Financial Markets Chapter 1 Intro PDF

Introduction 1  Investments Real assets used to produce goods and services: the land, equipments, buildings Financial assets: stocks, bonds, options 2  ESG Investments Firms take into...

Introduction 1  Investments Real assets used to produce goods and services: the land, equipments, buildings Financial assets: stocks, bonds, options 2  ESG Investments Firms take into account ethical and societal considerations beyond their private pursuit of profit. Taking into account environmental, social, and governance (ESG) characteristics of firm’s when making investment decisions. 3 The main functions of the financial system The financial system plays a key role in the economy by stimulating economic growth and affecting economic welfare. The financial system allows funds to flow from investors who have a surplus of funds to those who have a shortage of funds. The financial system facilitates the transfer of funds from savers to economic agents (firms, states, etc.) needing funds. 4 The main functions of the financial system The financial system comprises financial markets, financial intermediaries and institutions, and financial regulators. The role of financial markets is to facilitate the flow of funds from households (savers) to firms and governments who want to finance their investments. Financial institutions perform the function of intermediation. The financial regulators perform the role of monitoring and regulating. 5  Venture capital & private equity Listed firms raise funds from financial markets. Young firms (start-ups) are financed by investors who are interested to invest in them (business angels). Venture capital is a method of financing for young innovative companies (start-ups). This method of financing was born on the East Coast of the United States (Silicon Valley). 6  Venture capital & private equity Venture capital is invested in the startup's share capital for a period of approximately 5 years. Venture capital is paid for through the capital gain realized at the time of resale. Private equity is defined as an investment in companies not listed on the stock market. 7 The financial market: primary and secondary Primary market is the market where financial securities (bonds, stocks) are issued.  Issuing first time (IPO) Secondary issue or seasoned offerings Secondary market is the market where the issued securities are traded. 8  Examples of Financial Markets Tadawul Euronext London Stock Exchange Nasdaq Nyse Foreign Exchange Market (FX) 9  Main types of traded assets Shares (ownership in a corporation) Bonds (debt security) Options (derivatives) Trackers and ETF (Exchange-Traded Funds) Currencies Commodities (precious metals, industrial metals, agricultural products, energy products, credit for carbon reduction, etc.) Contracts (forward or futures: standard) Swaps Other contracts (CDS) 10  Financial Markets The choice of a financial market (from the side of investors and managers: listing of their firms) depends on the ability of the market to :  Determine the proper price for the assets traded in the market (market efficiency)  Provide enough liquidity for the assets traded in the market  Minimize information asymmetry (transaction costs) G information about G to get into youhave to pay ? companyitaliguthat o J52/1y5 11  Market efficiency CemH] The efficient market hypothesis suggests that all available information is reflected in stock prices. There are 3 forms of efficiency: The weak form The semi-strong form The strong form 12  Market efficiency Fama (1991) divides work on market efficiency into three categories: weak-form tests (How well do past returns predict future returns?) semi-strong-form tests (How quickly do security prices reflect public information announcements?) Estock price strong-form tests (Do any investors have private information that is not fully reflected in market prices?) > - if even info you knew its not Private gonna reflect MP 13  Liquidity In a liquid market, we can trade quickly a large quantity of the asset without causing a significant price variation 14  Asymmetric information Grad thing The asymmetric information hypothesis deals with an economy composed of two categories of investors: Informed traders (insiders) Coo have ho in Uninformed traders don't > - infor about know company 15  Financial intermediaries Financial intermediaries help investors by facilitating the exchange of assets. There are several intermediaries: -buy selor Brokers : they do not trade with their clients but they help them by findings counterparties. takes in trest Block brokers: they help large traders. Investment banks: provide advices to corporate clients, especially for M&A, seasoned securities offering, etc. Exchanges: provide place where traders can meet and trade. Alternative Trading Systems (ATS); Multilateral Trading Facilities (MTF); Electronic Communications Networks (ECN) : they have the same trading function as exchanges except the regulatory role. Dark pools are ATSs that do not reveal client information ( orders, identity, etc.). Paternate trading systems 16  Financial intermediaries Dealers : provide liquidity to the market by trading with their clients. G buys sell from you Securitizers: create new financial products (they pool large amount of securities/assets: mortgages, car and bank loans, etc.) and then sell them. Depository institutions: commercial banks, credit unions, saving and loan banks. They raise funds from depositors (they give them interest and transaction services) and make loans with the funds. Insurance companies: they collect insurance premium and provide payment if some loss occurs. -some company indiffent Saiwait same amount of assets Arbitrageurs : trade if there is an opportunity to buy/sell similar assets in different places at different prices. Clearinghouses : they arrange for final settlement of trades: escrow services, transferring cash and assets, contract completion, assurance that traders have capital and adequate assets, limit the aggregate net (buy minus sell) quantities that investors can settle. 17  Market anomalies Market Anomalies are some empirical observations that reject the market efficiency hypotheses. We can cite: Calendar anomalies: January effect (higher returns during the first days of this month), day of the week effect (positive Friday returns and negative Monday returns) Post-Earnings-Announcement Drift (PEAD): under-reaction around earnings announcement and the reaction occur during several days IPO Momentum effect Size effect (small cap outperform large cap) G from smalles companies goin more Book to market ratio (High minus low) B/M = 18  Behavioral finance The behavioral finance explain market anomalies by cognitive biases and investors’ psychology traits (reject the rationality hypothesis). overconfidence conservatism: slowly and gradual reaction to change G not quick with change Gambler’s fallacy: recent events affect investors’ forecasting's and probability Loss aversion: investors are more risk averse when faced potential losses than when faced potential gains. Mimetism > - way in a nonchalant reaction 19 Technical and fundamental analysis The goal of technical analysis is to make profit by using historical data (price and volume): weak form of efficiency? Investors who use fundamental analysis take into account public information: semi-strong form efficiency G that people know about If the market is efficient according to the semi-strong form, investors can invest passively (invest in ETF (trackers) that replicate the market index). * Empirical observations show that portfolio managers rarely beats (outperform) the market. 20 & Security Market Indices "stock : jy The index value is generally used to compute total returns and risk for an aggregate market or some component of the market over a specified time period. Also, the index return can be used as a benchmark to judge the performance of individual portfolios. The benchmark allows to compute the beta of the CAPM Passive portfolio Management 21  Types of equity indices Broad market index: inform about the market overall performance (Tadawul, S&P500, Dow Jones, FTSE, CAC40, Dax). Multi-market index: computed from the indexes of markets in Ginternation several countries (MSCI World index for example). Sector index: an index which is specific for an industry sector. G Banks for Biochemistry or Style index: specific index by market capitalization (small cap, mid-cap, large cap). 22  Indices representing alternative investments Commodities indices (futures contracts, metals, energy, etc.) Real estate indices Socially Responsible Investment (FTSE4 Good index, DJSI World) Islamic indices (MSCI Saudi Arabia IMI Islamic Index) 23  Price weighted index = G happens after stock split A price weighted index is an arithmetic mean of current prices of securities included in the index. The divisor is adjusted for stock splits. Example of price weighted index: Dow Jones Industrial Average (DJIA) and Nikkei 24  Equal weighted index An equal weighted index is based on an arithmetic average returns of all index stocks. 25 Value-weighted (market capitalization) index This type of index considers the proportion of the market capitalization of each index stock (market value= number of shares outstanding * current market price) as a proportion of the total market capitalization of all the stocks in the index. Example of Value weighted index: S&P500 work I since 26 Us Float-adjusted market capitalization- weighted index This type of index is computed as the previous index. But, the weights are based on the freely floating shares (shares that are available to investors excluding controlling stockholders). 27 Thank you for your attention 28