Fundamentals of Financial Markets and Institutions Lecture PDF

**Fundamentals of Financial Markets and Institutions** **29.01.2025 -- Lecture 7** Shadow banking: financial intermediaries which take in some sort of investment (excluding deposits) and invest it into capital markets but operate outside regular banking regulations and oversight. - *Mutual fund...

**Fundamentals of Financial Markets and Institutions** **29.01.2025 -- Lecture 7** Shadow banking: financial intermediaries which take in some sort of investment (excluding deposits) and invest it into capital markets but operate outside regular banking regulations and oversight. - *Mutual funds, ETFs, hedge funds, VC, PE, investment banks, Fintech, insurance companies and pension funds.* Mutual fund: pool resources of many small investors under a professional money manager (institutional investor) and use proceedings to invest in securities. - Benefits: 1. Liquidity intermediation: investors can leave whenever, converting investments into cash, while still being able to invest in long-term funds through the mutual fund. 2. Denomination intermediation: investors can participate in securities offerings that would typically require larger capital. - Some securities offerings may cost hundreds of thousands, individually you may not be able to afford this, but the pooling of funds means you can. 3. Diversification 4. Cost advantages as mutual funds can negotiate lower transaction fees. 5. Managerial expertise of money manager. - Many people believe they can generate more returns than if they did it themselves however it is not guaranteed the benchmark will be met. A graph of the number of the currency AI-generated content may be incorrect. - Deposits in the EU and Japan are higher than in the US, where most of the money is in regulated funds. - In 2022 when interest rates went up it was bad for those with loans, however for investors it was good as prices fell -\> money market rates increased. - In the US many began investing in the money market, compared to Finland where they did -\> lost out on potential earnings. - Banks utilize deposits to fund their operations and lending activities -\> don't have incentive to tell people about money markets -\> people are unaware of this option, one of the reasons Finnish people did not participate in this. [Structure of mutual funds:] - Investment companies offer several different types of mutual funds. - Investors can move funds around these funds without penalty fees, like subscription or redemption fees. - Investors pay indirectly, as management fees are taken directly out of funds' assets instead of imposing separate fees directly from customer, - Main fees: subscription, redemption and management fee.  Administrator: takes care of dividends, taxes, net present value -\> makes the investment managers role as easy as can be. Custodian: assets are held in separate bank from issuing bank, to protect shareholder interests. Investment manager: manages fund's portfolio according to funds objective. Broker-dealer sells funds shares to the public. - How this is done varies by country. - Nordea would offer you Nordea funds, but an independent financial intermediary can offer you Aktia's or Nordea's funds. A graph of numbers and a number of stocks AI-generated content may be incorrect. - Open-end funds: meaning it can be exchanged daily. - The mutual funds market is already large and still growing. Undertakings for the collective investment in transferable securities (UCITS): investment funds regulated at an EU level. -\> growing amount. - Since it is hard to be approved as compliant, it proves as a certification of quality and reliability. - Alternative investment fund managers directive (AIFMD) is similar but less stringent. - 20% in same equity, instead of 10%  - There used more discretionary mandates than investment funds, but now the roles have reversed. Investment fund: pools savings of investors with similar investment goals, with each fund having its own particular investment objective. - *For example, ESG fund.* Discretionary mandate: this is a type of opt-out fund done from investors private bank account, where an investment mandate is delegated to an asset manager by a specific investor. - *For example, avoiding a certain type of company, or exposure to a specific firm*. - Tailors' solutions to investor's needs. ESG in discretionary mandates: 1. ESG integration: asset manager applies all three factors in investment decision. - Applies to DM or MF. 2. Best-in-class: asset manager invests in a defined percentage of companies that lead in their peer group in sustainability performance. - Applies to DM or MF. 3. Exclusion: asset managers exclude from their fund. - Applies to DM or MF. - *Investor is against nuclear power, excludes related firms.* A screenshot of a graph AI-generated content may be incorrect. - Aktia has seen growth in its asset management. - The acquisition of Taaleri, which offered mainly DM, allowed for this. - Taaleri offered mainly DM, the acquisition allowed for growth in asset management Exchange-traded funds (ETF): pool resources of investors and use proceedings to invest in a bask of securities to track and index, traded throughout the day. - *For example, tracking S&P* - Allows for investors to develop a diversified portfolio, as investments are pooled into a fund with a variety of assets, without needing money managers expertise, as they are passively managed, following an index. - ETF are listed on the stock exchange, providing liquidity and flexibility. Mutual funds vs ETFs: - MF are actively managed, while ETFs are passively managed. - Active management can be argued for an against. - If a fund manager is constantly making wrong choices, it is not good -\> right choices are not guaranteed. - However, if a fund manager provides professional expertise -\> right choices can be made to provide higher returns. - MF are key offerings in retirement plans, while some do not allow ETFs. - MF have fees, are not listed in stock exchange.  - Fund sizes in the US are larger than in the EU. - There has been significant growth in ETF markets over the last 10 years.  - There has been a shift from actively managed funds to passively managed ETFs. - The EU has been somewhat late to the trend, but there has finally been growth in ETF markets. - This has led to reduced revenues and consequences of active mutual funds. ETF market: - The ETF market is highly competitive, with some having fees are low as 0%. - They can keep fees low through profit from stock lending, and other such tricks. - To increase revenues, there has been financial innovation -\> actively managed ETFs, which has been a growing market since 2022. Hedge fund: an offshore investment duns, that engages in a multitude of skill-based investment strategies with a broad range of risk and return objectives. - Target abnormal positive return, the benchmark is essentially 0. - In comparison, a MF targets a specific benchmark return. - Require very large amounts to join -\> typically only wealthy investors allowed. - They charge a management fee and success fee. - During the GFC many hedge funds lost value due to illiquidity in the markets. - When the markets are bad, they block investors from drawing money, making them illiquid. - MF follow strict regulations, allowing for less flexibility. - Hedge funds are registered in offshore accounts, so they do not need to follow these strict regulations, allowing them to report as they like and when they like. - Hedge fund management is based on "trust me principle". Betting on zero: - Ackman, a billionaire hedge fund manager, began shorting Herbalife, knowing this, investors bought shares, causing a \$6bn loss for the fund. Venture capital funds: pooled investment funds that manage the money of investors who seek private equity in startups and small- to medium-sized enterprises with strong growth potential, to nurture and grow them and then taking them public or selling them in M&A deals. Private equity funds: pooled investment funds that target fairly mature companies, which may be underperforming or undervalued, with the goal of improving their profitability and selling them for return on their investment.  - Private equity markets are a lot smaller than mutual funds but still make up a significant amount. A chart with text and images AI-generated content may be incorrect. - Although VC and PE search for private equity, they are classified as separate asset classes. -  - Most VCs fail, however due to the selection bias of news, we focus on the success cases. - VC compared to similar risk investment in stock markets, earns a positive risk-adjusted return before 2000. - In the last 25 years they have on average received the same return. - Meanwhile PE have had positive risk-adjusted returns consistently. A graph of a market capital/major cityization AI-generated content may be incorrect. - The number of listed companies has almost halved since the 90s. - Companies have been delisting buy buying out shareholders. [Case: Spa Holdings Oy tender offer for Ahlstom-Munksjö] - In the first share buyback offer many found the premium to be too small -\> investors did not agree to sell, hoping Spa Holdings Oy would increase their offer. - However, they did not but extended the offer period and eventually got 90% to agree, forcing the remaining out. - During this process Spa Holdings and Ahlstrom-Munksjö needed financial advisors and legal advisors, highlighting the importance of financial advisory services provided by investment banks. Why companies delist: 1. Avoid SEC regulations. 2. Provide flexibility and avoid public scrutiny of earning - Allows them to take bigger risk to pursue longer-term growth. 3. Attract CEO talent not interested in being a public-company CEO. 4. Tax advantages and higher compensation for partners.  - The largest PE firms are massive, being able to finance billions into a single deal. Investment banks: an advisory based financial service, performing a variety of crucial functions in financial markets. - Underwriting fee: finding correct price for shares, distribution, aftermarket support, roadshows. - Deal maker in M&As. - Middleman in purchases and sales of companies. - Private broker for wealthy individuals. - Main: IPOs, M&As, debt issuance. - Customers are willing to pay around 150 bn for investment banks. [Why do investment banks exist?] - Asymmetric information - What is the true value of a company? -\> intermediaries in information sensitive transactions. - Bring together those who want to sell information and those who want to purchase information -\> investors/analysts to investors and corporate security issuers. - The investment banks reputation is at stake: perform well, sell access to clients. [Case: IPOs] - IPOs only occur once, so it is important to do it correctly -\> investment banks have informational advantage about state of market -\> able to help determine the correct price. - IPO underpricing: price slightly under true value to attract investors. - However, if an investment bank were to underprice too much, other companies will be aware of this and will avoid working with them -\> reputation at stake. - The same can be said for excessive overpricing of IPOs. - Typically. investment banks make most of their money from M&As. - However, this varies depending on what the bank it best at: debt issuance, M&As, IPOs. Feature Investment Bank ETFs Mutual Funds Hedge Finds VC&PE Discretionary Mandate --------------- ------------------------------ ----------------------------- ---------------------------------------- --------------------------------------------------- --------------------------------- --------------------------------------- Purpose Advisory services Passive investing Diversified, active investing High-risk strategies for abnormal positive return Private company investment Portfolio management Investor type Mainly corporations Retail + institutions Retail + institutions HNWI Institutions + HNWI Retail + institutions Liquidity High: market-based High: stock exchange listed Medium: daily NAV Low: lock-up periods Very low: long-term investments Varies: depends on type Risk level High: market exposure Moderate: market-based Moderate: diversified but market-based High: leverage and shorting High: illiquid investment Varies: depends on assets invested in Regulation Strict Regulated Regulated Light Light Regulated Fees Transaction and advisory fee Low Management, subscription, redemption Management, success High Management fee