PART 1: FINANCIAL MARKET

Unit 1: Functions of Financial Market

Introduction: This lesson is focused on financial market’s functions. Financial

market creates essential channels to stimulate the fund flow between individuals,
households, firms and governments that have surplus funds to those that have
financial shortage. Financial markets are not only beneficial for its participants, but
also increase the efficiency of the entire economy plus the welfare of everyone in the
society. The study on functions of financial market provide students with the first
basic background on banking and finance issues. In this lesson, students will be given
reading passages, exercises and translations to improve their reading, pronunciation,
translation and writing skills. They are also introduced to new terms and terminologies
related to financial market and its functions.
1. READING
The Financial Intermediary Function
Financial market performs the essential economic function of channeling funds
from households, firms, and governments that have saved surplus funds by spending
less than their income to those that have a shortage of funds because they wish to
spend more than their income. This function is shown schematically in Figure 1.
Those who have saved and are lending funds, the lender-savers, are at the left, and
those who must borrow funds to finance their spending, the borrower-spenders, are at
the right. The principal lender-savers are households, but business enterprises and the
government (particularly state and local government), as well as foreigners and their
governments, sometimes also find themselves with excess funds and so lend them out.
The most important borrower-spenders are businesses and the government
(particularly the federal government), but households and foreigners also borrow to
finance their purchases of cars, furniture, and houses. The arrows show that funds
flow from lender-savers to borrower-spenders via two routes.

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 In direct finance (the route at the bottom of Figure 1), borrowers borrow funds
directly from lenders in financial markets by selling them securities (also called
financial instruments), which are claims on the borrower’s future income or assets.
Securities are assets for the person, who buys them, but liabilities (IOUs or debts) for
the individual or firm that sells (issues) them.
Why is this channeling of funds from savers to spenders so important to the
economy? The answer is that the people who save are frequently not the same people
who have profitable investment opportunities available to them, the entrepreneurs. In
the absence of financial markets, savers and spenders might never get together.
Without financial markets, it is hard to transfer funds from a person, who has no
investment opportunities, to the one who has them; they would both be stuck with the
status quo, and both of them would be worse off. Financial markets are, thus, essential
to promoting economic efficiency.
The existence of financial markets is also beneficial even if someone borrows for a
purpose other than increasing production in a business. Say that you are recently
married, have a good job, and want to buy a house. You earn a good salary, but
because you have just started to work, you have not yet saved much. Over time, you
would have no problem saving enough to buy the house of your dreams, but by then
you would be too old to get full enjoyment from it.
If a financial market were set up so that people who had built up savings could
lend you the funds to buy the house, you would be more than happy to pay them some
interest in order to own a home while you are still young enough to enjoy it. Then,
over time, you would pay back your loan.

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 Now we can see why financial markets have such an important function in the
economy. They allow funds to move from people who lack productive investment
opportunities to people who have such opportunities. Thus financial markets are
critical for producing an efficient allocation of capital, which contributes to higher
production and efficiency for the overall economy.
Well-functioning financial markets also directly improve the well-being of
consumers by allowing them to time their purchases better. They provide funds to
young people to buy what they need and can eventually afford without forcing them to
wait until they have saved up the entire purchase price. Financial markets that are
operating efficiently improve the economic welfare of everyone in the society.
(Source: Federic S. Mishkin (2006), The Economics of Money, Banking and
Financial Markets, Seventh Edition Update, Addison-Wesley, Longman)
QUESTIONS
1.1. What is the main function of financial market?
1.2. Who are the participants in financial markets?
1.3. In what ways do funds flow in the economy?
1.4. How does direct finance work?
1.5. How can financial markets benefit individuals with consuming purposes?
1.6. Why is financial market so essential to the economy?
2. EXERCISES
2.1. Read the paragraph below and find the right word or phrase from the
box to fill each of the gaps

shortage purchases efficiency excess improves

indirect finance direct finance channel intermediary securities

The basic function of financial markets is to (1) funds from savers who have an (2)
of funds to spenders who have a (3) of funds. Financial markets can do this either
through (4), in which borrowers borrow funds directly from lenders by selling them
(5), or through (6), which involves a financial (7) that stands between the lender-
savers and the borrower-spenders and helps transfer funds from one to the other. This
channeling of funds (8) the economic welfare of everyone in the society, because it
allows funds to move from people who have no productive investment opportunities
to those who have such opportunities, thereby contributing to increased (9) in the
economy. In addition, channeling of funds directly benefits consumers by allowing
them to make (10) when they need them most.
2.1. Put the words/phrases in order to make sentences
1. If/prices/stay/oil and gas/impact/food/prices/high/there/be/on/will.
2. The/every/information/financial market/money/available/any/without/makes/
type of/spending.
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3. The/financial market/traded/is/currencies/forex market/where/are/a.
4. Mutual funds/ability/give/buy/to/once/a lot of stocks/at/investors/the.
5. The/forces/any/the/demand and supply/of/price/goods or services/is/by/
determined/of.
2.2. Find the best answer
1) Financial markets have the basic function of
a) getting people with funds to lend together with people who want to borrow
funds.
b) assuring that the swings in the business cycle are less pronounced.
c) assuring that governments need never resort to printing money.
d) providing a risk-free repository of spending power.
2) Financial markets improve economic welfare because
a) they channel funds from investors to savers.
b) they allow consumers to time their purchase better.
c) they weed out inefficient firms.
d) eliminate the need for indirect finance.
3) Well-functioning financial markets
a) cause inflation.
b) eliminate the need for indirect finance.
c) cause financial crises.
d) produce an efficient allocation of capital.
4) The principal lender-savers are
a) governments.
b) businesses.
c) households.
d) foreigners.
5) Which of the following can be described as direct finance?
a) You take out a mortgage from your local bank.
b) You borrow $2,500 from a friend.
c) You buy shares of common stock in the secondary market.
d) You buy shares in a mutual fund.
2.3. Match the words on the left with the phrases on the right

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 1. bankruptcy 4. bulls
2. bubble 5. day traders
3. bears 6. institutional investors

a. a name for investors who buy shares because they expect their price to rise.
b. financial organizations that own a lot of shares.
c. a people who buy and re-sell shares in a very short time, often just a few hours
d. a name for shareholders who sell because they expect the price to fall.
e. a period of rapidly rising share prices, followed by a quick collapse.
f. when you have no money to pay your debts, so you have to sell your assets

2.4. Put these words and phrases in the appropriate columns

Commercial banks Shares Finance companies Financial market
Financial intermediaries Stock Exchange Savings Associations
Financial cooperatives Stocks Bank borrowing Bonds
Dividend

Direct finance Indirect finance

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3. TRANSLATION
Translate the following texts into Vietnamese, paying a special attention to the
standard use of terms and clarification of expression.
Text 1

Primary and secondary market

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 The financial market is a world where new securities are issued to the public regularly.
It is a world full of varied financial products and services, tailored to the need of every
individual from all income brackets. These financial products are bought and sold on
the capital market, which is divided into primary market and secondary market.
The primary market is also known as new issues market. Here, the transaction is
conducted between the issuer and the buyer. In short, the primary market creates new
securities and offers them to the public.
For instance, Initial Public Offering (IPO) is an offering of the primary market where a
private company decides to sell stocks to the public for the first time. An important point
to remember here is that in the primary market, securities are directly purchased from the
issuer.
In secondary market, the securities issued in the primary market are bought and sold.
Here, you can buy a share directly from a seller and the stock exchange or broker acts as
an intermediary between two parties.
The secondary market is actually formed by another layer of investors who deal with
primary market investor to buy and sell financial securities such as bonds, futures
and stocks. These dealings happen in the proverbial stock exchange.
National Stock Exchange (NSE) and New York Stock Exchange (NYSE) are some
popular stock exchanges. Majorly, the trade happens between investors without any
involvement with the company that issued the securities in the primary market.
(Source: http://www.financewalk.com/primary-market-secondary-market/ )

Text 2
The Bond Market
The bond market is where organizations go to obtain very large loans. Generally,
when stock prices go up, bond prices go down. There are many different types of bonds,
including Treasury Bonds, corporate bonds, and municipal bonds. Bonds also provide
some of the liquidity that keeps the U.S. economy functioning smoothly.
It's important to understand the relationship between Treasury bonds and Treasury
bond yields. Basically, when Treasury bond values go down, the yields go up to
compensate. When Treasury yields rise, so do mortgage interest rates. Even worse, when
Treasury values decline, so does the value of the dollar. This makes import prices rise,

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which can trigger inflation. Treasury yields can also predict the future - an inverted yield
curve usually heralds a recession.
(Source: https://www.thebalance.com/an-introduction-to-the-financial-markets-3306233)

4. TERMINOLOGY
Bear – Nhà đầu tư bi quan: A name for shareholders who sell because they expect the
price to fall
Bull – Nhà đầu tư lạc quan: A name for investors who buy shares because they expect
their price to rise
Corporate bond – Trái phiếu doanh nghiệp: A corporate bond is a debt security issued
by a corporation and sold to investors. The backing for the bond is usually the payment
ability of the company, which is typically money to be earned from future operations. In
some cases, the company's physical assets may be used as collateral for bonds.
Day trader – Người giao dịch nội nhật: A person who buy and re-sell shares in a very
short time, often just a few hours.
Direct finance – Tài chính trực tiếp: Direct finance is a method of financing where
borrowers borrow funds directly from the financial market without using a third party
service, such as a financial intermediary.
Indirect finance – Tài chính gián tiếp: Indirect finance is where borrowers borrow funds
from the financial market through indirect means, such as through a financial intermediary.
This is different from direct financing where there is a direct connection to the financial
markets as indicated by the borrower issuing securities directly on the market.
Financial market – Thị trường tài chính: A financial market is a market in which
people trade financial securities, commodities, and other fungible items of value at low
transaction costs and at prices that reflect supply and demand. Securities include stocks
and bonds, and commodities include precious metals or agricultural products.
Forex market (foreign exchange market) – Thị trường ngoại hối: The foreign
exchange market (forex, FX, or currency market) is a global decentralized market for the
trading of currencies. This includes all aspects of buying, selling and exchanging
currencies at current or determined prices.
Futures market – Thị trường tương lai: A futures market is a central financial exchange
where people can trade standardized futures contracts; that is, a contract to buy specific
quantities of a commodity or financial instrument at a specified price with delivery set at a
specified time in the future. These types of contracts fall into the category of derivatives.

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Municipal bond – Trái phiếu địa phương: A municipal bond is a debt security issued
by a state, municipality or county to finance its capital expenditures, including the
construction of highways, bridges or schools. Municipal bonds are exempt from federal
taxes and from most state and local taxes, making them especially attractive to people in
high income tax brackets.
Mutual fund – Quỹ tương hỗ: A mutual fund is a professionally managed investment
fund that pools money from many investors to purchase securities. While there is no legal
definition of the term "mutual fund", it is most commonly applied to open-end investment
companies, which are collective investment vehicles that are regulated and sold to the
general public on a daily basis. They are sometimes referred to as "investment companies" or
"registered investment companies".
Options market – Thị trường quyền chọn: An option is a financial derivative that
represents a contract sold by one party (the option writer) to another party (the option
holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell
(put) a security or other financial asset at an agreed-upon price (the strike price) during a
certain period of time or on a specific date (exercise date).
Primary market – Thị trường sơ cấp: A primary market is a financial market in which
new issues of a security, such as a bond or a stock, are sold to initial buyers by the
corporation or government agency borrowing the funds.
Secondary market - Thị trường thứ cấp: A secondary market is a financial market in
which securities that have been previously issued (and are thus second-hand) can be
resold.
Securities broker – Nhà môi giới chứng khoán: A regulated professional individual,
usually associated with a brokerage firm or broker-dealer, who buys and sells stocks and
other securities for both retail and institutional clients through a stock exchange or over
the counter in return for a fee orcommission.
Securities dealer – Nhà kinh doanh chứng khoán: A person or firm in the business of
buying and selling securities for their own account, whether through a broker or
otherwise.
Treasury bond – Tín phiếu kho bạc: A Treasury bond (T-Bond) is a marketable, fixed-
interest U.S. government debt security with a maturity of more than 10 years. Treasury
bonds make interest payments semi-annually, and the income received is only taxed at
the federal level. Treasury bonds are known in the market as primarily risk-free; they are
issued by the U.S. government with very little risk of default.