Financial Markets Overview PDF

**[LESSON 1: OVERVIEW OF FINANCIAL MARKETS]** **[Market]** -- a place where buyers and sellers facilitate the exchange or transaction of goods and services. **[Market Structure]** -- how different industries are classified and differentiated based on their degree and nature of competition for good...

**[LESSON 1: OVERVIEW OF FINANCIAL MARKETS]** **[Market]** -- a place where buyers and sellers facilitate the exchange or transaction of goods and services. **[Market Structure]** -- how different industries are classified and differentiated based on their degree and nature of competition for goods and services. **[TYPES OF MARKET STRUCTURE]** 1. **[PERFECT COMPETITION]** (market sellers: meat, fruit, veggies) - large number of small companies, sell similar products, lack price influence, and free enter or exit of the market 2. **[OLIGOPOLY]** (Smart, Globe, Sun, DITO ; Grab, Angkas, Joyride, MoveIt) - small number of large companies; competitive strategies are dependent & strategic planning is a MUST 3. **[MONOPOLY]** (Meralco & Maynilad) - Single company that represents the whole industry; control and dictate the price of the service they offered; no competitor; restricts other companies from entering the market 4. **[MONOPOLISTIC COMPETITION]** (P&G, Jack n Jill, Unilever) - Imperfectly competitive; sellers compete among themselves and can differentiate their goods in terms of quality and branding to look different **[FINANCIAL MARKET]** - Marketplace where there are buyer and seller of trades - Known for transparent pricing, stricter regulations, costs & fees, and clear guidelines - NGRA -- National Government Regulatory Agencies) - Acts as an intermediary between sellers and investors; helps savers become dealers - Helps businesses to raise money to expand their business **[FUNCTIONS OF FINANCIAL MARKET]** 1. **[PRICE DETERMINATION]** -- interaction between investors to determine price 2. **[MOBILIZATION OF SAVINGS]** -- connects those with money with those who require money 3. **[ENSURES LIQUIDITY]** -- investors can easily sell those assets and covert them into cash whenever they want 4. **[SAVES TIME AND MONEY]** -- a platform where buyers and sellers can easily find each other w/o too much effort or wasting time **[STRUCTURES OF FINANCIAL MARKET]** **[BY NATURE OF CLAIM]** - **[DEBT MARKET:]** fixed claims or debt instruments such as bonds (bonds/nagpapautang; Issues: Certificate of Indebtedness - **[EQUITY MAREKT:]** investors buy and sell equity instruments (shares of stocks; Issues: Certificate of Ownership) **[BY TIMING OF DELIVERY]** - **[CASH MARKET:]** real time buyer and seller; on the spot transaction (SPOT MARKET) - **[FUTURES MARKET:]** commodities are delivered at a future specified date **[BY ORGANIZATIONAL STRUCTURE]** - **[EXCHANGE-TRADED MARKET:]** centralized organization with standardized procedure - **[OVER-THE-COUNTER MARKET:]** decentralized organization with customized procedure **[BY MATURITY OF CLAIM]** - **[MONEY MARKET:]** matures within one year or less - **[CAPITAL MARKET:]** medium and long-term financial assets & divided into 2 types: - **[PRIMARY MARKET:]** company listed on the stock exchange for the first time; IPO - **[SECONDARY MARKET:]** stock market; already issued securities are traded **[\*THE MONEY MARKET\*]** - participants can lend and borrow short-term; with average maturities of one year or less **[TYPES OF INSTRUMENTS TRADED IN MONEY MARKET]** 1. **[TREASURY BILLS]** - Issued with a full guarantee by the government (Bureau of Treasury) - Issued to refinance treasury bills reaching maturity & finance the government's deficits - Safest investment in the world: US Treasury Bill (guaranteed by the federal reserve/US government) - GSED (Government Securities Eligible Dealers) -- authorized to connect saver to dealer - Maturity: short term in nature (91, 182, 364 days in tenor) 2. **[CERTIFICATE OF DEPOSIT]** - Issued by commercial banks but can be purchased through brokerage firms; fixed maturity date and interest rate - Maturity: 3 months to 5 years in any denomination 3. **[COMMERCIAL PAPER]** - Issued by large institutions; only institutions with a high credit rating can issue this - Issued in any denominations of \$100,000 and above - Maturity: 1 and 9 months 4. **[BANKER'S ACCEPTANCE]** - Issued by a firm, guaranteed by a bank - Created by a drawer with bearer of rights to the money indicated in it; use in international trade due to the benefits to both drawer and bearer 5. **[REPURCHASE AGREEMENT]** - Involves selling a security as a collateral with an agreement to repurchase it at a higher price at a later date - Used by dealers in government securities; Federal Reserve buys this as a way of regulating money supply of bank reserves - Maturity: overnight to 30 days or more 6. **[EURODOLLARS]** - Dollars held in foreign banks; not subject to Federal Reserve regulations - Held in Cayman Island & Bahamas - Pays slightly higher interest rate than US Government debt **[\*THE BOND MARKET\*]** - Where investors go to trade debt security; issued by corporations or government (bond, credit, or debt security) - Matures more than one year: - Corporate Bonds -- issued by corporations - Treasury Bonds - issued by government - Bondholders -- nagpautang - Bond issuer -- nangutang **[\*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** **[LESSON 2: THE DERIVATIVES MARKET]** - The financial market for financial instruments such as **FUTURES CONTRACTS** or **OPTIONS** that are based on the values of their underlying assets **[TYPES OF DERIVATIVE CONTRACTS -- futures market]** **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. - Contract but the buyer has the right but no obligation - Set some time in the market **American Options --** exercised at **any time** before the options expiry **European Options -** can only be exercised on its **expiration date** **[CURRENCY OPTION]** - Contractual right: buyer ; not for seller, seller is for obligation - Compensation: option premium is a risk compensation; tuloy or not the contract, may makukuha from option buyer to seller; protect the assets from loss, to mitigate the loss - Right belongs to option buyer, option seller have obligation and to receive option premium **A Call on the EUR is a Put on the USD** 3 mos. -- On a pre-defined period or date: the expiry 1.2600 -- At a specific price: the strike in EUR/USD EUR Call -- The right to BUY or SELL On EUR 10 000 000 -- A pre-agreed amount: the notional - When mag eexpire the contract of buyer and seller of option: 3 months - Kelan isesettle yung option; strike price or exercise price; the future price - Either the right to buy or sell, when nagkakaroon - Potentially exposed position; the transaction amount to protect **[TYPES]** **CALL** -- right, not obligation **to buy** a currency pair; When calling, you're buying **PUT -** right, not obligation **to sell** a currency pair; You're selling *Currency option is both a CALL and a PUT, e.g., Option to sell USD/JPY: USD Put and JPY Call, Option to buy EUR/USD: EUR Call and USD Put* *Party can be a Buyer or Seller (Writer) of a currency option: can buy or sell a Call or Put* **Option** **Buyer** **Seller; Option Writer** ------------ --------------- --------------------------- **CALL** Right to Buy Obliged to Sell **PUT** Right to Sell Obliged to Buy *Right to exercise belongs only to Option Buyer!* **[CURRENCY OPTION]** **Strike (Exercise) Price:** price at which the Option Buyer has the right to buy or sell the underlying currency pair; future price Value Terms - **In-The-Money (ITM): Profit if exercised**, strike price better than market rate; always exercise - **At-The-Money (ATM): Neither profit nor loss,** strike price same as market rate; always exercise - **Out-Of-The-Money (OTM): Loss if exercised,** strike price worse than market rate; never exercise *Value Terms are dynamic, e.g., from OTM to ATM to ITM, from ITM to ATM to OTM* **Spot USD/JPY 81.00** ------------------------ ---------------------- ----------------- **USD/JPY Call** **USD/JPY Put** **OTM** Strike USD/JPY 84.00 **ITM** **OTM** Strike USD/JPY 83.00 **ITM** **OTM** Strike USD/JPY 82.00 **ITM** **ATM** Strike USD/JPY 81.00 **ATM** **ITM** Strike USD/JPY 80.00 **OTM** **ITM** Strike USD/JPY 79.00 **OTM** **INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION -- perform oversight of functions** Example: A USD Put/JPY Call was written at the strike price of 81.00 on May 1 for 3 months (***Option Period: May 1 to Aug 1***); +2 day to settle cash flow or option premium Expiration Date: Date on which the Buyer's right to exercise ends **[Exercise Dates -- AA BB EE]** +-----------------------------------+-----------------------------------+ | **XXXXXXXXXXXXXXXXXXX** | **AMERICAN** | | | | | | **Anytime; can exercise anytime** | +===================================+===================================+ | **\-\-\-\--X\-\-\-\--X\-\-\-\--X\ | **BERMUDAN** | | -\-\-\--X\-\-\-\--X** | | | | **Between (Start/End); in | | | between** | +-----------------------------------+-----------------------------------+ | **\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\ | **EUROPEAN** | | -\-\-\-\-\-\-\-\-\-\-\-\-\-\--X** | | | | **Expiry; commonly used; exercise | | | at expiration date** | +-----------------------------------+-----------------------------------+ **[Option Premium]** - 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) - **Calculation of flat percentage of strike price or fixed amount of exchange points** - Need to pay as a risk compensation; settle or pay upfront from the time the contract was written; T+2 **[TYPES OF DERIVATIVE CONTRACTS]** **[FUTURES]** - Standardized contracts that allow the holder of the contract to buy or sell the respective underlying asset at an agreed price on a specific date; settle sometime in the future - Not only possess the right but also are under the obligation to carry out the contract as agreed; both may obligation and right - Standardized, meaning they are traded on the exchange market - Over the market **[FORWARDS]** - 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 - Underlying assets are commodities **[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 requirements of both parties involved - [Interest rate] swaps are the most common swaps contracts - Fixed and floating: flat and depends **[ALTERNATIVE INVESTMENTS]** - A financial asset that does not fall into one of [the conventional investment categories (stocks, bonds, and cash)] - Include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts - Real estate is also often classified as an alternative investment **[LESSON 3: FOREIGN EXCHANGE (FX)]** - Trading of one currency for another - Can take place on the foreign exchange market, known as the forex market - Largest, most liquid market in the world, with trillions of dollars changing hands every day (**FX market recorded USD5.3 T in 2013**) - An electronic network of banks, brokers, institutions, and individual traders (mostly trading through brokers or banks) - Major financial centers are located in Sydney, Singapore, Tokyo, Frankfurt, London, and New York **What is a 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 value dates **[Parties involved in FX Transaction]** **Market Makers** (or sometimes referred to as **Quoting Party**) - professional traders who offer to sell securities at a given price (the ask price) and will also bid to purchase securities at a given price (the bid price) (obliged gumawa ng market price) **Price Takers** (or sometimes referred to as **Calling Party**) - come into the market and trade on existing orders. If a price taker wants to buy, the contract must be bought at a price maker's offer, and if a price taker wants to sell, the contract must be sold at a price maker\'s bid. Price Taker has to deal at the price of Market Maker. (either who will deal or not deal; responsibility whether to deal or not to deal) **[Elements of an FX Cash Flow]** - Direction - Inflow or Outflow - If you want to buy USD against PHP; Inflow is USD, Outflow is PHP - Currency Involved - Currency bought and currency sold - Buy USD -- Inflow ; Pay PHP -- Outflow - Value Date - Spot or Forward - Domicile - Locus or Settlement (domestically or internationally) -- place of the settlement **[Currencies in an FX Transaction]** **Commodity Currency** is a currency that comes from a country with large reserves of some specific valuable item or commodity (first currency in the pair) **Terms Currency** is the currency in which an exchange rate is quoted (second currency in the pair or the other currency) USD/JPY 113.30 First currency: Commodity Currency Oblique (/): Against not Per Second currency: Terms Currency; the "other" currency Amount: Price of Commodity currency *Example: USD/PHP 58.94 -- read as USD against PHP; the value of dollar is PHP 58.94* **[ISO International Standard 4217 (International Currency Codes)]** **US DOLLAR** **USD** --------------------------- --------- **EURO** **EUR** **JAPANESE YEN** **JPY** **BRITISH POUND** **GBP** **SWISS FRANC (Swissie)** **CHF** **MALAYSIAN RINGGIT** **MYR** **AUSTRALIAN DOLLAR** **AUD** **PHILIPPINE PESO** **PHP** **SINGAPORE DOLLAR** **SGD** **INDONESIAN RUPIAH** **IDR** **THAILAND BAHT** **THB** **HONG KONG DOLLAR** **HKD** **[RECIPROCAL CURRENCY]** - Describes a situation where a currency pair involves the US dollar USD, but the USD is not the base currency; instead, it is the quote currency (known as the counter currency) *Remember the abbreviation **K.A.P.E.** on reciprocal currency which includes the following* - ***K -- Kiwi -- NZD/USD (other jargon term: Sterling)*** - ***A -- Aussie -- AUD/USD*** - ***P -- Pound -- GBP/USD*** - ***E -- Euro -- EUR/USD*** **[UNDERSTANDING A TWO-WAY QUOTE]** **QUOTE** - the price at which an asset can be traded; it may also refer to the most recent price that a buyer and seller agreed upon and at which some amount of the asset was transacted. **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; offer price **SPREAD --** difference between the bid and the ask, giving traders an idea of the current liquidity in the security **[What is a Pip?]** EUR/USD \| 1.0425 USD/JPY \| 113.30 0.01 1 PIP How would you express 200 pips? 2.00 USD/PHP \| 49.630 0.001 1 PIP How would you express 300 pips? 0.300 ***[Last significant digit in a quote]; depends on how a currency pair is quoted, different from basis point (BPS -- interest rate)*** **[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 Month-end to month-end Rule - Transaction Date June 28 - Spot Value Date (T+2) June 30 - 1-month Forward July 31