Lecture 1: Introduction

Financial Markets
Wei Xu
2023 Fall
 Overview
✓ What is financial market
✓ How big are financial markets
✓ The function of financial market
✓ Why do we need financial market?
✓ Financial intermediaries
✓ Chines financial market
 Markets and Financial Markets
 Market
works by placing many interested buyers and sellers in one
"place", thus making it easier for them to find each other.

 Financial market
a “place” to buy and sell (trade) financial assets
❖ stocks
❖ bonds
❖ commodities (such as precious metals or agricultural goods)
 US Financial Markets Outstanding
Money Market Fixed Income Equities Derivative
$1 tr. $ 52 tr. $ 40 tr.

• CD • Treasury Securities: $24 tr • Common stocks • Future

• Commercial paper • MBS: $12 tr • Preferred stocks • Swap
• Repo/reverse repo • Corporate Bonds: $10 tr • option
• T-bill • Munis: $4 tr
• Euro-dollar • ABS: $1 tr
• Federal Agency Securities: $2 tr

Source: SIFMA capital market fact sheets 2023;

Note: numbers are rounded to integers.
 GLOBAL BOND MARKET OUTSTANDING ($ Trillion)
Australia Canada China EU27 HK Japan Singapore UK US DM EM Total
2007 1.3 1.5 1.7 19.3 0.1 9.9 0.2 4.7 26.1 0.6 0.8 66.2

2008 1.1 1.4 2.2 20.3 0.1 12.3 0.2 4.1 28.0 0.6 1.0 71.1

2009 1.5 1.7 2.6 24.1 0.2 12.3 0.2 5.3 29.1 0.8 0.8 78.5

2010 1.7 1.9 3.1 23.3 0.2 14.6 0.2 5.2 30.2 0.8 1.0 82.3

2011 1.9 2.0 3.5 23.5 0.2 15.8 0.2 5.6 31.0 0.8 1.0 85.5

2012 2.0 2.2 4.3 24.3 0.3 14.3 0.3 5.9 32.3 1.0 1.1 87.9

2013 1.9 2.2 5.0 25.0 0.3 11.9 0.3 5.9 33.3 1.0 1.1 87.8

2014 1.9 2.2 5.8 22.1 0.3 10.6 0.3 6.2 34.3 0.9 1.2 85.8

2015 1.8 2.8 7.8 19.9 0.4 10.6 0.3 5.9 35.3 0.9 1.2 86.8

2016 1.8 2.9 9.4 19.4 0.4 11.2 0.3 5.4 36.7 0.9 1.3 89.9

2017 2.0 3.3 11.8 22.1 0.5 11.9 0.4 6.1 37.9 1.0 1.5 98.5

2018 1.9 3.1 12.9 21.4 0.5 12.5 0.4 5.8 39.5 1.0 1.5 100.6

2019 2.0 3.4 14.7 21.8 0.5 12.8 0.5 6.3 41.2 1.1 1.6 106.0

2020 2.5 3.9 18.6 25.2 0.6 14.7 0.5 7.2 47.2 1.3 1.8 123.5

2021 2.4 4.0 21.8 24.7 0.6 13.4 0.6 7.2 49.1 1.3 1.7 126.9

2022 2.3 4.1 21.7 22.5 0.6 12.1 0.7 4.8 51.9 1.3 7.9 129.8

DM: developed markets EM: emerging markets

Source: SIFMA capital market fact sheets 2023
 Global Bond Market Outstanding Global Bond Market Outstanding
- 2013 - 2022
$ 87.8 Trillion $ 129.8 Trillion

Source: SIFMA capital market fact sheets 2023

 GLOBAL EQUITY MARKETS CAPITALIZATION ($ Trillion)

Australia Canada China EU27 HK Japan Singapore UK US DM EM Total

2007 1.3 2.2 4.5 11.8 2.7 4.5 0.5 3.8 19.9 4.2 8.2 63.6

2008 0.7 1.0 1.8 5.8 1.3 3.3 0.3 1.9 11.6 2.4 3.7 33.7

2009 1.3 1.7 3.6 7.7 2.3 3.4 0.5 2.8 15.1 3.8 8.3 50.4

2010 1.5 2.2 4.0 7.7 2.7 4.1 0.6 2.7 17.3 4.6 10.6 58.0

2011 1.2 1.9 3.4 6.4 2.3 3.5 0.6 2.9 15.6 3.9 9.0 50.8

2012 1.4 2.1 3.7 7.3 2.8 3.7 0.8 3.3 18.7 4.5 8.5 56.7

2013 1.4 2.1 3.9 9.2 3.1 4.8 0.7 3.9 24.0 5.3 8.3 66.9

2014 1.3 2.1 6.0 8.4 3.2 4.4 0.8 3.6 26.3 5.3 8.4 69.8

2015 1.2 1.6 8.2 7.6 3.2 9.7 0.6 3.9 25.1 5.2 7.3 73.5

2016 1.3 2.0 7.3 7.7 3.2 5.1 0.6 3.5 45.7 5.3 8.2 89.9

2017 1.5 2.4 8.7 9.8 4.4 6.2 0.8 4.5 32.1 6.4 10.9 87.7

2018 1.3 1.9 6.3 8.1 3.8 5.3 0.7 3.6 30.4 5.7 9.6 76.8

2019 1.5 2.4 8.6 9.7 4.9 6.2 0.7 4.2 33.9 8.7 8.8 89.5

2020 1.7 2.6 12.3 11.1 6.1 6.7 0.7 4.0 40.7 9.8 10.0 105.8

2021 1.9 3.3 14.4 13.8 5.4 6.5 0.7 3.8 52.2 11.0 11.4 124.4

2022 1.7 2.7 11.5 11.0 4.6 5.4 0.7 3.11 40.3 9.5 10.9 101.2

DM: developed markets EM: emerging markets

Source: SIFMA capital market fact sheets 2023
 Global Equity Market Capitalization Global Equity Market Capitalization
- 2013 - 2022
$66.2 Trillion $101.2 Trillion

Source: SIFMA capital market fact sheets 2023

Is Financial Market Necessary?
 Systemic Risk
Systemic risk
 A trigger event, i.e. economic shock or institutional
failure, causes a chain of bad economic consequences
➢ A chain of financial institution and/or market failures;
➢ Significant losses to financial institutions ;
➢ Substantial financial-market price volatility.
Example
 Great depression
➢ Stock market crash of October 1929 → bank run→ more bank
failure (2000 banks)
 2008 Global Financial Crisis
S&P 500 from Jan. 1, 2007 to May 1 2010
1800

3/14/2008: Fed provides an

1600 emergency loan to Bear Stearns，
two days later it was sold to
JPMorgan Chase
1400
09/15/2008: Lehman Brothers
file for Chapter 11 bankruptcy
protection. The filing marks
1200 04/02/2007: 02/13/2008: the largest bankruptcy in U.S.
New Century files for Bush signs stimulus history.
bankruptcy. package which aims to
1000 avoid economic recession.

800 09/18/2007:
cut the interest rate by
0.5 point percentage.
600

07/26/2008: U.S. Congress

offers up to 300 billion U.S.
dollars, The Treasury raise
the credit quota without
limitation and buy unlimited
stakes.
 SP500 Index Level
1260

1240

1220

1200

1180

1160

1140

1120

1100
11 12 15 16 17

Close price
 Capital Market Failure

(on Sept. 17) Huddled in his officeWednesday "Without these funds' participation, the $1.7
with top advisers,Treasury Secretary Henry trillion commercial-paper market, which
Paulson watched his financial-data terminal finances automakers' lending arms or banks
with alarm. One market after another began to credit-card units, faced higher costs.Without
go haywire. Investors were fleeing money- commercial paper, 'factories would have to shut
market mutual funds, long considered ultra- down, people would lose their jobs, and there
safe.The market froze for the short-term loans would be an effect on the real economy,' says
that banks rely on to finance their day-to-day Paul Schott Stevens, president of the Investment
business.Without such mechanisms, the Company Institute mutual-fund trade group."
economy would grind to a halt. Companies
would be unable to fund their daily operations.
Soon, consumers would panic.
 Fed’s action in 2020 COVAC Crisis
March 15
• 1% rate cut, taking the Fed’s benchmark for
short term lending down to near zero.
2020 March SP500
• Lowered the rate for banks to borrow at the
3200
discount window by 1.5% cut the reserve
requirement ratio to zero. 3/09 -7.6%
3000
March 17 3/11 -4.89%
• buying commercial paper, or the short-term 2800 3/12 -9.5%
unsecured debt that businesses rely on for
2600
3/16 -12%
operational cash.
March 19
2400
• A new operation focused on currency swaps
aimed at other institutions in need of dollar- 2200
denominated assets.
March 20 2000

3/10
3/2
3/4
3/6
3/8

3/12
3/14
3/16
3/18
3/20
3/22
3/24
3/26
• buy municipal debt.
March 23
 Expand Fed’s asset purchases, which were
supposed to max out at $700 billion to be
unlimited.
 Roles of Financial Markets
 Financial markets distribute resources (money) from

savers to entrepreneurs

 Financial markets allow for a separation of

▪ savings decisions

▪ investment decisions
 Roles of Financial Markets (ctd.)

❑Alter consumption timing

❑Information role of market prices (example VIX)

❑Risk allocation

❑Separation of ownership and management

▪ does not always work well

 VIX "fear index"
skyrockets to highest level in
nearly 7 years (Yahoo
Finance)
Aug 23, 2015

The CBOE Volatility

Index VIX jumped to its
highest level in more than six-
and-a-half years Monday
following a broad early
morning stock selloff. The
VIX, or so-called "fear
index," hit an intraday high of
03/16/2020:
53.29 at the beginning of the VIX surged nearly 25 points to close at a record high of 82.69, surpassing the peak of 80.74 on Nov. 21,
trading day, its highest 2008.
Stocks suffered a brutal sell-off Monday with the Dow Jones Industrial Index tanking
reading since January 21, nearly 3,000 points, posting its worst day since the “Black Monday” market crash in 1987.
2009. The S&P 500 dropped 12%, — hitting its lowest level since December 2018.
Investors have been dumping stocks amid intensifying fears that the fast-spreading coronavirus
would disrupt global supply chains and damage the world economy significantly.

Update to 2023.11.09
11/20/2008: 2008 May 6: flash crash 08/24/2015: China's 02/05/2018:concerns
08/08/2011: 3/16/2020: All US
financial crisis Dow plunged Shanghai Composite over inflation and
A.I.G Sues Bank stock indices
panic over nearly 1,000 points crashed 8.5% in what is rising interest rates,
of America Over declined about
automakers and intraday, and A $1 now being dubbed China's which have pushed
Mortgage Bonds 12% on fear of
city group. trillion European "Black Monday." up bond yields at the
causing Bank of covac19.
aid package failed expense of stocks.
America stock
to assuage worries
drop.
about Greece and
other struggling Update to 2023.11.09
European nations.
 02/26/2020:
07/06/2015, 09/01/2015:
02/09/2018: Gem (创业板) fell sharply; Under the
Affected by China’s stock market crash influence of the sharp decline of US stocks
Affected by the down of US
from June 2015 to September 2015. The affected by the COVID-19, A shares and H
stock market.
index hits the bottom line on 25th August. shares both fell sharply; Net outflow of
The volatility rockets the highest level on Northward capital all day.
1st September 2015.
07/24/2020: (Oversea factor) unfriendly attitude of U.S. leads to pessimism; The 50
index of the science and technology innovation board fell sharply by more than 7%;
ShangZheng Index fell below 3200 points; Poor semi-annual performance affected
Update to 2022.8.22 by the epidemic; Net outflow of Northward capital.
 Role of Financial Intermediaries

Difficult for small households to interact with large

corporations that need finance.
 Financial Intermediaries

 Financial Intermediaries: bring borrowers (businesses)

and lenders (households) together:
1) pool savings from households (deposits);
2) diversify risk by lending to many businesses;
3) have expertise in screening and monitoring.
Advantages From Using Financial Intermediaries
Cost advantage (over direct lending/borrowing)
 Reconciling conflicting preferences of lenders and borrowers
 Risk aversion: help spread out and decrease the risks
 Economies of scale

Information advantage
 Asymmetric information
 Adverse selection
 Moral hazard
 When these problem become severe, we have market failure

 Financial intermediaries are specialized in information production

 Players in Financial Markets
❑ Business Firms – borrow
❑ Households – save
❑ Government
❑ Financial Intermediaries:
➢ Banks
➢ Investment Companies
➢ Insurance Companies
➢…
 Types of financial intermediaries
Financial intermediaries include:
➢ Banks
➢ Credit unions
➢ Financial advisers or brokers
➢ Insurance companies
➢ Collective investment schemes
➢ Pension funds
 Current US Financial Assets
Total: $ 93 Trillion

Money Market: Fixed Income: Equities:

$1 tr. $52 tr. $40 tr.

• Treasury Securities: $24 tr

• MBS: $12 tr
• Corporate Bonds: $10 tr
• Munis: $4 tr
• ABS: $1 tr
• Federal Agency Securities: $2 tr

All held by: House Holds

Mutual/Hedge funds
Banks
Pension funds
Insurance companies
Data Source: SIFMA2023, Update to end-2022;
Note: numbers are rounded to integers.
Current Chinese Financial Market Statistics

Total: ￥223 Trillion

Stock Market: Domestic Debt Securities:

￥78 Trillion ￥145 Trillion

Shanghai Market: Shenzhen Market: Government Securities: Financial Bonds: Corporate Bonds: Others:
￥46 Trillion ￥32 Trillion ￥60 Trillion ￥52 Trillion ￥32 Trillion ￥1 Trillion

Update to end-2022
Data Source: Chinese Central Bank Financial Market Statistics 2022;
Note: numbers are rounded to integers.
 Fast Growing Chinese Market
 China’s financial markets have enjoyed a Financial Market In
period of strong growth since 1990’s Comparison
%of GDP, 2021
 They are still relatively small
USA
Chinese Financial Market in Global
Context 2021 Germany

Bonds 17.20% Brazil

Korea

Banks 25.37% Russian

Japan
Equity 11.60%
China
0 50 100 150 200 250
0 100 200 300 400 500 600
China World
Stock market capitalization to GDP (%)
Private credit by deposit money banks to GDP (%)
Data source: SIFMA, Statista Research Department, Newest data only updates to 2021 Bond outstanding(%)

Data source: World bank, Newest data only updates to 2021

 Fast Growing Chinese Banks
TOP 10 WORLD BANKS 2022
RANK BANK Country Capital($ Trillion)
1 ICBC China 5.54
2 China Constrcution Bnak China 4.76
3 Agriculture Bank of China China 4.58
4 Bank of China China 4.21
5 J.P. Morgan Chase USA 3.74
6 Mitsubishi UFJ Financial Group Japan 3.18
7 Bank of America USA 3.17
8 HSBC Holding PLC UK 2.95
9 BNP Paribas France 2.91
10 Crédit Agricole Group France 2.67

THE MOST PROFITABLE COUNTRIES

Rank Country Aggregate pre-tax profit ($ bn)
1 China 400
2 USA 343
3 Eurozone 158
4 UK 55
5 Japan 44

Data source: BIS data portal World bank, Update to end-2022

 Bond and Stock Market in China
The Structure of Bond Issue in China
700000

600000

500000

400000

300000

200000

100000

0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

<1Y 1-3Y 3-5Y 5-7Y 7-10Y >10Y

Data Source: IfinD

Updated to Dec. 2022
 China Bond Issue in 2011 and 2022
China bond issue in 2011 >10Y, China bond issue in 2022
6.61%
>10Y,
7%

7-10Y, 7-10Y,
5-7Y,
9% 9.34%
4.80%
<1Y,
5-7Y, 35%
3-5Y, <1Y,
12% 9.39% 52.57%

3-5Y, 1-3Y,
20% 17.27%
1-3Y,
17%

<1Y 1-3Y 3-5Y 5-7Y 7-10Y >10Y <1Y 1-3Y 3-5Y 5-7Y 7-10Y >10Y

Data Source: IfinD

Updated to Dec. 2022
 Bond and Stock Market in China
Stock Market Capitalization in China
600,000.00 7,000.00

6,000.00
500,000.00

5,000.00
400,000.00

4,000.00
300,000.00
3,000.00

200,000.00
2,000.00

100,000.00
1,000.00

0.00 0.00

Stock Market Capitalization (Shanghai) RMB.bn） Shanghai Composite Index（Right)

Data Source: IfinD Updated to Dec. 2022

 Stock Market Cap in Comparison
250

200

150
% of GDP

100

50

0
China Russia India Canada Japan Germany France USA
2005 2010 2015 2020

Data Source: The Global Economy Newest data updates to 2020

Top Stock Exchanges
-Among Members of World Federation of Exchanges

Market Capitalization
Rank Economy Stock Exchange
(USD Trillion)

1 United States NYSE 25.0

2 United States NASDAQ 21.7
3 Europe Euronext 7.2
4 China Shanghai Stock E. 6.7
5 Japan Japan Exchange G. 5.9
6 China Shenzhen Stock E. 4.5
7 Hong Kong (China) Hong Kong Exchanges 4.2
8 India National Stock E. 3.5
9 UK LSE Group 3.4
10 Saudi Arabia Saudi Exchange 3.1

Data Source: Statista, update to October. 2023

 Overview of China’s Stock Exchanges
Shenzhen Stock Exchange Shanghai Stock Exchange
end-2021 end-2022 end-2021 end-2022
Companies Listed 2578 2743 2079 2213

Market Cap.(RMB bn) 39638 324212 51968 46379

A shares 46249 40472

25614 21150
B shares 89 44
SME - - - -
ChiNext 14024 11272 - -
STAR - - 5630 5815
Total Traded Value
143973 128253 114000 96256
(RMB bn)
A shares 103417 84221
89642 83176
B shares 41 48
ChiNext 54330 45078 - -
STAR - - 10542 11987

Data Source: SSE, SZSE

Key Events in China’s Financial Market Regulation
Establishment of People's Bank of Establishment of China Issurance
1948 1998 2013 Draft on Reform of New Share Issuing
China(PBC) as mono-bank Regulatory Commission
Ninth National People's Congress
Tentative Measures on Refinancing
1951 Renminbi(RMB) introduced 1999 designates financial reform as 2014
Business Supervision and Management
national policy reform goal
Establishment of Shenzhen-Hong Kong
1981 First issuance of treasury bills 2001 Membership in WT 2016
Stock Connect program
First issuance of local enterprise Launch the pilot of full circulation of H
1982 2002 Introduction of QFII scheme 2017
bonds shares
Approval of first foreign bank Law on Banking Regulation and Merge of CBRC(银监会) and CIRC(保
1985 2003 2018
offices Supervision 监会)
Open the scientific innovation board(科
Law of the People's Bank of
1986 Membership in ADB 2004 2019 创板); Reform the LPR formation
China(Amended)
mechanism

1988 Bankruptcy Law 2004 Commercial Bank Law(Amended) 2020 Amendment of the new securities law

Establishment of Shanghai Law of Securities Investment

1990 2004 2020 Issue digital RMB
Securities Exchange Funds

Establishment of Shenzhen Establishment of Beijing Securities

1991 2006 Regulations on Foreign Banks 2021
Securities Exchange Exchange
Establishment of China Securities Regulations on Foreign Currency Establishment of financial 16, Real
1992 2008 2022
Regulatory Commission Exchanges estate policy quickly landed
PBC formally confirmed as China's The implementation of personal pension
1995 2009 Insurance Law(Amended) 2022
central bank policy
Administrative Regulations on Establishment of National financial
1996 Membership in BIS 2012 2023
Futures Trading(Amended) regulatory administration