Capital Market Overview of Financial Markets PDF

CAPITAL MARKET ‘OVERVIEW OF FINANCIAL MARKETS’ FINANCIAL MARKET Markets and Market Structure — primarily refers to a marketplace where buyers and sellers participate in the trade. Market — is a pl...

CAPITAL MARKET ‘OVERVIEW OF FINANCIAL MARKETS’ FINANCIAL MARKET Markets and Market Structure — primarily refers to a marketplace where buyers and sellers participate in the trade. Market — is a place where buyers and sellers can meet to facilitate the exchange or transaction of goods and — known for transparent pricing, strict regulations, services. costs and fees, and clear guidelines. Market structure — refers to how different industries — acts as an intermediary between savers and investors, are classified and differentiated based on their degree or they help savers to become investors. On the other and nature of competition for goods and services. hand, they also help businesses to raise money to expand their business. Types of Market Structures FUNCTIONS OF FINANCIAL MARKETS Perfect Competition Price Determination — interaction between investors, — occurs when there is a large number of small industries and other market forces helps to determine companies competing against each other the price. (Micro and macro indicators) — sell similar products (homogeneous), lack price Mobilization of Savings — helps in connecting those influence over the commodities, and are free to enter or with money with those who require money. exit the market Ensures Liquidity — investors can easily sell those assets — e.g. market sellers of meat, fruits, and vegetables and convert them into cash whenever they want. Oligopoly Saves time and money — serves as a platform where — consists of a small number of large companies that buyers and sellers can easily find each other without sell differentiated or identical products making too much effort or wasting time. — competitive strategies are dependent on each other Structures of Financial Markets — strategic planning by these types of players is a must — e.g. Smart, Globe, Sun Monopoly — a single company represents the whole industry — no competitor, and it is the sole seller of products in the entire market — restrict other companies from entering the market; has the power to control the market and set prices for By Nature of Claim its goods - Debt Market: The market is the market wherein — e.g. Meralco, Maynilad fixed claims or debt instruments, such as debentures or bonds, are traded between investors. Monopolistic Competition - Equity Market: A market wherein the investors buy — refers to an imperfectly competitive market with the and sell equity instruments. It is the market for equity traits of both the monopoly and competitive market claims. — sellers compete among themselves and can Maturity: differentiate Capital market over a year their goods in terms of quality and branding to look Money market within a year different — e.g. P & G, Jack & Jill, Unilever By Timing of Delivery — short—term in nature, usually with tenors of 91, 182 and 364 days and sold at a discount. (money market) - Cash Market: This market can be defined as a market where all the transactions are settled in real— T bond – mature over the years. time between buyers and sellers. government securities - T bond, t bills, fixed-rate - Futures Market: A futures market is one wherein treasury notes commodities are delivered at a future specified date. Settled some time in the future the safest instrument around the globe – real – us government By Organizational Structure Certificate of Deposit (CD) ~ Exchange-Traded Market: This market has a centralized organization with a standardized procedure. — issued directly by a commercial bank, but it can be purchased through brokerage firms Exchange of bond - PDEX — fixed maturity date and interest rate, and they attract. Over-the-Counter Market: This market is a penalty for withdrawing prior to the time of maturity characterized by a decentralized organization, having customized procedures. — short—term in nature, usually with maturity date ranging from three months to five years and can be By Maturity of Claim issued in any denomination. - Money Market: The market where monetary assets Commercial Paper such as commercial paper, certificate of deposits, treasury bills, etc. which mature within one year or less, — unsecured loan issued by large institutions or are traded is called the money market. corporations to finance short—term cash flow needs - Capital Market: The capital market is defined as a — only institutions with a high credit rating can issue market wherein medium and long-term financial assets commercial paper are dealt with. It can be further divided into two types: — issued in denominations of $100,000 and above Primary Market: Financial market, wherein the — comes with a maturity date between one month and company listed on a stock exchange, for the first time, nine months. issues new security or already listed company brings a fresh issue. It is also known as IPO. Banker’s Acceptance Secondary Market: Alternately known as the Stock — a form of short—term debt that is issued by a firm market, a secondary market can be defined as an but guaranteed by a bank organized marketplace, wherein already issued — created by a drawer, providing the bearer the rights securities are traded between investors, such as to the money indicated on its face at a specified date. individuals, merchant bankers, stockbrokers, and mutual funds. — often used in international trade because of the benefits to both the drawer and the bearer The Money Market — maturity date usually lies between one month and six — an organized exchange market where participants months from the issuing date. can lend and borrow short—term, high—quality debt securities with average maturities of one year or less. Repurchase Agreement (Repo) Types of Instruments Traded in the Money Market — a short—term form of borrowing that involves selling a security with an agreement to repurchase it at a Treasury Bills – safest instrument higher price at a later date — issued with a full guarantee by the government — commonly used by dealers in government securities — issued to refinance Treasury bills reaching maturity who sell Treasury bills to a lender and to finance the government’s deficits — agreements’ date of maturity ranges from overnight to 30 days or more — Federal Reserve buys repurchase agreements as a American Options - exercised at any time before the way of regulating the money supply and bank reserves option’s expiry Eurodollars European Options - can only be exercised on its expiration date. — dollar—denominated deposits held in foreign banks, and are thus, not subject to Federal Reserve regulations Currency Option — very large deposits of eurodollars are held in banks in the Cayman Islands and the Bahamas — pay a slightly higher interest rate than US. government debt The Bond Market — is where investors go to trade (buy and sell) debt securities, prominently bonds, which may be issued by corporations or governments. By buying a bond, credit, or debt security, you are lending money for a set period and charging interest—the same way a bank does to its debtors. The Equity Market — a market in which shares of companies are issued and traded, either through exchanges or over—the— counter markets — gives companies access to capital to grow their business, and investors a piece of ownership in a company with the potential to realize gains in their investment based on the company's future performance The Derivatives Market — refers to the financial market for financial instruments such as futures contracts or options that are based on the values of their underlying assets Equity market - Certificate of ownership Debt instrument – certificate of indebtedness THE DERIVATIVES MARKET - refers to the financial instruments such as futures contracts or options that are based on the values of their underlying assets Types of Derivative Contracts Options - give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price (referred to as the strike price) during a specific period of time. Definitions and Key Concepts Strike (Exercise) Price: Price at which the Option Buyer has the right to buy or sell the underlying currency pair Value Terms In-The-Money (ITM): Profit if exercised; strike price better than market rate At-The-Money (ATM): Neither profit nor loss; strike price same as market rate Out-Of-The-Money (OTM): Loss if exercised; strike price Definitions and Key Concepts worse than market rate Option Premium Value Terms are dynamic, e.g., from OTM to ATM to ITM, from ITM to ATM to OTM - Fair value is the present value of the expected pay-out - Fee paid by the Buyer as a risk compensation to the seller for writing the option - Paid upfront (Spot value date from option writing) - Flat percentage of strike price or fixed amount of exchange points Types of Derivative Contracts Futures - standardized contracts that allow the holder ofthe Market rate for USD/IDR is 9,000.00. Are the following contract to buy or sell the respective underlying asset at options ATM, ITM, or OTM? an agreed price on a specific date USD Put at USD/IDR 9,200.00 - income - ITM - always - not only possess the right but also are under the obligation, to carry out the contract as agreed USD Put at USD/IDR 7,000.00 - loss - OTM - never - standardized, meaning they are traded on the USD Call at USD/IDR 9,000.00 - no dif - ATM - always exchange market. USD Call at USD/IDR 9,200.00 - p. loss - OTM - never Forwards USD Call at USD/IDR 8,995.00 - gain - ITM - always - similar to futures contracts in the sense that the holder of the contract possesses not only the right but is also under the obligation to carry out the contract as agreed - over-the-counter products, which means they are not regulated and are not bound by specific trading rules and regulations - unstandardized, meaning customizable to suit the requirements of both parties involved. Swaps - involve two holders, or parties to the contract, to exchange financial obligations - over-the-counter products, which means they are not regulated and are not bound by specific trading rules and regulations - unstandardized, meaning customizable to suit the the contract must be sold at a price maker's bid. Price requirements of both parties involved Taker has to deal at the price of Market Maker. - Interest rate swaps are the most common swaps Elements of an FX Cash Flow contracts Cash Flow Alternative Investments  Direction - is a financial asset that does not fall into one of the conventional investment categories (stocks, bonds, and  inflow or Outflow cash)  Currency Involved - include private equity orventure capital, hedge funds,  Currency bought and currency sold managed futures, art and antiques, commodities, and derivatives contracts  Value Date - real estate is also often classified as an alternative  Spot or Forward investment  Domicile  Locus of Settlement Currencies in an FX Transaction Foreign Exchange (FX) Commodity Currency is a - (forex or FX) is the trading of one currency for another currency in forex that comes from a country with - can take place on the foreign exchange market, also large reserves of some known as the forex market specific valuable item, or commodity. - largest, most liquid market in the world, with trillions of dollars changing hands every day (FX market recorded Terms Currency is the USD5.3T in 2013) currency in which an exchange rate is quoted. - an electronic network of banks, brokers, institutions, and individual traders (mostly trading through brokers ISO International Standard 4217 (International or banks) Currency Codes) - major financial centers are located in Sydney, Singapore, Tokyo, Frankfurt, London and New York. Foreign Exchange (FX) Contract A Bilateral agreement - 2 parties To buy or sell - 2 Cash flows One currency against another - 2 Currencies At an agreed price - 2 way-quote At a specific value date - 2 values dates Parties involved in an FX Transaction Market makers (or sometimes referred to as Quoting Reciprocal Currency Party) are professional traders who offer to sell securities at a given price (the ask price) and will also - describes a situation where a currency pair involves bid to purchase securities at a given price (the bid price). the U.S. dollar (USD), but the USD is not the base currency; instead, it is the quote currency (also known Price takers (or sometimes referred to as Calling Party) as the counter currency). come into the market and trade on existing orders. If a price taker wants to buy, the contract must be bought at Remember the abbreviation K.A.P.E. on reciprocal a price maker's offer, and if a price taker wants to sell, currency which includes the following:  K - Kiwi - NZD/USD Month-end to month-end Rule A - Aussie - AUD/USD Transaction Date June 28 P - Pound - GBP/USD Spot Value Date (T+2) June 30 E - Euro - EUR/USD 1-month Forward July 31 Understanding a Two-Way Quote Three (3) Golden Rules in Forex Trade Execution Quote - the price at which an asset can be traded; it Rule No. 1 - KNOW YOUR ROLE may also refer to the most recent price that a buyer and seller agreed upon and at which some amount of the Rule No. 2 - THINK OF THE COMMODITY CURRENCY asset was transacted. Rule No. 3 - EXECUTE THE TRADE Two-way (or two-sided) quote - indicates both the current bid price and the current ask price of a security during a trading day on an exchange. A two-way quote tells traders the current price at which they can buy or sell a security. Bid Price - maximum price that a buyer is willing to pay Ask Price - minimum price that a seller is willing to take Spread - difference between the bid and the ask, giving traders an idea of the current liquidity in the security EUR/USD - 1.0425 - 0.0010 = 10 pips USD/JPY - 113.30 - 2.00 / 2 = 200 pips USD/PHP - 49.630 - 0.3 = 300 pips Determining Forward Value Date Fix the Spot Date Transaction Date = June 16 Spot Value Date (T+2) = June 18 Rules in determining the Forward Value Date Date-to-Date Rule 1-month Forward July 18