ECOM137 China and Global Financial Markets

Section 1

Are the following statements true or false? If false, give reasons.

1) The narrow measure of money supply, M1, in China includes currency in circulation, demand deposits, and balances in mobile payment accounts such as WeChat Pay and Alipay.

[3 marks]

2) Compared to other emerging economies (e.g. Brazil, Russia, India, South Africa), China has a bigger banking sector and higher trading volume in its stock market.

[3 marks]

3) The benchmark interest rate for lending in China is the loan prime rate, published by People’s Bank of China monthly.

[3 marks]

4) The risk structure of interest rates describes the relationship among bonds with different maturities.

[3 marks]

5) If a portfolio has a 5% one-month value-at-risk (VaR) of 1%, then there is a 1% chance of the portfolio declining in value by 5% in one month.

[3 marks]

6) Chinese enterprise bonds are traded in both the interbank market and the exchange market.

[3 marks]

7) The main investors in the local government bonds in China are retail investors.

[3 marks]

8) The split-share structure reform in China aims at converting non-tradable shares such as state and legal person shares to tradable shares in the stock market.

[3 marks]

9) Before the regulatory reform in 2017, China’s model of financial regulation followed the integrated model.

[3 marks]

10) In 2018, the China Banking Regulatory Commission and the China Insurance Regulatory Commission were merged to form the China Banking and Insurance Regulatory Commission.

[3 marks]

Section 2

1) Zhejiang provincial government issued a 5-year coupon bond in 2015, with a face value of 100,000 RMB and a coupon rate of 6%. Ben bought one unit of this bond and held it until 2017, when there were still 3 years remaining until maturity.

a) When Ben sold the bond in 2017, the interest rate was 5%. What was the price for the bond Ben could get in 2017?

[2 marks]

b) What is Ben’s holding period return?

[4 marks]

c) What would Ben’s holding period return have been if the interest rate in 2017 had been 6%?

[4 marks]

d) Comparing the holding period return in b) to that in c), when does the holding period return tend to be higher for Ben and why?

[4 marks]

2) As of the end of 2020, China Minsheng Bank holds loans that are worth 5.9 trillion RMB, cash reserves that are worth 652 billion RMB, and other assets with a total worth of 186 billion RMB. To finance the asset holding, the bank maintains deposits worth a total of 4.9 trillion and long-term debts worth 1.1 trillion.

a) What is Minsheng Bank’s total equity (in billion RMB)?

[3 marks]

b) Sketch Minsheng Bank’s balance sheet in 2020 (in billion RMB). You can fill in a table in the following format:

[5 marks]

c) What is the debt-to-equity ratio of Minsheng Bank?

[2 marks]

d) What would Minsheng Bank’s net profit after taxes need to be (in billion RMB) to generate a return on asset (ROA) of 10%?

[2 marks]

e) What would Minsheng Bank’s return on equity (ROE) be if its ROA was 10% as in d)?

[2 marks]

f) How are ROA, ROE, and the debt-to-equity ratio related? Please write down the definitions of ROA and ROE and derive an identity that links ROA, ROE and debt-to-equity ratio.

[4 marks]

3) Consider the following figure taken from Hu, Xing, Pan and Wang (2018), which shows the nominal value of an account of 1 RMB invested in the year end of 1992 in a portfolio of small company stocks (i.e. the higher light red line) and a portfolio of large company stocks (i.e. the lower dark red line), together with the level of inflation (i.e. the green line). More specifically, holding the small company stocks portfolio until the year end of 2016 yields 105.07 RMB in your account, while holding the large company stocks portfolio until the year end of 2016 yields 3.90 RMB in your account.

a) What is annualised nominal return on the portfolio of small company stocks? What is its annualised real return?

[4 marks]

b) What is annualised nominal return on the portfolio of large company stocks? What is its annualised real return?

[4 marks]

Section 3

Short Answers. Please answer 1) and choose one between 2) and 3) to answer.

1) Interest liberalisation in China. Before 2013, the People’s Bank of China (PBOC) imposed a floor and a ceiling on the commercial bank deposit rate as well as the lending rate. The ceiling on the deposit rates is artificially low to guarantee cheap funding for the commercial banks. a) What is the effect of the deposit ceiling on the commercial banks’ supply of loans? [1 mark] b) How does the equilibrium level of the quantity of loans and their interest rate compare to an equilibrium without the deposit ceiling? [2 marks] c) Name two quantity-based policy tools and explain how the PBOC can use these quantity-based policy tools to alleviate the adverse effect from imposing the deposit ceiling in the loan market. [5 marks] d) Describe the main steps the PBOC took between 2015 and 2019 to liberalise the interest rates. [6 marks] e) Describe briefly how interest rates are determined in a fully liberalised market economy. How does the current practice in China compare with that? [6 marks]

Choose one of 2) and 3) below to answer.

2) A unique feature of the Chinese stock market is the co-existence of tradable and non-tradable shares.

a) What are the rights of the holders of tradable and non-tradable shares and how do they differ?

[2 marks]

b) What was the historical reason for some shares to be non-tradable?

[4 marks]

c) The share of market capitalization of non-tradable shares decreased from 80% in early 1990s to 20% in recent years. Describe the reform that enabled such change. What was the main challenge of the reform and how did the reform achieve the effect it did?

[4 marks]

3) In 2013 the local government debt outstanding was 1.45% of GDP, by 2017 it rose to 20.9% of GDP.

a) Why was the level of local government debt so low in 2013?

[2 marks]

b) How did the local government finance their expenditures in and before 2013? What were the undesirable effects of local governments’ funding model then?

[4 marks]

c) Describe the reform that gave birth to the rapidly growing local government bond market?

[4 marks]