Intro to Financial Markets

• Academic year for this learning material is 2024/2025
• The topics covered in this session include overview, types of financial markets, role of financial markets and market participants
• This course is designed to provide an introduction to financial markets along with the products traded, and fundamental principles of market operations.
• A goal is for students to understand financial instruments, market structures, trading strategies, risk management, and financial market career opportunities.
• The course will cover traditional financial markets like equities and interested rates and will further cover environmental, socictal, and governance (ESG) issues
• The course is designed for those who will interact with finance people, future corporate finance officers and investment bankers, composed of analysts, salespeople, commercial and investment bankers and advisors.
• Grading for this course will include a 50% final exam and a 50% midterm exam
• Emphasis will be placed on words in red which are important and should be part of a personal glossary

Session Topics

• Introduction to financial markets (overview, market types/roles/participants)
• Time value of money (introduction to the mathematics of finance)
• Financial insturments
• Stock valuation (Book Value Per Share and Dividend Discount Model/CAPM)
• IPO + Revision session 1
• Portfolio management : diversification, risk-return, portfolio management strategies (part 1 and 2)
• Trading and execution: order types; order book operations
• Fixed income and bond markets: bond characteristics, yield measures and calculations, bond pricing
• Fixed income and bond markets + Revision session 2
• Regulation and Ethics : regulatory bodies and financial crisis
• ESG and Sustainable investment
• Course wrap-up

Tips for future financial professionals

• Financial knowledge requires understanding financial markets, accounting, economics, and investment theory
• Analytical skills involve financial modeling, risk analysis, and portfolio management
• Problem-solving abilities are the ability to find creative and effective solutions
• It is vital to pay attention to detail, as errors in financial data can have significant consequences
• Being tech-savvy includes being familiar with financial software, data analysis tools, and automation
• It is important to be adaptable and open to learning new concepts and strategies
• Time management is key, multi-tasking ability and meeting deadlines are essential
• It is also important to have integrity as finance professionals deal with sensitive information
• It is important to be curious and maintain commitment to ongoing learning
• Client focus and ability to build good client relationships are important
• It is critical to be able to communicate complex financial concepts in a clear and concise manner
• Know the jargon, make your own glossary, ask questions, never assume anything, rephrase with non-jargon words and follow the news

Financial Assets: Useful Concepts

• An asset is any possession that has value in an exchange, classified as tangible and intangible
• A tangible asset has value based on physical properties, such as buildings, land, or machinery
• Intangible assets represent legal rights to future benefits, and their value isn't linked to physical form
• Financial assets are intangible assets where the value is a claim to future cash
• The issuer is the entity that agrees to make future cash payments
• The investor is the owner of the financial asset
• A claim is the holder of a financial asset and may be a fixed, varying, or residual amount; if fixed, it is a debt
• An equity instrument obligates the issuer to pay the holder an amount based on earnings
• The price of a financial asset equals the present value of its expected cash flow
• One economic function of a financial asset is to transfer funds to those who need funds to invest in tangible/intangible assets
• Another function is to redistribute the unavoidable risk associated with the cash flow from tangible assets among those seeking and providing funds
• These risks can be inflation, default (credit), and exchange-rate risks

Financial Markets: Role and Definition

• Financial markets are platforms/institutions/systems where individuals, businesses, and governments buy and sell financial instruments like stocks, bonds, currencies, commodities, and derivatives
• These markets allow participants to trade assets, establish prices, and determine value
• Regulations and a variety of factors, including events, investor sentiment, and government policies influence financial markets
• Financial markets serve to raise capital, manage risk, and provide liquidity
• They are categorized into primary and secondary markets and include stock, bond, money, and foreign exchange markets and also commodities
• Financial markets help transfer funds from savers to borrowers and provide valuable information about asset prices and economic conditions
• Financial markets help facilitate the flow of funds and allow financing and investing by households, firms, and government agencies
• An issuer and investor can coordinate on a transaction in what is know as an Over The Counter(OTC) Market
• Organized markets facilitate transactions between two parties, providing a mechanism for investors to buy or sell assets, making the cost of transactions and information effective, and allowing a price to be determined
• Corporate finance involves corporate decisions like how much funding to obtain, what types of securities to issue, what types of risk management strategies to use, and what kinds of financial instruments to use
• Treasury teams are responsible for financial market operations in non-financial companies

Primary, Secondary, Liquidity

• Primary markets assist the issuance of new securities
• Secondary markets allow for change of ownership in the securities through the trading of existing securities
• Some debt securities have a secondary market so investors don't have to hold them until maturity
• Primary market transactions provide funds to the initial issuer; secondary market transactions don't
• Liquidity is an important characteristic of securities traded that measures how easily securities can be sold without loss of value
• Some securities have a liquid secondary market with many willing buyers and sellers

Bonds, Equities, and Loans

• Capital markets in the U.S. fuel the economy
• They provide 71.9% of equity and debt financing for non-financial corporations (64.5% + 7.4%) as of 2023 data
• Capital markets facilitate debt issuance, which is more efficient, stable, and less restrictive for corporations
• As of 2023 in the U.S., debt capital markets (DCM) are more dominant at 75.0% of total financing
• Bank lending is less dominant (21.3% on average) in other regions
• Companies need capital for business purposes like investing in growth and funding mergers and acquisitions
• IPOs allow businesses to grow, innovate, and better serve customers

Financial Market Size (2022)

• Global Fixed Income outstanding: $129.8 Trillion
• Global Equity Market Cap: $101.2 Trillion
• Fixed Income (outstanding): $129,800 Billion
• Equities (outstanding): $101,235 Billion
• Foreign exchange markets (per day): $7,523 Billion
• Commodities (outstanding): $20,000 Billion
• Oil (outstanding): $2,000 Billion
• Money Markets: $82,700 Billion

Financial Market Participants

• Investors include individual investors, institutional investors, hedge funds, mutual funds and private equity firms
  • Individual Investors: Regular individuals who invest their personal savings in stocks, bonds, mutual funds and real estate
  • Institutional Investors: Large organizations that invest on behalf of others. These include pension funds, endowments, insurance companies, and mutual funds
  • Hedge Funds are private investment funds that employ various strategies to generate returns for their investors
  • Mutual Funds pool funds from many investors and invest them in a diversified portfolio of stocks, bonds, or other securities
  • Private Equity Firms invest in private companies or take public companies private, often with the goal of restructuring or improving their operations
• Corporations issue and trade their stocks and bonds to raise capital for their operations.
• Banks:
  • Commercial Banks provide a wide range of financial services, including taking deposits, offering loans, and facilitating payments
  • Investment Banks engage in activities such as underwriting securities, mergers and acquisitions, and trading in financial markets
• Insurance Companies invest premiums received from policyholders in financial assets to generate returns and cover claims
• Central banks play a pivotal role in monetary policy and open market operations, influencing the money supply and interest rates
• Government entities may issue and trade bonds to fund public projects, manage debt, and influence monetary policy
• Rating agencies assess and assign credit ratings to issuers of financial instruments, such as bonds
• Brokers act as intermediaries between buyers and sellers, executing orders on behalf of clients
• Dealers engage in buying and selling financial assets for their accounts, often facilitating liquidity
• Regulators and Supervisors: oversee and regulate financial markets for fairness, transparency, and stability
• Financial Advisors provide financial planning and investment advice

Financial Institutions

• Financial institutions resolve limitations caused by market imperfections and channel funds from surplus units to deficit units
• Roles Include; transforming financial assets, exchanging assets on behalf of customers, exchanging for their own account, assisting in creation of assets and selling to market participants
• Roles Include; providing investment advice and managing portfolios for other participants

Depository Institutions

• Depository institutions take deposits from those with extra money and provide loans, offering deposit accounts and expertise in creditworthiness
• Commercial banks are the main type of depository institution and offer deposit accounts to give loans or buy debt securities
• Banks follow strict regulations like (prudential regulation) to reduce failure risk
• In the U.S., the Federal Reserve (Fed) regulates banks, while in Europe, it's the European Central Bank (ECB)
• Savings institutions (savings and loan associations and savings banks) offer deposit accounts like commercial banks but use funds more broadly
• Credit unions are nonprofit and serve their members, who share a common connection

Non Depository Institutions

• Non-depository institutions do not rely on deposits for funding
• They raise funds through issuing securities and lending these funds to individuals and businesses
• Mutual funds are a key type of non-depository institution that sells shares to buy securities-They hold large share of assets here
• Money market mutual funds focus on short-term money market securities
• Securities firms offer services, acting as brokers to facilitate transactions for a fee or as dealers/market makers, and holding a stock of securities to buy and sell on demand
• Insurance companies use premiums to cover costs related to death, illness, or property damage, investing to generate returns and are one of Europe's largest investors
• Pension funds are set up companies or government agencies and funds are managed until retirement

Regulation

• Regulators promote fair and transparent investment through:
  • Creating a level playing field that eliminates unfair advantage.
  • Investors with confidential information must share it publicly or not use it.
  • Requiring useful information: companies must publish information so that investors will have greater awareness of the risks involved
  • Ensuring comparability: Data needs to be comparable across markets