Capital Markets: Exploring Debt, Borrowing, and Risk in Financial Markets

This document delves into the intricacies of capital markets, focusing on topics such as the exclusion of financial sector debt from the credit-to-GDP ratio, why state-owned enterprises borrow more, and the riskiest firms from an investor's perspective. It also examines the annual report of one of the big four Chinese banks, providing insights into non-loan assets such as precious metals and held-to-maturity investments.

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3a. Why the Authors Decided to Exclude the Financial Sector Debt from the Domestic
Credit-to-GDP ratio
The authors decided to exclude the financial sector debt from the Domestic Credit-to-
GDP ratio since additional credit (debt) would have led to a similar amount of value addition as
in the past years, and thus the credit-to-GDP ratio would remain stable. Rapid credit growth in
the non-financial sector supported the steady growth of China following the Global Financial
Crisis (GFC). The efficiency of financial sector credit had deteriorated over the past years,
signifying the rapid growth of resource misallocation (Sharpe and Sharpe 2015, pp. 28).
Therefore, the authors decided to exclude the financial sector debt from the Domestic Credit-to-
GDP ratio.
3b. Why State-Owned Enterprises May Have Borrowed More Than Private Enterprises
State-owned enterprises may have borrowed more than private enterprises as a result of
the continued deterioration in the efficiency of credit in the industrial sector as well as the service
sectors. Due to inefficiency, state enterprises have been able to acquire more debts from the two
sectors than private enterprises. The fact that the service sector contributes more than the
industrial sector in terms of GDP gives the state enterprises a prime opportunity to acquire more
credit than the private enterprises (Fabozzi, Modigliani and Jones 2003, pp. 129).
3c. How Total Bank Assets as a Percentage of GDP Fall When the Growth Rate of Bank
Assets Year on Year is Still Positive
The total bank assets as a percentage of GDP may fall when the rate of growth of bank
assets is still a positive year on year. The sizeable maturity mismatch between the bank’s
liabilities and assets causes the fall. Many banks are net borrowers with maturities that hover

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near the short end indicating they could create interlinkages which make liquidity crunch to
spread over quickly to the broader financial system. It causes the bank to suffer WMPs, thus
stressing its balance sheet considering the widespread perception on the bank’s WMP
sponsorship implicit guarantees (Didier and Schmukler 2013, pp. 107).
3d. Firms’ Debt Liabilities that would be The Riskiest from an Investor’s Point of View
From an investor’s point of view, the firms that would be the riskiest are those in the
bottom right. Since the author plots, the debt-to-equity ratio on the X-axis and current ratio on
the Y-axis, firms located at the bottom right of the graph would have a low current ratio and a
high debt to equity ratio. The low current ratio indicates that the firms have lower assets than
liabilities while the high debt to equity ratio shows that the firms have more substantial liabilities
(debts) than equity 9net assets). Therefore, the firms in the bottom right are most risky
(Campbell, Lo and MacKinlay 2017, pp. 88).
3e. When a Country Runs Current Account Surpluses, Can its Net External Debt Rise?
When a country runs a current account surplus, its net external debt can rise. Consistent
surpluses in the current account can help eliminate probable crisis in external funding caused by
a sudden halt of external flows of capital. However, countries can still experience booms of
credit which would end badly, regardless of the surpluses on the current account since funding
crisis can take place without exposure to external funding (Didier and Schmukler 2013, pp. 107).
3f. Examine the Annual Report of One of the Big 4 Chinese Banks
After examining the 2017 annual report of China Construction Bank, one of the big four
Chinese banks, I established that the bank has significant non-loan assets such as precious metals

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and held-to-maturity investments. Precious metals are those that have a high economic value due
to their rarity and their varied uses in industrial processes. They include gold, silver, platinum,
and iridium among others. Held-to-maturity investments are non-derivative financial assets
which have fixed payments and fixed maturity, and the bank holds them till maturity (Sharpe and
Sharpe 2015, pp. 42). The author does not provide enough distinction between a loan and non-
loan assets specifically regarding precious metals and held-to-maturity investments. He does not
give a proper explanation of what non-loan assets are.

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References
Campbell, J.Y., Lo, A.W. and MacKinlay, A.C., 2017. The econometrics of financial
markets (Vol. 2, pp. 149-180). Princeton, NJ: Princeton University Press.
Didier, T. and Schmukler, S.L., 2013. The financing and growth of firms in China and India:
evidence from capital markets. The World Bank.
Fabozzi, F.J., Modigliani, F. and Jones, F.J., 2003. Capital markets. McGraw Hill.
Sharpe, W.F. and Sharpe, W.F., 2015. Portfolio theory and capital markets (Vol. 217). New
York: McGraw-Hill.