower
• Causing concerns due to lack of transparency
• Various meetings between SWF and government officials to iron
out issue

• High profile failures!!!

• Total estimated losses in 2008: US$600 billion (from US$3.6 to
US$3 trillion)
• Most has recovered since then

70 Financial Institutions – 2. Non‐Depository
Lecture summary
• What are financial assets?
• Legal claims to future benefits which have monetary values
• Debt, equity, and others

• What are financial markets?

• Structures where financial assets are traded
• Roles: liquidity provision, price discovery, transaction cost
reduction
• Types by stage, instrument, maturity, trading, and delivery

• What are financial institutions?

• Institutions or business entities which provide financial
services
• Depository and non-depository institutions differ by source of
funds

72 Sem2 AY2020/21
The rest of the course
• Financial institutions
• Banks and risk management

• Financial markets
• Debt markets and interest rates
• Equity markets
• Foreign exchange markets
• Derivatives markets

• Group project (student teaching assignments)

• Current issues

73 Sem2 AY2020/21