Malaysian Economy and Financial Market Due to the recent increase in fuel prices, inflation as measured by consumer price inflation is expected to exceed 6% in June 2008 (May 1982 –6.1% and June 1982 – 5.7%). By end of 2008, inflation expected to reach 5.2% (double than the rate forecasted at beginning of 2008 – 2.8%)

Country Outlook by Economist Intelligence Unit Despite the upward forecast of inflation for 2008, economy is still expected to expand by 5.8% this year. Growth will be driven by domestic demand, and in particular by private consumption and investment. Private consumption will continue to make the largest contribution to GDP growth. First quarter of 2008, real GDP expanded by 7.1% yoy. External sector is expected to remain weak (export growth slows). Unemployment rate is also expected to increase to 3.4 %(from 3.2% in 2007).

Bank Based vs Market Based Financial System Bank-based: banks play a leading role in mobilizing savings, allocating capital, overseeing the investment decisions of corporate managers, and in providing risk management vehicles. Market-based: securities markets share center stage with banks in terms of getting society’s savings to firms, exerting corporate control, and easing risk management.

Bank Based vs Market Based Financial System Germany and Japan are examples of bank-based economy countries. England and United States : market-based economy. Malaysia – is highly market-based according to Levine (2000) because of its active market. Countries that are neither bank-based nor market- based, are considered as having underdeveloped financial system.

Stock Market Capitalization/GDP Private Credit by Financial Institutions /GDP

Malaysian Financial System Comprises of the Financial Institutions and the Financial Market. –Financial Institutions: Banking system and the non-bank financial intermediaries –Financial market: money and foreign exchange markets, capital markets, derivatives markets, and offshore market.

Function of Financial Markets 1. Allows transfers of funds from person or business without investment opportunities to one who has them 2. Improves economic efficiency

Classifications of Financial Markets 1.Debt Markets Short-term (maturity < 1 year) Money Market Long-term (maturity > 1 year) Capital Market 2.Equity Markets Common stocks 1.Primary Market New security issues sold to initial buyers 2.Secondary Market Securities previously issued are bought and sold 1.Exchanges Trades conducted in central locations (e.g., BURSA MALAYSIA) 2.Over-the-Counter Markets Dealers at different locations buy and sell

Internationalization of Financial Markets International Bond Market 1. Foreign bonds 2. Eurobonds World Stock Markets U.S. stock markets are no longer always the largest: Japan sometimes larger

Function of Financial Intermediaries Financial Intermediaries 1.Engage in process of indirect finance 2.More important source of finance than securities markets 3.Needed because of transactions costs and asymmetric information Transactions Costs 1.Financial intermediaries make profits by reducing transactions costs 2.Reduce transactions costs by developing expertise and taking advantage of economies of scale

Function of Financial Intermediaries Risk Sharing 1.Create and sell assets with low risk characteristics and then use the funds to buy assets with more risk (also called asset transformation). 2.Also lower risk by helping people to diversify portfolios

Asymmetric Information: Adverse Selection,and Moral Hazard Adverse Selection 1.Before transaction occurs 2.Potential borrowers most likely to produce adverse outcomes are ones most likely to seek loans and be selected Moral Hazard 1.After transaction occurs 2.Hazard that borrower has incentives to engage in undesirable (immoral) activities making it more likely that won’t pay loan back Financial intermediaries reduce adverse selection and moral hazard problems, enabling them to make profits

Regulation of Financial Markets Two Main Reasons for Regulation 1.Increase information to investors A.Decreases adverse selection and moral hazard problems B.SC forces corporations to disclose information 2.Ensuring the soundness of financial intermediaries A.Prevents financial panics B.Chartering, reporting requirements, restrictions on assets and activities, deposit insurance, and anti- competitive measures