Financial markets

Chapter 1
Introduction
1.1. Background
Financial markets help corporation and governmental units to raise capital through the
mobilization of public and private saving, in channeling those savings into productive and
technological investments, and in showing the potential earning capacity of corporations.
Financial markets are categorized in different ways, one of them is based on the
maturity of financial claim traded. Under this way, financial markets encompass two
components: capital market and money market. These markets cater to the financial
requirements of the real sectors of the economy. The money market trades short-term debt
instruments with maturity of one year or less. The capital markets, are those for longer-term
debt instruments and stocks. A capital market can further be classified into non-securities and
securities markets. The non-securities market provides non-negotiable medium and long-term
debt through the involvement of development financial institutions (DFIs), banks, and
contractual savings institutions that mobilize savings, later lending them directly to the users of
these funds. The securities market provides medium and long-term equity and debt in
negotiable from that are issued by government, companies, and corporations.
The non-securities market in most developing countries, generally, is developed and
well-organized. However, the securities market has lagged behind and developed rather late,
even though in some developing countries, like Vietnam, it has not existed yet. Thus, this
research study, therefore, emphasize on external and internal factors that influence
establishing capital market, especially securities market in Vietnam.
1.2. Rationale
Vietnam, now, needs huge capital from different resources for its industrialization and
modernization stage. Besides, business environment in Vietnam has, recently, been changing
fast. Along with opening the economy to the world, international relationship has improved.
Government’s policies and regulations related to business operations also are being improved
to facilitate doing business of enterprises and attract foreign investment. As result, many
private companies and foreign companies in form of Joint-venture or full foreign owned
enterprises have been set up in Vietnam. But now, Vietnam has encountered difficulties that
how to raise capital for its industrializing and modernizing in generally, for expanding business

operation of investment of domestic and foreign investors, especially. Due to the lack of
development of a capital market is probably the most serious obstacle to a continued
marketlization of Vietnamese economy. Vietnam’s present financial system is poorly equipped
to meet these challenges. It is almost entirely credit-based, with the state banks playing the
major role. The post-1989 Vietnamese market economy has shown, like others, that resources
are created by the process of expansion of markets and rise in business confidence. Also, the
drastic increase in mobilization issues may partly reflect the erosion of social safety nets that
has taken place in recent years. Therefore, with a view to attract foreign investors and
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mobilize saving efficiently, the government of Vietnam has taken few bold steps in making law
relating to establishment of capital market in coming years.
1.3. Objectives
Securities market is quite a new issue in Vietnamese business environment. For
Vietnamese businessmen, they still have not an insight into the market mechanism. In order to
provide them an overview of this market, the main objectives of the study is to explore legal
issues, legislative framework and analyze advantages and disadvantages in carrying out
securities market. Several specific objectives are as follows:
• Assess the fundamental concepts, terminology about stock markets and investment as
they relate to Vietnam;
• To determine the well known of the market and the constraints to development;
• To determine the impact of the banks’ role in the embryonic stage of sock market;
• To determine from potential investors and listed companies what they expect;
• To determine the organizational structure of this market;
• To look into the future prospects of the markets and give recommendations.
1.4. Scope of the study
This study is focused on analysis of obstacles that result from capital market which has
not been established yet. It also analyzes opportunities and advantages in establishing and
operating of this market. The study will concentrate on following areas:
• Investment entities and participants in the market;
• The regulatory and institutional framework;

• The role of the stock market and the condition necessary for business operations in
Vietnam;
• The role of banks in embryonic stage;
• Introduce the fundamental structure and the stages of the securities market development.
1.5. Research methodology

1.5.1. Information requirement
In order to conduct the research, the following information are needed:
• Socio-economic conditions analysis of investments, savings, and income.
• Infrastructure in terms of banking system and information system.
• Laws and regulations to guide participants in the market.
• Changing financial system.
• Policies that encourage foreign investors in the market.
• Major players identification.
• Investors’ attitude toward the market.
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• The instruments which will be traded in the initial period.
• Organizations which can help to establish stock market in term of equipment, training, an
insight market mechanism.
• The companies which have privatized and issued shares within corporation.
• The organizational structure of the market.
1.5.2. Collection of data
* Secondary data
General information were collected from published materials. These materials were
obtained from various sources such as Statistical Bureau of Vietnam, State Bank of Vietnam
and Ministry of Finance. Apart from the mentioned sources, secondary data were collected
from published information in both Vietnamese and English which were taken from Libraries,
State Departments and Research Institutions.
* Primary data
Along with the secondary data, primary resources are also required. To obtain the

primary data, interviews, and surveys were conducted. Guidelines were designed for
conducting interviews with managers and officials working in the State Bank of Vietnam,
Ministry of Finance.
Besides, four State-owned Commercial Banks, nine banks (including foreign banks and
branches of foreign banks), ten Jointstock Banks, forty investors (in which twenty domestic
investors and twenty foreign investors) were selected for purpose of the research. Interviews
and discussions with the managers in selected interviewees were conducted to get their
opinions on the securities market.
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1.5.3. Framework of study
39
Research objectives
Research objectives
External factors
influencing establishment
of Securities Market
External factors
influencing establishment
of Securities Market
Internal factors in
Securities Market
Internal factors in
Securities Market
Data Collections
Data Collections
Concepts, Literature
on Securities Market
Concepts, Literature
on Securities Market
Conclusions and

Recommendations
Conclusions and
Recommendations
Figure 1.1: Research Framework
Chapter 2
Literature Review

2.1. Definitions
2.1.1. Capital markets
There are various definitions on capital markets. According to Kidwell [1984], financial
markets can be classified on the basis of maturity of the financial claims that are traded.
Therefore, in this context, money markets trade in short-term debt instruments having maturity
of one year or less. Capital markets, on the other hand, describes the market that deals with
any long-term debt instrument or equity obligations having maturity greater than one year.
Kitchen [1986] has used the term “capital market” to include both securities market and
the money market. According to him securities market is the market dealing with government
bonds and debt and equity issued by corporations. Another researcher, Robbins, makes no
distinction between the securities and non-securities market and from the understanding of his
definition, capital market is the securities market.
M.B.Abbasi [1994] define capital market is as a set of institutions, processes and
individuals which facilitate the flow of society’s saving into productive investments.
Wijewardene [1993] also divides financial markets into the money market and the
capital market. The former deals with maturity of one year or less, while the later consists of
transactions with maturity of more than one year. In the capital market, he detailedly divides
into medium- and long-term, transactions with maturity between one and five years are
medium term, while those with maturity of more than five years fall into long-term. The capital
market can therefore be divided into submarkets:
• Loan market or the no-securities market, where the money is made available to the users
in the form of loan from financial intermediaries without creating a tradable security in the
process.

• Securities market, where money is acquired by the users by selling debt or equity
instruments to savers which may be tradable or non-tradable in the market.
According to view of Asian Development Bank (ADB), capital market as typically
defined include the portion of the financial system that provide medium- and long-term funds
for creating fixed assets (such as plant and machinery) used in the production of other goods.
In contrast, money markets provides short-term finance generally for working capital needs on
a loan basis for period of less than one year. Thus, money markets provide shot-term funds
for meeting fluctuating needs and must be paid relatively quick, and capital markets provide
long-term funds which can be used to make “capital investments”.
For the purpose of this research study, the definition given by the ADB will be used is
clear and precise.
2.1.2. Efficient capital market
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The purpose of capital market is to transfer funds between lenders (savers) and
borrowers (producers) efficiently. In an efficient capital market, prices fully and instantaneously
reflect all available relevant information. This means that when assets are traded, prices are
accurate signals for capital allocation.
Drake, P.S [1977] has done a great deal to operationalize the notion of capital market
efficiency. He defines three types of efficiency, each of which is based on a different notion of
exactly what type of information is understood to be relevant in the phrase “all prices fully
reflect all relevant information”.
1. Weak-form efficiency: no investor can earn excess returns by developing trading rules
based on historical price or return information. In other words, the information in past
prices or returns is not useful or relevant in achieving excess returns.
2. Semistrong-form efficiency: no investor can earn returns form trading rules based on any
publicly available information.
3. Strong-form efficiency: no investor can earn returns using any information whether publicly
available or not.
Allen, M [1991] has extended the definition of market efficiency. The market is said to
be efficient with regard to an information event if the information causes no portfolio changes.

The definition requires not only that there be no price change but also that there be no
transactions.
2.2. Structure capital market
According to ADB, the capital market consists of two segments: the non-securities
markets and the securities market. The non-securities markets provide non-negotiable
medium- and long-term debt funds through financial institutions such as development finance
institutions, commercial banks, and contractual savings institutions which mobilize savings
and then lend these mobilized funds directly to business, industry, and users of funds.
Securities markets provide medium- and long-term equity and debt funds in negotiable form
which are issued by corporations and governments, or through financial institutions such as
investment or merchant banks and venture capital firms, directly to individual and institutional
investors are then traded among different holders. Thus , investors in the securities markets
can sell their securities whenever they need funds, through equities they can participate in the
financial risk of the enterprise.
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Table 2.1: Organization of capital market [1]
Non-securities markets Securities markets
Instruments Loans
Mortgages
Leases
Sales and lease-back
Equity (shares and stocks)
Equity equivalents (convertible bonds or
debentures)
Debt securities (bonds or debentures)
Primary market Secondary market
Institutions Development banks
Specialized banks
Commercial banks
Saving banks

Insurance companies
Pension and employee
Provident funds
Leasing companies
Corporate
government issuers
Investment, merchant
banks
Brokers, dealers
Securities regulatory
bodies
Debenture trustees
Venture capital firms
Over the counter markets
Stock exchanges
Brokers, dealers
Clearance and settlement
agencies
Transfer agents and
mutual funds
Generally, the institutions and individuals that constitute the capital market may be
divided into two categories:
1. Participants: who are the ultimate savers and users of capital, as well as the financial
institutions and intermediaries that channel capital from savers to users.
2. Supporting and supervisory entities: Which are typically government bodies that facilities
and regulate the activities of the participants.
The main features of capital market are three fold:
• Collection and provision of capital for real investment, i.e. to fulfill the investment needs of
the company.
• Provide an opportunities to gain higher return through financial investment for investors,

i.e. provide a medium of investment.
• Provide higher liquidity, i.e. readily encashable and transactable investment instruments
for investors in the market.
2.3. Significance of capital market
2.3.1. Economic development and capital market
* Demand-following approach: The role of financial markets, largely comprising of
the capital market, in economic development has been an area of increasing interest for
development economics. This sector was initially through of as playing more or less a
passive role in economic development - “where enterprise leads finance follows”. The view
that growth in the financial sector is an outcome of the development in the real sector has
been explained that this approach places emphasis the demand side for financial services; as
the economy grows it generates additional and new demands for these services, which bring
about a supply response in the growth of the financial system. In this view, the lack of financial
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institutions in undeveloped countries is simply an indication of the lack of demand for their
services.
The more rapid the growth rate of real national income, the greater will be the demand
by enterprises for external funds and therefore financial intermediation, since under most
circumstances firms will be less able to finance expansion from internally generated
depreciation allowances and retained profits. The financial system can thus support and
sustain the leading sectors in the process of growth.
The nature of the pace of growth of financial sector depends on factors such as growth
rate real output and the commercialization and monetization of agriculture and other
subsistence sectors. The demand-following-supply response of the growing financial system is
presumed to come about more or less automatically i.e. the supply of entrepreneurs is highly
elastic and no constraint on the provision of favorable legal, institutional and economic
environment is envisaged.
* Supply-leading approach: This approach suggests the creation of financial
institutions and the supply of their assets, liabilities and other financial services in advance of
the demand for them, especially the demand of entrepreneurs in the modern growth - inducing

sectors. The supply-leading strategy has to simultaneously deal with the issue of transferring
resources from traditional sectors to modern sectors, and to promote and stimulate an
entrepreneurial response in these modern sectors. This strategy is considered to be most
suited to the countries where entrepreneuship is a major constraint on development. In the
process the top management of the financial institutions may ply the role of entrepreneurs in
industrial enterprises.
The supply-leading strategy is more effective during the initial phases of development
and induces growth in the real sector by financial means. The more backward the economy
relative to others, the greater the emphasis on the strategy of supply-leading finance. The use
of this strategy, however, should ensure that the use of resources, especially entrepreneurial
talents and managerial skills, and the costs of implicit or explicit subsidies should produce
sufficient benefits in the form of stimulating real economic development for this approach to be
justified.
Irrespective of which of the two strategies is practiced, the thrust of recent times is
focus on financial liberalization and encouragement of efficient markets through financial
deepening and elimination of fragmentation of markets to improve the process of mobilization
of financial savings as well as the efficiency of investment. This would help eliminate the
conditions of what M.B. Abbasi [1994] calls “financial repression” resulting from credit
rationing, subsidized credit and other factors responsible for distortions in the financial
markets.
2.3.2. Mobilization of savings
Mobilization of domestic savings - private and public is one of the three essential steps
involved in the process of capital formation; the two other steps being the channeling of
savings through a finance and credit mechanism and the act of investment itself. In Vietnam,
the level of domestic savings is still low. Sustained high growth rates will be critically
dependent on a significant increase in the level of domestic savings, both from the public and
the private sector. The savings rate is projected to increase from 17.0 to over 20.0 percent of
GDP during the projection period.
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The government is expected to contribute significantly to this increase with its own

savings; its efforts have already produced encouraging results in 1994. The scope for further
increase in public savings through increase in revenues may be limited in the future since the
share of revenue in GDP is already large. Further public savings will need to come from
expenditure restraints which can only be implemented through careful setting of priorities in
public spending.
Progress in the mobilization of savings will however depend on the maintenance of a
stable macroeconomic environment and the development of an appropriate incentive regime
for investment - including the strengthening of the legal framework, the financial system, and
the framework for the trade and investment.
2.3.3. Determinants of savings
* Financial repression: One of the major impediments to saving in developing
countries, according to M.B. Abbasi [1994], is the persistence of financial repression in these
economies. The intensity of financial repression in an economy is measured by the existence
of negative real rates of interest. The role of various factors leading to financial repression can
be judged from their contribution to widening the gap between real and normal interest rates
while interacting with ongoing inflation. The factors that contribute to financial repression
include taxation, usual restrictions on interest rates, heavy reserve requirements on bank
deposits, compulsory credit allocations etc. as they reduce the attractiveness of investment in
financial assets and holding claims on the domestic banking system.
* Income: Income, occupies the central place in determination of savings in the
economy. The amount of savings is determined by the absolute level of income as well as the
proportions of income saved out of each additional unit of income i.e., the marginal propensity
to save (MPS). The MPS should, according to the theory, increase with the increase in income
over time and across various income sections in the economy.
* Interest rates: The rates of interest is a major determinant of the demand of money
whereas the saving rate is only indirectly affected. A rise in the rate of interest reduces the
level of investment which result in the fall of the level of income and hence savings in the
economy. This indirect interaction implies a negative relationship between these two variables.
* Taxation: Most studies of the effects of taxation on saving show that government
savings increase with increased revenue taxation. However, several other studies [Please, S.,

1970] indicate that the increase in government savings is more than offset by a decrease in
the rate of private saving, while studies by Landan .L.[1980] found the reserve to be the case.
* Foreign aid: Studies conducted on the impact of foreign aid on savings have found
that foreign capital is a substitute for domestic savings. In other words, an increase in foreign
aid usually result in a decline in domestic savings or more accurately a part of the capital
inflow finances increased consumption.
* Export: Several studies have shown a positive relationship between savings and
exports. However, it is not clear whether this implies that the export sector has a higher
propensity to save than other sectors, or if it is the growth engendered by exports which is
responsible for the higher savings rates.
2.3.4. The role of financial intermediaries
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Financial intermediaries are defined as the “economic units whose principal function is
managing financial assets of other economic units - business concerns and individuals. Thus
they bring savers and borrowers together by selling securities to savers from money and
lending that money to borrowers” [Benton E. Gup, 1976].
UNIDO [21], has stressed the essential role that financial institutions have to play as
intermediaries and promoters of industrialization process. The following statements support
this claim.
• Financial institutions in less developed countries have to play an important role in the
process of economic development and they should be properly organized and oriented
towards the specific objectives they are expected to fulfill [Zolates, Xenophan, 1963].
• In order to ensure efficient and rational mobilization of savings and channeling of these
funds for the financing of the investment programs consistent with the development
objectives, financial institutions play a very important role, because they act as
intermediaries between surplus and deficit sectors in the country [Kivanc, Tarik, 1984].
• Economic development of any country depend on the contribution to growth of the financial
sector [World Bank, 1985].
Edwards [1987], has listed characteristics of successful economies and all successful
cases of economic resurgence which highlight the importance of finance and financial

institutions in industrial investment. They are:
1) Political acceptance of the importance of industry in the national economy;
2) The political will to act to create favorable financial circumstances and appropriate
institutions to help industry flourish;
3) An organization which acts as a financial ombudsman which, from a deep knowledge of
the circumstances of a particular industrial situation, can approve a company’s
investment plans (and frequently improving them in the process);
4) A financial system committed to the national success of its manufacturing industries;
5) Relatively cheap long-term loans for industry from the financial system;
6) The absence of any nonsensical theories about the ‘proper relation’ of debt to equity; and
7) A co-operative and practical approach by government, industry and banks to solve the
national economic problem.
It is widely recognized that during prosperous economic times there is always a rapid
increase in overall indebtedness, and during economic recessions there is always a slowdown
in the rate of growth of outstanding debt. The implication for financial intermediation is that the
greater the amount of spending financed externally through debt on equity issues, the greater
will be the role played by financial institutions. The term of financial institutions can be applied
as the central bank (State bank of Vietnam), commercial banks, investment and development
banks, finance companies, insurance corporation.
2.4. What is the securities market
2.4.1. Concept of securities market
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The concept of a securities market arises from three distinguishing principles. One is
the type of funds attracted to it. Funds moving through the securities market may include risk
averters, but the unique characteristic of this market is that it draws from investors who are
risk assumers and are therefore willing to provide capital to new growing ventures where the
chances of loss are marked by equal or greater opportunities for eventual gain. The second
principle of securities market is that the mechanism for moving its money flows involves
specialized institutions such as stock exchanges and securities dealers that have their own
procedures, technique of control and applicable legislation. The third principle refers to the

instruments used which are securities including stocks and bonds not ordinarily available in
other markets. The development of any capital market must give consideration to these three
aspects. Since its growth depends on the incentive embodied in the potential gains available
to risk assuming investors, uncertainty is an essential characteristic of the securities market
[Robbins, 1985].
2.4.2. Functions of securities market
As securities market has two closely interrelated parts: a new issue market where
corporations sell securities for the first time to the public which is termed as the primary
market and the secondary market or trading market where the securities, after they have been
initially issued, may be bought and sold among investors. each of these segments plays a part
in the overall contribution that the capital markets to a nation’s economy [Robbins, 1985].
The establishment of an efficient trading market is an essential precondition for a
thriving new issue market and any factor real or artificial, which tends to reduce the
marketability of securities or the investors confidence in the price making mechanism,
adversely affects the new issue market. This degree of efficiency, both of the trading and the
new issue market has a direct influence on the economic climate and potential of the country.
By providing a secondary market in securities the stock exchange not only epitomizes the free
enterprise system but acts a prerequisite for its survival and operation.
The primary market implies the very beginning stage of the securities market where
securities are issued by the issuers and sold to the investors and then the money flows to the
issuers from investors (buyers of the securities). This market characterized by the followings:
1. Secutalization process of the needed capital;
2. Process of the direct finance transforming money into the long-term capital.
The secondary market can be referred to as all types of markets where existing
securities are being traded between investors. The features of this market are as follows:
1. To get holding securities cashed;
2. Fair price determination of securities, free auction (perfect competition)
3. The fair price in the secondary market affects the issuing price in the primary market, two
markets are interdependent.
Securities Securities

Fund Fund
46
Firm
Investors
Investor
Primary market Secondary market
Figure 2.1: Structure of the securities market [2]
An important aspect of the primary and secondary market is that they expose a
company seeking funds to the test of outside judgment, which is particularly important in
developing countries to ensure that the funds more along economic channels. Without capital
markets, ventures are ineligible for bank funds cannot be launched or must obtain their
financing from private sources. Therefore, due to bank bias a venture which has merit is killed
and economy suffers. If the reserve takes place where a potentially more useful outlets, and
economy suffers. In many developed capital markets, the judgment of investors, reflected in
the pricing mechanism of the market, has provided an effective means of discriminating the
values of different enterprises and of assessing their future worth to the national economy.
In addition to the financing, allocating and testing role, the securities market serve
other purposes. Once functioning properly, they are a significant source of savings, through
institutions such as mutual funds: this function has increased prominence due to inflationary
tendencies where individuals have being able to protect the capital value of at least a portion
of savings from being eroded by rising price levels. From the company’s point of view, the
market enables equity financing thereby reducing the risk of overly extended borrowing and
permitting the company’s to attain a better balanced capital structure between bonds and
stocks. Finally, by creating a objective basis for establishing prices, the securities market
facilitates the determination of valuation for taxation and mergers [Robbins, 1985].
2.4.3. Advantages of securities market
◊ A stock market enables companies to raise fresh capital both initially, by going public
(primary issues) and subsequently through secondary issues (rights or placements of
stocks) thus a stock exchange can provide additional capital for companies. Therefore,
company expansion takes place more readily.

◊ A stock market provides governments with an alternative means of selling bonds and
raising capital. The virtue of this depends on the ability of the government to use the funds
efficiently for the national economy.
◊ A stock market provides savers and financial institutions with a further outlet for their
funds. Investment in equities (and government stock unless held to maturity)is of course
investment in risky instruments. However investors have different risk taking capacities
and like to be offered a range of risks and a corresponding range of expected return. A
stock market enables investors to select a portfolio which gives a risk return combination
according to their liking. It enables them to diversify their investment and reduce risk. A
stock market by offering various returns, may be important to investors whose only
alternative is to place deposits and receive low repressed rates of interest. It can
therefore encourage savings and mobilization of funds. If the secondary market is active
investors have a market which is more liquid.
◊ A stock market provides a hierarchy of rates of return (and therefore of cost of capital)
between equities, corporate bonds and government stocks. Therefore firms and
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government rising new capital have to pay a rate of return which reflects both of rate of
return and alternative investors and risk associated with the undertaking. Therefore
allocation of capital is improved exante. This is important in capital markets which
otherwise repressed and when the cost of borrowing is not related either to the demand
for capital or risk of the investment.
◊ The stock market provides a vehicle for government corporations to go to public especially
with the privatization program worldwide.
◊ Stock market can bring foreign capital into a country from foreign portfolio investors
wishing to diversify internationally.
2.4.4. Disadvantages of securities market
The criticisms of stock markets are essentially the following:
◊ The encourage unequal distribution of wealth, by enabling those who are wealthy to invest
with a view to increasing their wealth, without working for it.
◊ Stock markets can encourage rash speculation both by individuals and institutions when

followed by collapse can lead to the ruin of both with consequent destabilizing effects on
the national economy. Wall street in late 1920’s, Hongkong in 1973.
◊ Stock markets can provide an opportunity for dishonest activity, such as conflict of
interest, market rigging insider dealing, issuing false or misleading prospectus, pushing
and selling overpriced or worthless stock.
◊ Although stock markets may allocate funds to the activities which are expected to show
the greatest financial profit, may not be the most profitable from a national point of view
because markets and prices are seriously distorted in many developing countries.
2.4.5. The supply of securities
Investors need a reasonable choice of both government securities and company so
that they can set up the type of portfolio they wish, and change it readily. This implies that
there must be a reasonable number of fairly large companies willing to make their shares
available to the public (Kitchen 1986).
Supply of securities could come from the state enterprises when they want to raise
debt by issues of bond s or debentures, also another source of supply is from the
privatization of state enterprises, where enterprises capital is raised by a public issue in the
primary securities market. Other sources of supply are the formation of new companies,
increases of capital of companies already public, private companies going public and
also in some instances joint ventures and wholly owned subsidiaries and companies
approved by Board of Investment in different countries (Robbins).
However, it must be stressed that in developing countries family owned companies
may be reluctant to dilute ownership and control. Also some private companies have found
ample opportunity for tax evasion which may not be available if they go to public. One way of
inducing private companies to go to public is for the broad of investment to offer additional
benefits such as tax reduction etc. for quoted companies.
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2.4.6. The demand for securities
The demand for shares depends on savings. A well functioning market requires a mix
of long term investors such as Insurance Companies, Pension funds, Investment trusts, Unit
trusts, dealers and short term investors (often individuals) which keep the market fluid. There

must therefore be substantial number of institutions which hold the savings of individuals and
individual investors [Kitchen 1986]. This in turn implies a reasonably widespread distribution of
wealth and income within a country, and a sizable middle class. Countries which have highly
skewed income and wealth distributions are unlikely to have the right mix of investors to keep
the market active and fluid. The success of the Malaysian and Singaporean stock exchanges
may be attribute partly to the large number of middle and lower middle class shareholders
[Darke 1977].
In addition to having and adequate level and distribution of wealth a country must
possess individuals willing to buy share. Investors need to be made aware of the stock
exchanges, of possible risks as well as of possible returns. This requires active, but
responsible, promotion on the part of the stock exchange authorities, investment trusts and
unit trusts and shareholders’ representative bodies.
At the same financial institutions need to be willing and able to buy shares. As Darke
(1977) has pointed out, institutions may need to be persuaded of the desirability of equity
investments; they may need to be freed from requirements to invest very heavily or even
entirely in government stocks.
The most important factor determining the willingness to buy and hold securities is the
elusive “investor confidence”. Investors need have confidence in the macroeconomics
performance of the economy (Market risk). Doubtful growth prospects and fears of inflation
are bad for stock markets, which perform badly under either worry. Investors need also to
have confidence in the firm whose shares they buy (specific risk). They need confidence in
the firm’s products and markets, its management and in its in integrity in disclosing
information. Finally they need to have confidence in the operation of the stock market and of
its members. Malpractice deter investor. They also need confidence in the accounting
standards required of the firm and in the auditing of the accountancy profession [Kitchen
1986].
Hopefully a direct interest in stocks would also be created by offering tax inducements
through the treatment of capital gains and dividend income [Robbins, 1985].
2.5. The instruments in the securities market
The generic term of for a wide variety of stocks and shares and bonds offered by

developed stock markets today is “securities”. They present what is known as capital of the
company. However when looking at the types of stocks and shares offered, it is usual to divide
the market into two: the bond market and equity market and other forms of a company’s risk
capital (Allen 1991).
2.5.1. Stocks
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Common stocks:
Stocks could also be termed the equity. They represent the true risk of the company.
They can be referred to as ordinary or common stocks. they are the true owners of the
company and they are entitled to the company profits once the fixed interest stocks are paid.
These are called earnings. When a company is doing well it will raise the earnings or
dividends to the ordinary shareholders get what is left after all debts are paid. Like all other
shares they have a par value, but in their case it is market value that counts and is quoted
every day on stock exchange.
Preference stocks:
Preference stocks are part of the true share capital of the company, but are a special
category, which carries less risk than equities. They carry a fixed annual dividend and follow
after debentures and loan stock in a share out of the company’s assets. Dividends may not
fluctuate with company profits, though is a company badly they may not be paid. Preference
shares may be cumulative in that interest not paid in a particular year has to be paid in
subsequent years. If interest rates rise sharply the price of preference stock could rise
sharply, so timing is important for anyone buying this stock. In some markets preference
stocks may be convertible into common stocks (Allens 1991).
2.5.2. The bond market
When you buy bonds you own a debt and become a creditor because you have loaned
money to the company or government. Individuals lend money to institutions, governments,
agencies, corporations etc. in exchange for bonds issued by the institutions as proof of the
loan agreement, plus regular interest payments. Interest payments are usually fixed. Bonds
may seems less glamorous than stocks because for years their prices fluctuated less
dramatically. And unlike dividends, the interest payments, don not increase when a company

is profiting. Perceptions may change and recently bond prices have fluctuated as much if not
more than stock prices.
As in stock trading there is an active group of investors looking to buy previously
issued bonds. The market for these bonds, where their selling prices fluctuate, is called
secondary market. Mostly, already issued bonds are traded over the counter. Dealers of
bonds across the country are connected via electronic display terminals that give them the
latest information in bond prices. A broker buying a bond consults a terminal to find out which
dealer is currently offering the best price, then calls that dealer to negotiate. Changes in
interest rates affect the price of a bond. Issuers of bonds offer to pay investors a rate of
interest which is competitive with other bond rates at the time. This rate is similar to other
rates as the prime rates, mortgage and personal loan rates. After a bond issued, however
interest rates in the economy may change - making the rate of the issued bond more or less
attractive to investors. If the bond is paying more interest than elsewhere investors will be
willing to pay more to own it. If the bond is paying less, the reserve is true. In general the
interest rate and the bond price fluctuate like two sides of a see saw. When interest rates
drop, the value of existing bonds usually goes up since the prevailing rate on the bond is
higher than the prevailing interest rates. When the interest rate goes up the value of bonds
comes down since the return on the bond is less attractive than the prevailing rate. The term
50
yield describes what you will earn from a bond. Investors determine bond values largely by
comparing yield. The yield is the interest divided by the price of the bond.
51
Chapter 3
External factors influencing the establishment of securities market
3.1. Review of macroeconomic performance
As Vietnam’s leaders turn their attention to the next Five-Year plan for 1996-2000, they
do so with a fast growing economy and a good track record of macroeconomic management.
During the past five years, the economy has grown at an average of eight percent per year,
inflation has been reduced to single digit levels, and the exchange rate is stable. Rapid growth
as also resulted in the recent widening of the trade and current account deficits, which need to

be controlled in order to ensure that growth is sustainable. The most remarkable achievement
of this period has been the steady rise of savings. This increase in savings, combined with
large inflows of foreign direct investment (FDI) and disbursements of official development
assistance (ODA), as fueled a significant increase in investment, which in turn has provided
the primary impetus to economic growth. These impressive results have been achieved
through a combination of stabilization, liberalization and structural reform, including a
progressive integration of Vietnam into the world economy. Price, trade and business
liberalization resulted in foreign trade advancing at double-digit rates and a steady increase in
the number of exported goods as well as trading partners.
This strong macroeconomic performance has been achieved in spite of limited policy
instruments and many remaining structural weaknesses. Budgetary management still relies
on crude expenditure classification and accounting which complicates expenditure
management. Similarly, monetary policy is conducted with direct instruments--bank by bank
credit ceilings, maximum lending rates and ceilings on spreads between lending and deposit
rates--which discourage intermediation and competition. Finally, institutional weaknesses
ranging from the legal framework to the payments system limit the ability of policy makers to
influence the behavior of markets. Therefore, sustaining recent economic achievements will
not be easy.
GDP growth: In 1996, the economic is expected to grow at 9.0-9.5 percent. This
growth rate mirrors the economic performance in 1995 when GDP growth reached an
estimated 9.5 percent, the highest recorded since the adjustment and reform program
accelerated in 1989 (see Table 4.1). All sectors grew rapidly in 1995. Growth in agriculture at
4.7 percent, was impressive, given that yields for most products are already high and that
limited expansion of cultivated areas could take place. Industry continued to grow at a double-
digit rate (13.9 percent in 1995) for the fourth consecutive year, with export-oriented consumer
goods and light industries showing the most rapid growth. The services sector also grew
rapidly, led by banking, finance, and retail trade, where the private sector now accounts for
three quarters of total sales.
52
Table 3.1: Macroeconomic indicators during period 1991-1996 [18]

1991 1992 1993 1994 1995 1996
Off.Est.
Growth rates of GDP 6 8.6 8.1 8.8 9.5 9.0-9.5
Inflation rate 67.5 17.2 5.2 14.4 12.7 ---
Agriculture 2.2 7.2 4.4 4.5 4.7 4.8-5.0
Industry 10.0 15.0 12.0 13.5 14.0 14.0
Services 8.2 8.3 13.0 12.5 12.6 ---
Exports* [22] 23.9 31.2 12.8 31.0 19.2 ---
Imports* [23] 15.3 19.8 47.6 31.9 17.6 ---
Inflation: Despite its reform, the monetary system has failed to catch up with the
development of the national economy. Over past five years, inflation rate was controlled and
fallen. In the first half of the year 1996 the inflation rate was not high. Prices of consumer
goods and services rose by 3.3 percent and 4.6 percent compared with December and June
last year, respectively. That was the lowest rate of increase in comparing with the period since
1991.
Investment and savings: On expenditure side, growth continues to be driven by
investment, confirming that Vietnam has the potential to embark on the same high investment,
high growth path as its East Asian neighbors. In 1995 investment grew by 22 percent,
reaching an estimated for 5.7 percent of GDP (25.5 percent in 1994, see Table 4.2).
Government investment accounted for 5.7 percent of GDP, while investment by private and
state-owned enterprises amounted to 21.4 percent of GDP. The large increase in investment
was fueled by USD$ 1.8 billion in FDI inflows, as foreign investors accelerated the pace of
implementation of earlier commitments. In fact, FDI financed nearly 25 percent of total
investment in 1995, compared to 16 percent in 1994. Substantial inflows are continuing in
1996, as inflows for the first quarter were estimated at $400 million by the State Bank of
Vietnam (SBVN), compared with $300 million for the same period in 1995.
Table 3.2: Savings and investment, 1991-1995 (percent of GDP) [27]
1991 1992 1993
Rev.
1994

Rev.
1995
Prel.
Investment 15.1 17.0 24.9 25.5 27.1
Government 2.8 5.8 7.0 6.6 5.7
Non-Government 12.3 11.2 17.9 18.9 21.4
National savings 13.2 16.3 17.4 16.9 17.1
Government 1.3 4.1 2.5 5.0 5.2
Non-Government 11.9 12.2 14.6 11.9 11.9
Foreign savings 1.9 0.7 7.5 8.6 10.0
Financing this higher level of investment, while ensuring the sustainability of the
balance of payments, requires a steady improvement in domestic savings. So far, the
performance of savings has been very good, and compares favorably with other countries at
similar income levels. In 1995, national savings was again the largest source of funding for
investment. The increase in savings in the past few years reflects higher government savings,
as private savings have remained at about 12 percent of GDP since 1991 (except for 1993).
Sustaining high growth in the future will require a steady increase in private savings, as further
53
improvements in Government savings will be difficult in the near term. Higher private savings
will require a stable macroeconomic climate, as improved financial system and further
structural reforms.
Foreign investment has provided the primary impetus to growth and has drastically
increased since 1990. In total, foreign direct investment approvals are estimated at more than
USD$ 20 billion by September 1996 (excluding USD$ 1.7 billion of canceled projects).
Table 3.3: Foreign direct investment (million USD$) [18]
1991 1992 1993 1994 1995
(1) Registered capital 1,232 2,168 3,169 4,041 7,100
(2) Actual capital 260 535 1001 1,500 2,500
(2) divided by (1) 19.6 24.5 34.7 37.1 35.2
3.2. The financial environment

♦ Banking system:
Vietnam’s financial sector reforms started in 1988 with the dismantling of the banking
monopoly system. At the same time, the State Bank of Vietnam (SBVN) performed both
central and commercial banking functions. In addition, there were two specialized banks, Bank
for Foreign Trade of Vietnam (Vietcombank), which handled trade finance and management of
foreign exchange, and the Bank for Investment and Development of Vietnam (BIDV), which
provided long-term finance for public works and infrastructure projects. SBVN gradually
developed its commercial banking functions, with the objective of shifting its role more to that
of a modern central bank.
Two additional State-owned Commercial Banks (SOCBs) were created: the Industrial
and Commercial Bank (Incombank), from the Industrial and Commercial loan Department of
the SBVN, and Vietnam Bank for Agriculture (Agribank), from the agricultural credit
department. With enabling legislation to include those of shareholding (Jointstock) banks,
Joint-Venture banks, branches/offices of foreign banks, and credit cooperatives, and some
housing banks.
In early 1994 regulations were introduced for establishing savings and loans
institutions known as Popular Credit (or People’s) funds. By the end 1994, in addition to the
four SOCBs, there were in operation 36 Shareholding Banks (30 in urban areas), 69 Credit
Cooperatives, 3 Joint-venture Banks, 9 Foreign Banks (and 32 Foreign Bank Representative
Offices), and about 153 Popular Credit Funds. There were also two Finance Companies, and
one Government Insurance Company. [Vietnam Financial Sector Review, 1995]
With fast growing number of banks, its operation is also expanding and diversifying
step by step. These include credit service, discount valued paper, leasing credit, buying
shares, services of collateral, bidding for Treasury bill and sell of goods on installment. Loan
structure has changed positively. The proportion of medium- and long-term loan and loan to
private-economic sector are still low but trend is upwards.
54
81%
90%
81%

65%
64%
57%
43%
36%
35%
19%
10%
19%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
90 91 92 93 94 95
State e conomic se ctor l oan Private e conomic sector l oan
Figure 3.1: The proportion of loan between State- and private-economic sector [27]
95%
85%
83%
77%
67%
59%
5%

4%
2%
21%
18%
14%
0%
9%
15%
20%
13% 13%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
90 91 92 93 94 95
Short te rm l oan Medium te rm l oan Long te rm loan
Figure 3.2: The changes in loan proportion [27]
However, at present operations of the banks and financial companies have many
shortcomings. This affects on establishment and development of financial market in general
and securities market in particular.
Based on selected banks which were interviewed, some findings are below:
First, the average capital of each bank is quite low. The State-owned banks with rather
large capital of VND 1000-3000 billion, some Jointstock Banks with over legal capital of VND

100 billion, the rest of them only VND 10-20 billion. The banks can not diversify its transactions
and can not invest in safely credit with too small legal capital.
55
Second, in most of the banks credit is carried out by collateral (including the State-
owned banks). There are no close relationship between banks and companies in doing
business.
Third, in the financial field is still lack of the management skills and professional
qualifications of managers. Managers have not gotten an efficient experience into banking
operation in the open market situation. In fact, the capacity for legal capital in Joint-stock
banks are higher than State-owned banks. This capacity, however, has not yet implemented
due to lack of development of securities and securities market. The Bank Association and
interbank market were established but they have not yet improved interbank transaction links.
For Foreign Banks, up to the mid-year 1996, there are forty-one in operation, including
twenty branches and twenty-one representative offices but their activities now are restricted.
In fact, these banks' activities have not yet integrated into the economy in Vietnam. It plays a
dim role in the economy. Its major customers are Joint-venture Companies, 100% foreign
investment companies, they avoid lending domestic investors.
The reason is lack of legal standards in the financial market. First of all, is the
accounting and auditing standards. Vietnam has recently adopted International Accounting
Standard (1996). A Vietnam auditing system has been set up. Domestic business is used to
this auditing system. Another reason is their inherent capital is very low, average capital of
VND 7 billion in a State-owned enterprise and VND 91 million in a private enterprise.
♦ Taxation system:
Besides the banking reform, the taxation reform has been the main step of the whole
financial reform. Economically, one of its most important tasks is to eliminate the
administrative supply-withdrawal system of state enterprise finances and to build a new tax
system applicable to every business. The new tax laws promulgated included the following
kinds of taxes: [Vu Tuan Anh, 1994]
• Agricultural tax collected only in agricultural cultivation (there is ongoing discussion
in the National Assembly on a new draft of the law on agricultural tax into land tax

and agricultural turnover tax);
• turnover tax;
• profit tax;
• special commodity tax (on cigarettes, alcoholic products);
• import-export tax;
• tax on use and exploitation of natural resources;
• tax on housing and the use of land;
• personal income tax.
Despite a slight increase in the past years, the tax revenue remains extremely low
(only a little more than 4.5 percent of gross domestic product) compared with other countries
in the world). There are still a number of flaws in the current tax system that have to be
continuously improved.
Firstly, the theoretical basis of taxation including the major principles of equity
(horizontal and vertical), incidence, structure, effects on the output of production, on
consumption and savings, on people’s lives, and so forth has not been clearly defined.
56
Different requests are made of the taxation system by different groups of people responsible
for taxation policy and financial policy-making, such as members of National Assembly,
governmental financial specialists, and local administrators. As yet there is no common
criterion.
Secondly, the lack of a theoretical basis means that the current tax system does not
take in all possible categories and sources of taxation; and some kinds of taxation do not
seem to have a rational basis. A typical case of this is the turnover tax, which is based on the
repeated taxation of product value. The feasibility of implementing value-added tax is also
being discussed.
Thirdly, the effects of the current tax system on economic output and its social
consequences have not been sufficiently investigated, so frequent readjustments and fine-
tuning continue to be required. This created an unfavorable environment for businesses, and
on saving and consumption.
♦ The accounting, auditing and statistical system:

From January, 1996, Vietnam officially shifted statistic-accounting system from the socialist
system to the capitalist system and implemented accounting system under instruction of
International Monetary Fund (IMF) and World Bank (WB) as well develop auditing system. The
State General Auditing (belongs to the government) was established in mid-year 1995. Two
domestic auditing companies were also established and four branches of foreign auditing
companies in Vietnam. Vietnamese companies (State and private) start to implement an
annual and semi-annual auditing regime.
♦ Issuing and trading stock:
Up to now, 160 Jointstock Companies are set up, including forty-eight banks, two
financial Companies and five SOEs completed equitisation program. total value of stock of
these companies estimate VND 960 billion. Besides, about VND 5,200 billion of government
medium-term bonds and VND 150 billion of corporate long-term bonds. Thus, total value of
securities in the market is now about VND 6,400 billion (equivalent USD$ 600 million).
[Financial Magazine, 1996]
In reality, the Vietnam Bank for Private Enterprises (VP Bank) is the only option since it
is the only one bank that the State Bank has allowed to sell shares to foreigners. Direct
investment in other Private Companies, Joint-stock Companies, or Joint-stock Banks is not
allowed.
These securities are not traded in the secondary market because majority of
Jointstock Companies are private, they manage shares and shareholders. Government bonds
do not bear completed market elements: low interest rate, high denomination. Issuing bond
has suffered by administrative, forced factors. Buyers of government bond are mainly
companies, buyers of corporate bond are mainly workers, staff with in company.
3.3. The start up of the securities market
57
It is not difficult to establish securities market but it is difficult to maintain its operation
regularly, efficiently and maintain its growth. A securities market will operate efficiently in an
adequate socio-economic environment. This means it has to have an infrastructure in
accordance with subjective and objective factors of this market. That is: economic factors,
legal situation, and awareness of the stock market. How are these factors in Vietnam?

3.3.1. The economic factors
Economic factors are influence by government policies. From 1986, Vietnam carried
out policies to develop the multi-sector economy, moving according to the market economy
with Government's management. With the policies, Vietnam has drastically changed in
structure of economic sectors and forms of business organization.
♦ The State-owned economic sector:
The State entrusts companies with capital management, but the companies must
produce themselves and make a certain profit.
Vietnam rearranged the organization of SOEs, dissolution or annexation of loss-
making and undeveloped enterprises. Simultaneously, Vietnam also carried out equitisation
program. The number of SOEs reduced from 12,297 units in 1990 to 6,480 units in 1994 with
total capital of VND 48,000 billion, average VND 7 billion of each. Most of them were
dismissed, some were annexed, and some were equitised.[Vietnam’s socio-economic
development, 1996]
The result of economic policies in the State-owned sector in recent years overcame
elementarily compensatory status of the State budget. Many enterprises shifted from loss-
making to a profit-loss break-even point and to a profitability and contribute to the State
budget.
♦ The private-economic sector:
According to the current law, Vietnam has three main organizational forms:
- Private Business
- Limited Company
- Joint-stock Company.
Till the end of year 1995, after four years of new laws on private businesses and
companies, Vietnam has 16,000 business units with approximately total capital of VND 8000
billion in the private-economic sector, average capital of each one is VND 500 million. Of which
private businesses account for 71%, average capital of VND 100-300 million, 28% of limited
companies, average capital of VND 600-700 million, only 1% of jointstock companies with
average capital of VND 6 billion. [Vietnam’s socio-economic development, 1996]
The proportion of capital in the private-economic sector is quite low comparing with the

State-economic sector, average capital is only VND 6 billion (equivalent USD$ 600,000) while
its capacity for mobilizing capital is potential.
♦ The economic sector with foreign participation:
According to the investment law, Vietnam has three forms:
58
- Business-cooperate contract
- Joint-venture
- 100% foreign investment.
3.3.2. The legal situation
The legal system on economic matter in Vietnam is considered weak. The National
Assembly has been concerned with this matter in recent years. The constitution in 1992 set up
the government’s economic regulation. Based on this, other laws were promulgated in
economic mechanism such as: civil law, labor law, law on enterprise bankruptcy, on
encouragement of domestic investment, and the on economic court.
However, in order to have a good legal environment in establishing and developing
financial market in generally, securities market in especially, Vietnam has to readjust some
laws that were enacted before 1992, for example, law on Jointstock Company, on limited
Company, on foreign investment and two ordinances on banks.
3.3.3. Awareness of the stock market
The Vietnamese perception of the securities and securities market now is at a low
level. The fundamental concepts of stocks, bonds, securities market, underwriting etc. are not
yet well-known, and the legal fundamentals are not yet established. In reality, the financial
investment is completely dependent on each persons limited experience and knowledge.
Businessmen only know to mobilize capital through internal sources and borrowing.
Joint-stock companies issuing stock, a method of borrowing without interest payment, is still
not used efficiently.
3.4. A prerequisite for the emergence of a stock market in Vietnam
3.4.1. Development of the bid market
Following a switch to the market economy mechanism and the two-tier banking model,
the SBVN has set up and brought into operation the Local Currency Interbanking market. In

order to create the conditions for capital intra-trading among Commercial Banks (CBs) with the
State Bank acting as the ultimate trader. In 1995, the Bid market on treasury bills and the Bills
trading market came into being, the participants which are the CBs, the Joint-Stock Banks, the
branches of foreign banks, as also the Financial Companies, the Insurance Companies the
Fund for Insurance and the Investment Fund (collectively referred to as Financial intermediary
organizations). The latter as the buyers, while the seller is the Ministry of Finance (Bank
Treasury) and the regulatory body is the State Bank; the rate of interest rate obtained through
bids constitutes the purchasing price, and purchases take the form of specific entries in books
or bill certificates.
After preparing the legal conditions and holding a trial bid, the first bid on treasury bills
was organized on June 8,1995. Thirty out of a total of thirty-four participants took part in the
bid, but only twenty-three were lawful ones. The predicted total issuance amount was VND 60
billion, registered purchases amounted to VND 395.2 billion, the lowest registered interest rate
59
and the highest registered interest rate were 16.66% and 24% respectively. As a result of bid
opening, eight banks were successful bidders, with bid interest rate amounting to 18% per
annum and total face value of successful bid amounting to VND 83.6 billion. [Vietnam
Economic Review, 1996]
Thereafter, the second bid was held on June 21, 1995 the third bid on July 20, 1995
and the fourth bid on August 10, 1995.
These four bids were organized in keeping with legal stipulations and did achieve, on
an initial basis, the objectives, although some units applying for bids did not provide deposit
money.
With bids carried out through the State Bank, the State Treasury could, within a short
period of time, save nearly VND 250 billion, a substantial reduction in state budget
expenditures as compared with the direct sale of Treasury bills by Treasury units. The interest
rate of Treasury bills could be gradually lowered and now stands, on an average, at 17.5% per
annum (that is 1.47% per month), much lower than 21% annual interest rate (that is 1.75% per
month) as was the case when the bills were directly issued by the State Treasury. All this has
resulted in saving about VND 10 billion per year for the state budget. Indeed, because of a

difference in interest rate of 0.28% per month, and the total value in all these four bids, one
could save each month VND 682 million for the state budget, that is VND 4.1 billion in six
months. The state bank has been able, on an initial basis, to achieve unified management of
the interest rate in the national economy, thereby creating the conditions for reducing the
interest rate relating to the mobilization of funds by the banking system and the State
Treasury.
The primary market has come into being following the first issuance and bid of
Treasury bills through the State Bank. The American City Bank’s branch in Hanoi bought VND
29 billion worth of Treasury bills from Vietcombank with an interest rate of 17.5%. Many CBs
have sold the Treasury bills to their customers and the population. In the future, if the bid
market of Treasury bills is well organized, leading to the development of that market and other
organizations and individuals, the secondary market would become buoyant, would be able to
meet more adequately the demands in circulation of the treasury bills and other securities as
investment funds and would create the material conditions for a stock market to emerge soon
in Vietnam. In other words, this is one of the prerequisites for the birth of a securities market
in this country in the foreseeable future.
3.4.2. Equitisation of enterprises
Along with the development of bid market, equitisation is also one of the factors that
supports the establishment of a securities market.
The concept of equitisation was first mentioned in Vietnam in 1987 when Decision
No.217/HDBT was issued. However, the process of equitisation of state-owned enterprises
(SOEs) officially began in Vietnam in June 8,1992, when Chairman of the Council of Ministers
(now the Prime Minister) issued Decision No.202/CT enclosed with the proposal on the
continuation of pilot equitisation of some SOEs and Decision No.203/CT which stipulated the
list of seven selected SOEs to be equitised under the direct instruction of the center as a pilot
program. Though these seven enterprises were affiliated to the center after the issuance of
the Decision, six of them required equitisation with the exception of one garment making
enterprise.
60