Transcript Financial Market Chapter - Oman College of Management

Financial Marketing
Dr S.M.Tariq Zafar
M.Com, PGDMM, PhD (Social Sector Investment)
[email protected],
[email protected]
Financial Market
Chapter - IV
Functions of the Financial System
Functions of the Financial System
Attributes of Financial Assets
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Return or yield
Total financial compensation received from an investment
expressed as a percentage of the amount invested
Risk
Probability that actual return on an investment will vary
from the expected return
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Liquidity
Ability to sell an asset within reasonable time at current
market prices and for reasonable transaction costs
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Time-pattern of the cash flows
When the expected cash flows from a financial asset are to be
received by the investor or lender
Continued:
The financial system facilitates portfolio restructuring
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The combination of assets and liabilities comprising the
desired attributes of return, risk, liquidity and timing of
cash flows
An efficient financial system:
 Encourages savings
 Savings flow to the most efficient users
 Implements the monetary policy of governments by
influencing interest rates
 The combination of assets and liabilities comprising the
desired attributes of return, risk, liquidity and timing of
cash flows
Strategic Function of Financial Market:
Financial market gives strength to economy by making finance
available at the right place.
(1) Mobilisation of Savings and their Channelization into more
Productive Uses:
Financial market gives impetus to the savings of the people. This
market takes the uselessly lying finance in the form of cash to
places where it is really needed. Many financial instruments are
made available for transferring finance from one side to the other
side. The investors can invest in any of these instruments
according to their wish.
Strategic Function of Financial Market (cont.):
(2) Facilitates Price Discovery:
The price of any goods or services is determined by the forces of
demand and supply. Like goods and services, the investors also
try to discover the price of their securities. The financial market is
helpful to the investors in giving them proper price.
(3) Provides Liquidity to Financial Assets:
This is a market where the buyers and the sellers of all the
securities are available all the times. This is the reason that it
provides liquidity to securities. It means that the investors can
invest their money, whenever they desire, in securities through the
medium of financial market. They can also convert their
investment into money whenever they so desire.
(4) Reduces the Cost of Transactions:
Various types of information are needed while buying and selling
securities. Much time and money is spent in obtaining the same.
The financial market makes available every type of information
without spending any money. In this way, the financial market
reduces the cost of transactions.
Core Function of Financial Markets
1. Savings Function:
The savings flow through the financial markets to the
investment stream so that more goods and services can be
produced in the future, which in turn enhances the
society’s standard of living. When savings flow decline in
the economy, the growth of investment tends to fall and
the living standard of the society as well.
2. Wealth Function:
While we might choose to store our wealth in “things” [for
instance, by purchasing home appliances, furniture, clothes,
possessing automobiles or personal car(s), and the like], such
assets often are subject to depreciation and as well carry
greater risks of loss. However, the financial instruments
(meaning financial assets) do not wear & tear overtime,
usually generate income, and, normally, their risk of loss is
much less than would be for other forms of storing wealth
3. Liquidity Function:
For wealth that is stored in financial instruments, the financial
markets provide a means of converting those instruments in to
ready cash with little risk of loss. In ‘modern societies’ the
definition of the most liquid financial asset – money – is broad
and constitutes mainly deposits held in banks. In this regard,
money is a special kind of financial asset (or instrument) and is
the only financial instrument that possesses perfect liquidity.
4. Credit Function:
 Consumers frequently need credit to purchase a home, other
consumable commodities & services, and retire outstanding
debt obligations.
 Businesses draw upon their lines of credit to stock their
shelves, construct buildings, meet payrolls, and grant
dividends to their stockholders.
 State, local, and federal governments frequently borrow to
construct buildings and other public facilities and cover daily
cash expenses until tax revenues flows in
5. Payment Function:
 Certain financial assets, mainly checking accounts and NOW
(Negotiable Order of Withdrawal) accounts serve as a medium
of exchange in the making of payments. (Note that NOWs have
become a common means of payments in advanced economies.)
 Plastic credit cards issued by many banks, credit unions, and
retail stores give the customer instant access to short-term
credit. They are widely accepted as a convenient means of
payment.
 Another type of plastic card – the debit card – is used today to
charge a buyer’s deposit account for purchases of goods &
services and transfer the proceeds instantly by wire to the
seller’s account
6. Risk Functions:
 The financial markets offer to businesses, consumers, and
government units a protection against life, health, property,
and income risks. This is accomplished, among other things, by
sale of life & property (or casualty) insurance policies.
 In addition to making possible the selling of insurance polices,
the money & capital markets have been used increasingly by
businesses and consumers to “self-insure” against risk. This
simply means building up one’s holdings of securities, deposits,
and so on as a precaution against future loss. The liquidity of
most financial instruments makes it easy to raise spendable
cash quickly in an emergency
7. Policy Function:
 Recent experiences in the advanced economies reveal that the
financial markets have been the principal channels through
which governments carried out the policy of attempting to
stabilize the economy and avoid excessive inflation.
 By manipulating the level of interest rates and the availability
of credit, governments can affect the borrowing and spending
plans of the public. This, in turn, influences the growth of the
economy, opportunities for jobs, increases in production, and
the rise in prices of goods & services.
Elements of the Financial System
 Conceptually, the financial system includes a complex set of
institutions and mechanisms that affect the generation of
savings and their transfer to those economic units which will
invest these funds somewhere in the economy. The financial
system may be said to be made of all those channels through
which savings become available for investments. The main
elements of the financial system are:
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Financial Instruments (Financial Assets or Securities),
Financial Intermediaries, and
Financial Markets
Financial Instruments(financial assets)
Financial assets are claims against the assets or resources of
other economic units and are held as a store of value and for the
return that is expected. While the value of a tangible (or
physical) asset depends on its physical properties, a financial
asset is a claim on a stream of income and/or a claim on a
particular asset.
Depending upon the nature of the claim/return, an instrument
may be classified as: Debt Security (such as bonds, debentures,
term loans, etc); Equity Security (i.e. common shares); and
Hybrid Security (such as preference shares and convertible
bonds).
Financial Instruments (Cont.)
 Equity
 Ownership interest in an asset
 Residual claim on earnings and assets
Dividend
Liquidation
 Types
 Ordinary share
 Hybrid (or quasi-equity) security
Preference shares
Convertible notes
Financial Instruments (cont.)
Debt
 Contractual claim to
Periodic interest payments
Repayment of principal
 Ranks ahead of equity
 Can be secured or unsecured
Derivatives
A synthetic security providing specific future rights that
derives its price from a
Physical market commodity
Gold and oil
Financial security
Interest rate-sensitive debt instruments, currencies
and equities
Used mainly to manage price risk exposure, and to speculate
 Four basic derivative contracts
• Futures
• Forward
• Option contract
• Swap
Financial Markets and their Kinds
The financial market can be describe as any marketplace where
buyers and sellers participate in the trade of assets such as
equities, bonds, currencies and derivatives. Financial markets
are typically defined by having transparent pricing, basic
regulations on trading, costs and fees and market forces
determining the prices of securities that trade.
Kinds of Financial Markets
1. Bond markets: Which provide financing through the
issuance of Bonds, and enable the subsequent trading thereof.
2. Money markets: Which provide short term debt financing
and investment.
Kinds of Financial Markets (cont.)
3. Derivatives markets: Which provide instruments for the
management of financial risk. Futures markets, which provide
standardized forward contracts for trading products at some
future date.
4. Insurance markets: Which facilitate the redistribution of
various risks.
5. Foreign Exchange Markets: Which facilitate the trading of
foreign exchange.
6. The capital markets: Consist of primary markets and
secondary markets. Newly formed (issued) securities are
bought or sold in primary markets. Secondary markets allow
investors to sell securities that they hold or buy existing
securities
Impact of Globalization
 Globalization of Financial Markets
• Refers to the interdependence of national financial
systems
• Global standardisation of financial instruments
• Facilitates the movement of funds between savers and
borrowers in different countries
Financial Institutions
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Financial institutions permit the flow of funds between
borrowers and lenders by facilitating financial transactions
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Institutions may be categorized by differences in the sources
and uses of funds
Categories of Financial Institutions:
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Depository financial institutions
Investment banks and merchant banks (money market
corporations)
Contractual savings institutions
Finance companies
Unit trusts
Depository Financial Institutions
Attract savings from depositors and investors to provide loan
facilities to borrowers
Commercial Banks
Building Societies
Credit Unions
Investment Banks and Merchant Banks
(money market corporations)
 Mainly provide off-balance-sheet (OBS) transactions to
corporations and government
 Advice on mergers and acquisitions, portfolio restructuring,
finance and risk management
 Provide some funding
Contractual Savings Institutions
The liabilities of these institutions are contracts that specify, in
return for periodic payments to the institution, the institution will
make payments to the contract holders if a specified event occurs
Funds are then used to purchase both primary and secondary
market securities
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Life and general insurance companies
Superannuation funds
Finance Companies
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Funds are raised by issuing financial securities direct into
money markets and capital markets
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Funds are used to make loans to ultimate borrowers
Unit Trusts
 Investors purchase units in the trust
 Trust manager invests funds in a range of investments
specified by trust deed
 Types of unit trusts
•Cash management trusts
•Equity trusts
•Property trusts
•Mortgage trusts
Financial Intermediaries:
Financial intermediaries are institutions that channel the savings
of investors (i.e. the savings of households & businesses) in to
investments through providing loans. Their main function is to
convert direct financial claims (or direct financial assets) in to
indirect forms of financial claims.
The indirect financial claims offer to individual investors a
variety of financial assets in the form of individual security by
pooling which it has created, for example, units of mutual funds
A. Convenience
Intermediaries convert direct (or primary) securities into a
more convenient vehicle of investment (indirect or secondary
claims).
They divide primary securities of higher denomination into
indirect securities of lower denomination.
They also transform a primary security of a certain maturity
into an indirect security of a different maturity.
B. Lower Risk
Lower risk associated with indirect securities results from the
benefits of diversification of investments. In effect, financial
intermediaries transform the individual investors in matters of
diversification into large institutional investors as the former
share proportionate beneficiary interest in the total portfolio of
the latter. Thus, their services, among others, help to reduce
investment risks.
C. Expertise Management:
Indirect securities give to the investors the benefits of trained,
experienced, and specialized management services together with
continuous supervision. In effect, financial intermediaries place
the individual investors in the same position in matters of expert
management as large institutional investors.
D. Low Cost:
The benefits of investment through financial intermediaries are
available to the individual investors at relatively lower cost due
to “economies of scale.” The major financial intermediaries are
banks, non-bank thrifts, insurances – both life & non-life
(general) insurance companies, mutual funds, non-bank
financial companies, and so on, which provide their services at
relatively lower costs.
The Changing Role of Institutional Investing
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Objectives and risks facing institutional investors
Limits to arbitrage
Regulation and other forces operating on institutional
investors
Impacts on institutional investing of a changing financial
world
Brokerage, ECNs
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The traditional exchanges: New York Stock Exchange, Amex,
regional exchanges
Nasdaq and electronic exchanges
The stock brokerage business
Stock price indexes
Spiders and other exchange-traded instruments
Consumer Finance
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Credit cards, home equity loans, etc.
Laws to protect consumers
Rising levels of consumer debt, concerns about rising
personal bankruptcy
The transformation wrought by new information technology
Forwards and Futures:
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Forward contracts and their limitations
Futures contracts since Osaka in 1600s
Fair value
Hedging function
Failure to hedge
Stock Index, Oil and Other Futures Markets
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The history of commodity futures
The evolution since 1980 of financial futures
Stock index futures
Interest rate futures
Oil as a fundamental factor in world economy
Innovation in the future
Options Markets
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Definition of options
Black-Schools formula
Chicago Board Options Exchange
The use of options in hedging and speculation
Increasing scope of options contracts in the future
Other Derivative Markets
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Swaps, Swaptions
Macro Securities and the American Stock Exchange
Stock Market Booms & Crashes
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Stock market crash of 1929
Stock market crash of 1987
Mexican Crisis 1994
Asian financial crisis 1997-1998
Nasdaq crash 2000-2001
Role of financial innovations in these crashes and in their
likelihood in the future
Thanks for your Patience
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