010：Financial Markets：The Complications of Time

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【音频英文稿】

Hello, Himalaya subscribers. My name is Timothy Taylor. 
For many people, thinking about supply and demand in a market, like buying shrimp at a grocery store or being hired at a job is fairly easy. But in the next few talks, I want you to think about a different set of markets. These markets don't involve buying or selling anything you can see. Instead, they involve making agreements across time. In these markets, more patient people who are willing to wait will be paid by less patient people who are not willing to wait. Those who want to buy something in the present and want the money to do that now will be able to get that money from those willing to wait and consume in the future. To put it a little differently, borrowers and investors will be people who need to pay savers. These are financial markets.

And in this lecture, we want to make four main points as we get started talking about financial markets. First, what are financial intermediaries? What does that term mean? Second, how do banks work? Third, how do bonds work? And forth, how do stocks work? We'll do a basic overview in this talk, and then return to these subjects as we move along.

So let's start off with our first point. Why do financial markets have intermediaries? Well, what does an intermediary mean, exactly? An intermediary is a party that stands in between a buyer and a seller. For example, it's often the case in an online website that the website might sell products from many different companies to many different consumers. If you buy something through that kind of website, then the website is acting as an intermediary between you and the company.

The job an intermediary is to arrange what is being bought and sold, arrange the payments, and also give some confidence to both sides that the transaction really is going to happen. Financial markets are just full of intermediaries. And the banks, bond markets, and stock markets that we're going to talk about in this talk are really just three examples. One big reason why there are so many intermediaries in financial markets is that money is in some ways almost fluid, almost like water. An intermediary can help by putting all these little bits of money together into larger pools.

For example, imagine that there are twenty individuals who all want to save a little bit of money, and there's one person out there who wants to borrow some money to buy an expensive house. Now, in the real world, it could be pretty hard for those twenty people to locate each other, and then to locate the person who wants to buy the house, for those people all to decide that the person who wants to buy the house is a good risk to repay the loan and then agree on what the terms of the loan would be, what the interest rate should be, and how long it take until it's repaid.

This would be even more complicated if it was a a big loan for a giant company, which might want to borrow an amount equal to the combined savings of a thousand people, or five thousand people, or ten thousand people. So what a financial intermediary can do is to bring together all of these parties. It can also help to clarify exactly what set of promises are being made about what return will be paid in the future.

For the rest of this talk, we're going to go through some organizations and financial intermediaries you've probably already heard of banks, bond markets, and stock markets.But we're going to talk about these financial intermediaries in a different way than you might be used to. We're going to think about them from the standpoint of demand and supply of financial capital, and how the intermediary is standing in between those who supply the capital and those who would like to use it.

So let's move to our second main point. How do banks work, in particular, as financial intermediaries? With a bank, the suppliers of capital are those who have bank deposits. They could be individuals or companies, or even branches of government.

When you put your money in a bank account, you know you aren't going to get a very high rate of interest, in recent years in China, maybe two or three percent or a little bit less. But, where does the bank get the money to pay that interest? Well, the bank has an advantage as an intermediary. It can take all the deposits, group them together, and then use them to make loans to those who are demanding to borrow financial capital and seem likely to repay. And that might include individuals or firms, or even again, branches of government.

Again, the bank is an intermediary. It's shaping the flow of money in the financial market. Now, banks, of course, can make money doing this. For example, say, they charge a five percent rate of interest to borrowers, but they only pay a two percent rate of interest to depositors. That gap between five percent and two percent is the money the bank can use to cover its expenses, figure out how to run its operations, and some of it could turn out to be profit for the bank as well. In addition, banks have an additional source of income, which can be charging fees for putting together in handling more complicated financial products.

Now, of course, a bank might be tempted to try to charge really high interest rates to borrowers, or to pay really low interest rates to savers. But when there are a number of different banks, that's going to be difficult. After all, borrowers are going to look around, try and find the lowest interest rate they can pay. And if some bank is trying to charge a lot, that bank won't get many people who want to borrow. On the other side, savers are looking around to find the highest interest rate they can.

So again, if a bank tries to offer a very, very low interest rate, it won't attract very much in the way of deposits. Now, banks are complicated. And then we'll have to talk about in more detail later how governments regulate banks and why. Here, I just wanna get the basic idea that banks are a financial intermediary between savers and borrowers.

Let's now think about our third main question, what are bond markets? And in particular, for those starting off, what is a bond anyway? Well, a bond is when a large organization, like a company or a branch of government, decides to borrow money. Now, in theory, of course, it could just go and get a bank loan. But we might be talking about a really, really large amount of money here. And rather than borrowing the money from the bank, the institution instead decides that it's going to sell a bond.

And so let me give you an example of a really basic bond. It works like this. Say there's a company that wants to borrow six million yuan. A very simple bond would be a contract that says we promise to repay the six million yuan after some period of time, in this example, say five years. In the meantime, we will pay six percent interest per year. Now that company might be building a factory, or it might be, say, a local government building a water treatment plant. The idea is get the plant built now, and then use money earned from the facility to help pay the interest over time, and eventually to repay the loan itself. You can have a bond that stretches out over twenty years or thirty years or even longer. A financial intermediary, like a bank, agrees to help sell a bond to customers and it gets a fee for doing so.

It sells the bond a little bit at a time, like one individual investor might buy ten thousand yuan of the bond. A big pension fund or money market fund might buy some of the bond too. Whoever buys the bond gets the interest payments. And after the five years or however long or up, it gets its original money back too. Banks can buy bonds also. They use the interest sometimes to set up a money market fund or what's sometimes called a wealth management product. And that allows them to pay higher interest, because they're passing along what the bond interest would be.

Now, the interest rate for a bond will depend on how risky the borrower is. A very safe borrower can pay a low interest rate, a high-risk borrower will have to pay a higher interest rate to compensate for the risk that they might not be able to repay.

Let's now turn to stock markets. What is a stock market? Well, at a basic level, stock refers to ownership of a company. How do you make money from stock ownership?Well, one way is dividends. A dividend is that for every share you own, the company makes you a payment. Of course, this only works at the company is earning some profits. But some companies do have a pattern of making regular dividend payments. However, it's important to know dividend payments are not guaranteed.

Another approach is what's called capital gains. The idea here is that you buy stock for, say, one hundred yuan per share, and you plan to sell it later for a hundred and twenty yuan per share, and thus, you'll make a gain. But, of course, it's also possible you might buy it for one hundred yuan per share, and the price of the stock could fall to eighty yuan per share, and then you would suffer a loss. Some of you may well remember that back in two thousand and fifteen, many Chinese investors experienced losses in the stock market.

What happens in a stock market is stock for one company is traded in one place in a stock market. And a stock market is a kind of intermediary. It brings together those who want to buy stock and those who want to sell it. Until recently, Chinese stock market investors had two main options for buying and selling stock. There was the Shanghai Stock Market, which tend to have larger companies and more financial firms. And the Shenzhen Stock Market, which had more small and midsized companies and companies in industries like technology, media and consumer goods.

In the last few years, there's also been some, what are called, connectors created from these markets to the Hong Kong Stock Exchange. So Chinese investors can invest in some of the companies that are on the Hong Kong Stock Exchange. It may seem a little strange, but some well-known Chinese firms don't buy and sell their stock on Chinese stock exchanges. For example, the stock of Alibaba, Baidu, and the China Life Insurance Company are bought and sold instead on US-based stock exchanges.

China's financial regulators have been trying to figure out some ways to make connections, so China's domestic investors could invest in some of these other China companies that are based in and bought and sold in the United States. But at least in the middle of two thousand eighteen, this hasn't yet happened.

Stocks are a little bit complicated, because there's a really common misconception that when you buy a stock, the company gets the money. But if you think about it for a minute, that just isn't true. If I buy stock from somebody else who owns that stock, the company doesn't get anything. It's like if you buy a house from someone, the ownership of the house changes, but a new house doesn't get built. The original builder of the house doesn't get any more money.

The one exception is that when companies are small and young, and they're just getting ready to take off in size, that's when they often sell stock in the company directly. And they sell off stock to get that big chunk of money they need to make a large investment and really take off. That's sometimes called a public offering or an initial public offering. It gets the money to the company directly.

Of course, when that happens, the owners of the company are essentially giving up ownership of the company. They used to own most or all of the company, but when they sell stock, now, ownership goes to the people who own the stock in the company instead. When established companies want to get funding for investment, they rarely sell additional stock, because people who already own the stock aren't very happy. If more stock gets sold, it makes the value of their stock somewhat less or diluted.

Instead, when established companies want to get funding for investment, they either can use profits the company is already earned as one source of investment funding, or if that isn't enough, then they can turn to borrowing, either with bank loans or with bonds.

I hope at this point it's clear that all of financial investments have an element of time involved, whether with banks or bonds or stocks. But the rewards and risks of putting your money into a bank or a bond or a stock look very different. A bank account has different risks and rewards than buying bonds, and this has different risks and rewards than buying stock or real estate or gold.

So when the talks that follow will spend more time on this specific issue of what an investor should be thinking about if making a choice between putting money in a bank, buying bonds or wealth management products from a bank, stocks or even other options for investing money, like gold and real estate.

I'm Timothy Taylor. Thank you for listening to Himalaya.