Financial System Introduction .pdf

Financial M a r k e t Organisation &Structure  Learning Objectives Articulate the objectives of market regulation...

Financial M a r k e t Organisation &Structure  Learning Objectives Articulate the objectives of market regulation List the key players of financial markets Classify markets and assets traded in these different market settings Describe the main functions of the financial system A Quick Tour to the Financial System  What is a Financial System? A network of markets and various financial intermediaries that help transfer assets and financial risks in various forms from one entity to another, and from one point in time to another 02 01 The assets include both financial assets such as bonds, equities and derivatives and also real assets such as commodities  The Main Functions of a Financial System the achievement of the the discovery of the rates of return the allocation of capital to purposes for which people use the that equate aggregate savings the best uses with aggregate borrowings; and financial system; Achievement of Purposes in the Financial System Borrowing Issuing Equity Savings A firm may borrow in The financial system Individuals will save and facilitates raising equity order to finance expect a return that capital. Investment banks capital expenditures. compensates them for risk help companies issue Governments may issue and the use of their money equities, analysts value the debt to fund their securities that companies sell expenditures Managing Risks Exchanging Assets Utilizing Information These risks include default People and companies often Investors trade to profit risk and the risk of changes trade one asset for another, from information that they in interest rates among believe allows them to such as trading one currency many others.They are mana predict future prices. They for another currency, or ged by trading contracts hope to buy at low prices money for a needed that serve as hedges and sell at higher prices commodity or right.  Functions of the Financial System(cont.) Return Determination Capital Allocation The financial system helps to discover equilibrium interest Investors weigh the expected rate, at which the amount risks and returns of different individuals, businesses, and investments to determine their governments desire to borrow most preferred investments. is equal to the amount that individuals, businesses, and governments desire to lend. As long as investors are well informed regarding risk and return and markets function well, Low rates of return increase this results in an allocation of borrowing but reduce saving capital to its most valuable uses. (increase current consumption). High rates of return increase saving but reduce borrowing. A Well-Functioning Financial System Informationally Operationally Allocationally efficient Efficient Efficient Security prices A market can Capital is reflect all the perform its allocated to its information functions at most associated with low trading productive use. fundamental value in a timely costs fashion Classification of Assets and Markets  Classification of Assets Equity Securities Derivative Contracts & Common stock, preferred Currencies stock, warrants. Forwards,futures,CDS,option Debt securities Real Assets Assets Bond,commercial paper, T-bills Equipment,building, land Pooled Investment Vehicles Commodities Mutual funds,ETF,Hedge Oil,wheat,coal,coffee funds. Securities, contract,s and currencies are known as financial assets, whereas commodities and real assets are classified as physical assets Breaking Down the Securities Pooled Equity Fixed Income Investment Securities Securities Vehicles Typically refer to debt Include mutual funds, Equity securities securities that are represent ownership in ETFs, and hedge promises to repay funds. The term refers a firm and include borrowed money in the common stock, to structures that future. Although the combine the funds of preferred stock, and terms are used loosely, warrants. many investors in a bonds are generally portfolio of long-term, whereas investments. notes are intermediate-term C u r r e n c i e s  Currencies are monies issued by national monetary authorities;  Approximately 180 currencies are currently in use throughout the world.;  Some of these currencies are regarded as reserve currencies. Reserve currencies are currencies that national central banks and other monetary authorities hold in significant quantities;  The primary reserve currencies are the US dollar and the euro. Secondary reserve currencies include the British pound, the Japanese yen, and the Swiss franc; L O R E M I P S U M D O L O R S I T A M E T , C U U S U A G A M I N T E G R E I M P E D I T.  Contracts/Derivatives Contracts are Financial agreements derivative between two contracts are parties that based on require some equities,debt, action in the debt indexes. future. whereas, Derivative physical contracts have derivative values that contracts are depend on (are based on derived from) physical assets the values of such as gold, other assets. oil, and wheat A forward contract is an Futures contract Swap contract Option contract agreement to buy or sell are similar to forward involves two parties gives its owner the right an asset in the future at a contracts except that making payments that are to buy or sell an asset at price specified in the they are standardized equivalent to one asset a specific exercise price contract at its inception. and offer high liquidity being traded for another in the future Commodities and Real Assets Commodities Commodities trade in spot, forward, Real Assets and futures markets. They include precious metals, industrial metals, Examples of real assets are real estate, agricultural products and energy equipment, and machinery. products; Although they have been traditionally held by Futures and forwards allow both firms for their use in production, real assets are hedgers and speculators to participate increasingly held by institutional investors both in commodity markets without having directly and indirectly. to deliver or store the physical commodities Buying real assets directly often provides income, tax advantages, and diversification benefits. However, they often entail substantial management costs. Furthermore, because of their heterogeneity, they usually require the investor to do substantial due diligence before investing.  Classification of Financial Markets Capital vs Money Markets Primary vs Secondary Capital markets: where the transaction of long-term Markets 01 02 securities takes Primary markets: where place(corporate bonds, newly issued instruments government bonds) Money markets: where the C P are bid: Secondary markets: where already instruments stocks trading of short-term securities are sold and bought (Repo, CDO, commercial paper, T-bills) takes place: Traditional vs. Spot vs Futures Markets Alternative Markets Spot markets: where immediate delivery takes place; S T Traditional investment markets: where debts and equities are traded: Futures markets: where 03 04 Alternative markets: contracts are traded and the where commodities and purchase is to be completed at a real assets are traded; later date Key Players and The Role of Regulation Financial Intermediaries Brokers Investment Dealers help their clients banks buy and sell securities by help corporations sell facilitate trading by buying finding counterparties to common stock, for or selling from their trades in a cost-efficient own inventory preferred stock, and debt manner securities to investors Securitizers Arbitrageurs Clearinghouses pool large amounts of Buy an asset in one market limit counterparty risk, securities or other assets and the risk that the other and then sell interests in the resell it in another at a party to a transaction will pool to other investors higher price. not fulfill its obligation Problems in the Absence of Regulations Fraud and theft Insider trading Costly information Defaults In complex financial If investors believe traders If obtaining Parties might not honor their markets, the potential for with inside information will information is obligations in markets theft and fraud increases exploit them, they will exit the relatively expensive, because investment man market and liquidity will be markets will not be as agers and others can take reduced. informationally advantage of unsophistica efficient and investors ted investors. will not invest as much  Objectives of Market Regulations  Require minimum standards of competency and make it easier for investors to evaluate performance; Prevent insiders from exploiting other investors; Require common financial reporting What If Regulations Fail? requirements (e.g., those of the International Accounting Standards Board) so that  liquidity declines information gathering is less expensive;  firms shun risky projects  new ideas go unfunded, and Require minimum levels of capital so that  economic growth slows market participants will be able to honor their long-term commitments: Key Regulators in the US Market  The Federal Reserve Board (FRB) is responsible for influencing money, liquidity,and overall credit conditions  The Federal Deposit Insurance Corporation (FDIC) was created by the Glass-Steagall Act of 1933 to provide insurance on deposits to guarantee the safety of funds kept by depositors at banks  The Securities and Exchange Commission (SEC) oversees securities exchanges, securities brokers and dealers, investment advisors, and mutual funds in an effort to promote fair dealing, the disclosure of important market information, and to prevent fraud THANK YOU