THE FINANCIAL

SYSTEM
Nguyễn Việt Hưng
OBJECTIVES
 Explore the structure of the financial system
 Study the relationship between risk and
returns
 Explain how to calculate present value of a
financial asset

2
THE FINANCIAL SYSTEM

Saving

Economic
Investment
Growth

Foreign
borrowing

3
 Financial
system

Financial Financial
markets intermediaries

Commercial
Stock market Bond market Mutual funds
Bank

4
THE FINANCIAL SYSTEM

 Financial markets are the institutions

through which savers can directly provide
funds to borrowers.

 Financial intermediaries are financial

institutions through which savers can
indirectly provide funds to borrowers.

5
STOCK VS. BOND
 Who issues stock and bond?
 What is the position of the stockholder and
the bondholder in the company?
 Where do returns of holding stock and bond
come from?
 Which is riskier and which offers a higher
average return?

6
THE FINANCIAL SYSTEM
 The Bond Market
A bond is a certificate of indebtedness that
specifies obligations of the borrower to
the holder of the bond.
 Characteristics of a Bond
 Term: The length of time until the bond matures.
 Credit Risk: The probability that the borrower will
fail to pay some of the interest or principal.
 Normally, bonds have a fixed interest rate
7
THE FINANCIAL SYSTEM
How can we calculate the present value of a bond, which promises to
pay $1,000 in 20 years, assume interest rate now is 10%?

$1, 000 =
Present value = 20
 $148.64
(1  0.10)

How can we calculate the present value of a bond, which promises to

pay $100 each year for next 20 years, assume interest rate now is 10%?

$100 $100 $100

Present value =  2
 ... 20
 $851.35
(1  0.10) (1  0.10) (1  0.10)

8
 THE FINANCIAL SYSTEM
Now assume interest rate is 2%, other things being equal. What would
happen to the answers of two cases above?

$1, 000
Present value = 20
 $673
(1  0.02)

$100 $100 $100

Present value =  2
 ... 20
 $1635.14
(1  0.02) (1  0.02) (1  0.02)

When interest falls, the present value of a given

payment in the future increase!!!

9
THE FINANCIAL SYSTEM
 The Stock Market
 Stock represents a claim to partial ownership in a firm and
is therefore, a claim to the profits that the firm makes.
 The sale of stock to raise money is called equity financing.
 Compared to bonds, stocks offer both higher risk and potentially
higher returns.

 The most important stock exchanges in the United States

are the New York Stock Exchange, the American Stock
Exchange, and NASDAQ.

10
THE FINANCIAL SYSTEM
 Returns to stockholder are expressed in two
types:
 Dividends (divided profits)
 Capital gains/losses (net change in stock price)
 This is determined by demand/supply of its stock in
the market, which in turn is determined by that firm’s
retained earnings and profitability.

11
THE FINANCIAL SYSTEM
The market value, or price, of the stock can be explained in
terms of investors’ forecasts of dividends and price and the
expected return offered by other equally risky stocks.

Price today = Present value of (DIV1, DIV2,…, DIVt,…)

DIV1 DIV2 DIV3 DIVt

    ...   ...
1  r 1  r  1  r 
2 3
1  r 
t

THE DIVIDEND DISCOUNT MODEL

12
THE FINANCIAL SYSTEM
How can we measure the riskiness of a particular financial
asset?

R  R 
2
t
Standard deviation    t 1

N 1

Standard deviation is a measure of volatility or

riskiness of a particular financial asset.
Higher standard deviation means higher risk.

13
THE FINANCIAL SYSTEM

14
15
The relationship between average returns and standard
deviation of stocks, bonds, and bills, 1900-2003

16
17
18
THE FINANCIAL SYSTEM
 When the risk is higher, the required rate of
return should be higher to compensate for
risk-taker
 When the rate of return offered is higher, it
should be remembered that you are exposed
to higher risk

19
THE FINANCIAL SYSTEM
 The Stock Market
 Most newspaper stock tables provide the
following information:
 Price (of a share)
 Volume (number of shares sold)
 Dividend (profits paid to stockholders)
 Price-earnings ratio

20
 52weeks

Hi lo stock sym div Yld PE Vol hi lo close Net

% 100s CHg
26.18 23.43 CslFnl TOPrS 2.09 8.6 … 59 24.25 23.81 24.25 +0.06

12.87 6.87 Coastcast PAR … 171 11.37 10.87 11.37 +0.37

75.43 47.31 Cocola KO 0.64 1.3 39384 51 49.75 51 +1.06

22.5 9.75 CCFemsa KOF .12e 0.9 2121 13.81 12.87 13.75 +0.06
ADR
45.39 19.75 ResMed RMD 52.5 3831 42.00 39.51 41.50

11.63 3.55 Revlon A REV 162 6.09 5.09 6.09 +0.12

77.25 55.13 RioTinto RTP 2.30 3.2 168 72.75 71.84 72.74 +0.03

31.31 16.63 Rit chieBr RBA 20.9 15 24.19 24.29 24.49 -0.01

8.44 1.75 RiteAld RAD 31028 4.50 4.20 4.31 +0.21

38.63 18.81 RobtHalf RHI 26.5 6517 27.15 26.5 26.50 +0.14
51.25 27.69 Rockwel ROK 1.02 2.1 14.5 6412 47.99 47.00 47.54 +0.24

21
 52weeks
Hi
Hi lo Lo stock sym div Yld PE Vol hi lo close Net
% 100s CHg
26.18
26.18 23.43
23.43CslFnl TOPrS 2.09 8.6 … 59 24.25 23.81 24.25 +0.06
12.87
12.87 6.87 Coastcast
6.87 PAR … 171 11.37 10.87 11.37 +0.37
75.43
47.31
22.5
75.43 47.31 Cocola KO 0.64 1.3 39384 51 49.75 51 +1.06
9.75
45.39
22.5 9.75 CCFemsa KOF .12e 0.9 2121 13.81 12.87 13.75 +0.06
19.75ADR
11.6
3.55 ResMed (52 week high
52.5& 3831
low): The
42.00stock’s
39.51highest
41.50 &
3 45.39 19.75 RMD
lowest closing price in the last 52 weeks
77.25
11.63
55.13
3.55 Revlon A REV 162 6.09 5.09 6.09 +0.12
77.25
31.31 16.63RioTinto
55.13 RTP 2.30 3.2 168 72.75 71.84 72.74 +0.03

8.44
31.31 1.75 Rit chieBr
16.63 RBA 20.9 15 24.19 24.29 24.49 -0.01
38.63 18.81
8.44 1.75 RiteAld RAD 31028 4.50 4.20 4.31 +0.21
51.25
38.63 27.69RobtHalf
18.81 RHI 26.5 6517 27.15 26.5 26.50 +0.14
51.25 27.69 Rockwel ROK 1.02 2.1 14.5 6412 47.99 47.00 47.54 +0.24
22
 52weeks

Hi lo stock sym div Yld PE Vol hi lo close Net

Stock Symbol % 100s CHg
26.18 23.43 CslFnl TOPrS 2.09 8.6 … 59 24.25 23.81 24.25 +0.06
CslFnl
12.87 6.87 Coastcast
Coastcast PAR
TOPrS … 171 11.37 10.87 11.37 +0.37

PAR
75.43 47.31 Cocola
Cocola KO 0.64 1.3 39384 51 49.75 51 +1.06
CCFemsa KO
22.5 9.75 CCFemsa KOF .12e 0.9 2121 13.81 12.87 13.75 +0.06
ADR
ADR
KOF
45.39 19.75 ResMed
ResMed RMD
RMD 52.5 3831 42.00 39.51 41.50

Revlon A REV
11.63 3.55 Revlon A REV 162 6.09 5.09 6.09 +0.12
77.25 55.13 RioTinto
RioTinto RTP 2.30 3.2
RTP 168 72.75 71.84 72.74 +0.03
Rit chieBr RBA
31.31 16.63 Rit chieBr RBA 20.9 15 24.19 24.29 24.49 -0.01
RiteAld RAD
8.44 1.75 RobtHalf
RiteAld RHI
RAD 31028 4.50 4.20 4.31 +0.21
38.63 18.81 RobtHalf RHI 26.5 6517 27.15 26.5 26.50 +0.14
ROK
51.25 27.69 Rockwel
Rockwel ROK 1.02 2.1 14.5 6412 47.99 47.00 47.54 +0.24
23
 52weeks

Hi lo stock sym div Yld PE Vol hi lo close Net

% 100s CHg
26.18 23.43 CslFnl TOPrS
Div2.09 8.6 … 59 24.25 23.81 24.25 +0.06

12.87 6.87 Coastcast PAR … 171 11.37 10.87 11.37 +0.37

75.43 47.31 Cocola KO 0.64 1.3 39384 51 49.75 51 +1.06

2.09
22.5 9.75 CCFemsa KOF   .12e 0.9 2121 13.81 12.87 13.75 +0.06
ADR Dividend Yield : The annual dividend
0.64
45.39 19.75 ResMed RMD.12e the3831
52.5 company
42.00has39.51
been 41.50
paying to
investors
 
11.63 3.55 Revlon A REV   162 6.09 5.09 6.09 +0.12
77.25 55.13 RioTinto RTP
2.302.30 3.2 168 72.75 71.84 72.74 +0.03

 
31.31 16.63 Rit chieBr RBA 20.9 15 24.19 24.29 24.49 -0.01
 
8.44 1.75 RiteAld RAD
  31028 4.50 4.20 4.31 +0.21
38.63 18.81 RobtHalf RHI 1.02 26.5 6517 27.15 26.5 26.50 +0.14
51.25 27.69 Rockwel ROK 1.02 2.1 14.5 6412 47.99 47.00 47.54 +0.24
24
 52weeks

Hi lo stock sym div Yld PE Vol hi lo close Net

% 100s CHg
26.18 23.43 CslFnl TOPrS
Yld % …
2.09 8.6 59 24.25 23.81 24.25 +0.06

12.87 6.87 Coastcast PAR … 171 11.37 10.87 11.37 +0.37

75.43 47.31 Cocola KO 0.64 1.3 39384 51 49.75 51 +1.06

Yield: What you would make
22.5 9.75 CCFemsa KOF .12e 8.6
0.9 2121
from the13.81 12.87 13.75
dividend, stated+0.06
as
ADR … a per cent of the stock’s
45.39 19.75 ResMed RMD 1.3 52.5 3831
price42.00 39.51
( annual 41.50 ÷
dividend
0.9 stock price )
11.63 3.55 Revlon A REV   162 6.09 5.09 6.09 +0.12
77.25 55.13 RioTinto RTP 2.30   3.2 168 72.75 71.84 72.74 +0.03
3.2
31.31 16.63 Rit chieBr RBA   20.9 15 24.19 24.29 24.49 -0.01
 
8.44 1.75 RiteAld RAD   31028 4.50 4.20 4.31 +0.21
38.63 18.81 RobtHalf RHI 2.1 26.5 6517 27.15 26.5 26.50 +0.14
51.25 27.69 Rockwel ROK 1.02 2.1 14.5 6412 47.99 47.00 47.54 +0.24
25
 52weeks

Hi lo stock sym div Yld PE Vol hi lo close Net

% PE 100s CHg
26.18 23.43 CslFnl TOPrS 2.09 8.6 … 59 24.25 23.81 24.25 +0.06

12.87 6.87 Coastcast PAR … 171 11.37 10.87 11.37 +0.37

…
75.43 47.31 Cocola KO 0.64 1.3 39384 51 49.75 51 +1.06
 
P/E: Tells you how the stock
22.5 9.75 CCFemsa to
price compares KOF
the .12e 0.9   2121 13.81 12.87 13.75 +0.06
ADR
company’s earnings over the
45.39 19.75 ResMed ( price
RMD÷   52.5 3831 42.00 39.51 41.50
last business
earnings)
52.5
11.63 3.55 Revlon A REV   162 6.09 5.09 6.09 +0.12
77.25 55.13 RioTinto RTP 2.30 3.2   168 72.75 71.84 72.74 +0.03
20.9
31.31 16.63 Rit chieBr RBA   20.9 15 24.19 24.29 24.49 -0.01
26.5
8.44 1.75 RiteAld RAD 31028 4.50 4.20 4.31 +0.21
38.63 18.81 RobtHalf RHI 26.5 6517 27.15
14.5 26.5 26.50 +0.14
51.25 27.69 Rockwel ROK 1.02 2.1 14.5 6412 47.99 47.00 47.54 +0.24
26
 52weeks

Hi lo stock sym div Yld PE Vol hi lo close Net

% 100s
Vol CHg
26.18 23.43 CslFnl TOPrS 2.09 8.6 … 100s59 24.25 23.81 24.25 +0.06

12.87 6.87 Coastcast PAR … 171 11.37 10.87 11.37 +0.37

59
75.43 47.31 Cocola KO 0.64 1.3 39384 51
171 49.75 51 +1.06
Vol 100s: How many shares
22.5 were
9.75traded
CCFemsa 39384
the dayKOF
before, .12e 0.9 2121 13.81 12.87 13.75 +0.06
ADR
in hundreds. The number 162 2121
45.39would
19.75mean
ResMed RMD
that 16,200 52.5 3831 42.00 39.51 41.50
3831
shares were traded
11.63 3.55 Revlon A REV 162
162 6.09 5.09 6.09 +0.12
77.25 55.13 RioTinto RTP 2.30 3.2 168 72.75 71.84 72.74 +0.03
168
31.31 16.63 Rit chieBr RBA 20.91515 24.19 24.29 24.49 -0.01
31028
8.44 1.75 RiteAld RAD 31028 4.50 4.20 4.31 +0.21
38.63 18.81 RobtHalf RHI 26.56517
6517 27.15 26.5 26.50 +0.14
51.25 27.69 Rockwel ROK 1.02 2.1 14.56412
6412 47.99 47.00 47.54 +0.24
27
 52weeks

Hi lo stock sym div Yld PE Vol hi lo close Net

% 100s Hi CHg
26.18 23.43 CslFnl TOPrS 2.09 8.6 … 59 24.25 23.81 24.25 +0.06
24.25 Lo
12.87 6.87 Coastcast PAR … 171 11.37 10.87 11.37 +0.37
11.37
75.43 47.31 Cocola KO 0.64 1.3 3938451 51 49.75 51 +1.06
23.81
13.81
22.5 ( hi9.75
& low)CCFemsa KOF & .12e
: The highest 0.9 2121 13.81 10.87
12.87 13.75 +0.06
ADR
lowest price the stock sold 42.00
45.39at the
19.75dayResMed 49.75
before RMD 52.5 3831 42.00 39.51 41.50
6.09
12.87
11.63 3.55 Revlon A REV 162 6.09
72.75 5.09 6.09 +0.12
77.25 55.13 RioTinto RTP 2.30 3.2 168 72.75 39.51
71.84 72.74 +0.03
24.19
5.09
31.31 16.63 Rit chieBr RBA 20.9 15 24.19 24.29 24.49 -0.01
4.50
71.84
8.44 1.75 RiteAld RAD 3102827.15
4.50 4.20 4.31 +0.21
38.63 18.81 RobtHalf RHI 26.5 6517 27.15 26.5 26.50 +0.14
47.99
51.25 27.69 Rockwel ROK 1.02 2.1 14.5 6412 47.99 47.00 47.54 +0.24
28
 52weeks

Hi lo stock sym div Yld PE Vol hi lo close Net

% 100s CHg
26.18 23.43 CslFnl TOPrS 2.09 8.6 … 59 24.25 23.81 24.25 +0.06
Close
24.25
12.87 6.87 Coastcast PAR … 171 11.37 10.87 11.37 +0.37
11.37
75.43 47.31 Cocola KO 0.64 1.3 39384 51 5149.75 51 +1.06

22.5 9.75 CCFemsa KOF .12e 0.9 2121 13.81 13.75

12.87 13.75 +0.06
ADR
41.50
45.39Close:
19.75TheResMed
closing price
RMDof 52.5 3831 42.00 39.51 41.50
6.09
the stock on the day before
11.63 3.55 Revlon A REV 162 6.09 72.74
5.09 6.09 +0.12
77.25 55.13 RioTinto RTP 2.30 3.2 168 72.75 71.84 72.74 +0.03
24.49
31.31 16.63 Rit chieBr RBA 20.9 15 24.19 4.31
24.29 24.49 -0.01
26.50
8.44 1.75 RiteAld RAD 31028 4.50 4.20 4.31 +0.21
38.63 18.81 RobtHalf RHI 26.5 6517 27.15 47.54
26.5 26.50 +0.14
51.25 27.69 Rockwel ROK 1.02 2.1 14.5 6412 47.99 47.00 47.54 +0.24
29
 52weeks

Hi lo stock sym div Yld PE Vol hi lo close Net

% 100s CHg
26.18 23.43 CslFnl TOPrS 2.09 8.6 … 59 24.25 23.81 24.25 +0.06
Net CHg
12.87 6.87 Coastcast PAR … 171 11.37 10.87 11.37 +0.06
+0.37
+0.37
75.43 47.31 Cocola KO 0.64 1.3 39384 51 49.75 51 +1.06
+1.06
22.5 9.75 CCFemsa KOF .12e 0.9 2121 13.81 12.87 13.75 +0.06
+0.06
ADR
 
45.39Net19.75
chg : ResMed
The changeRMD
in value from: The52.5 3831 42.00 39.51 41.50 +0.12
closing price two days before, to the
11.63closing
3.55 price on Athe day
Revlon REVbefore 162 6.09
+0.03
5.09 6.09 +0.12
77.25 55.13 RioTinto RTP 2.30 3.2 168 72.75 71.84 72.74 -0.01
+0.03

+0.21
31.31 16.63 Rit chieBr RBA 20.9 15 24.19 24.29 24.49 -0.01
+0.14
8.44 1.75 RiteAld RAD 31028 4.50 4.20 4.31 +0.21
+0.24
38.63 18.81 RobtHalf RHI 26.5 6517 27.15 26.5 26.50 +0.14
51.25 27.69 Rockwel ROK 1.02 2.1 14.5 6412 47.99 47.00 47.54 +0.24

30
THE FINANCIAL SYSTEM
A lot of challenges for partners when undertaking transactions
through financial markets!!!

31
THE FINANCIAL SYSTEM
That explains why we need financial intermediaries!!!

32
THE FINANCIAL SYSTEM
 Banks
 take deposits from people who want to save and use the
deposits to make loans to people who want to borrow.
 pay depositors interest on their deposits and charge
borrowers slightly higher interest on their loans.

 Mutual Funds
A mutual fund is an institution that sells shares to the
public and uses the proceeds to buy a portfolio, of various
types of stocks, bonds, or both.
 They allow people with small amounts of money to easily diversify.

33
THE FINANCIAL SYSTEM
 Diversification into a portfolio of financial
assets – or not putting all the eggs in one
basket – can reduce the risk.
 Purchasing insurance policy can help reduce
the size of loss when the bad outcome
realizes.
 Examples: fire insurance, deposit insurance, CDS
– credit default swap
34
THE FINANCIAL SYSTEM
 To veil the risk of individual financial assets
and enhance its liquidity, financial
intermediaries (such as Fannie Mae and
Freddie Mac) can purchase loans, re-package
them, and sell them to the financial markets

35
THE FINANCIAL SYSTEM
 Leverage, which means using borrowed funds
to purchase assets, also increase the risk
that financial intermediaries undertake.

DON’T RISK YOUR OWN MONEY. RISK OTHER’S MONEY

 Regulations
on the maximum leverage ratio
(debt/equity) can help reduce the risk

36