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Overview of
Financial System

Agenda

Module
Objectives

What is Financial System

How Financial System works
Structure of Financial System
Functions of Financial System
Constituents of a Financial System
Overview of financial markets
Who are Financial Intermediaries and their role
Financial Instruments
Investment Bank and its role
Differences between
Buy side and Sell side business
Investment Banks and Commercial/Retail banks
Investment banks and Merchant Banks
Mutual fund and Hedge Fund
Overview of Commodity market

What is Financial System

A system which gels together Financial Participants, Markets, Products, Services
Can be classified as Regional, Domestic, International
Predominantly channels funds between lenders and borrowers, which encourages
the movement of funds in an economy
Plays an important role in the growth of the economy by influencing economic
performance and economic welfare
This is achieved by financial infrastructure, in which entities with funds allocate
those funds to those who have potentially more productive ways to invest those
funds

Constituents of Financial System

Financial Participants
Financial Markets

Financial Instruments
Financial Regulators

Financial Services

The financial system of an economy consists of four main components.

Structure of Financial System

Financial System

Financial
Market

Financial
Instruments

Financial
Participants

Financial
Regulator

Financial
Services

Structure of Financial System

Financial System
Financial
Market

Capital
Market

Financial
Instruments

Money
Market

Primary
Market

Secondary
Market

Debt
Market

Equity
Market

Financial
Participants

FX Market

Treasury
Bills

Financial
Regulator

Financial
Services

Derivatives
Market

Certificate of
Deposit

Call Money

Commercial
Papers

Financial Market
A market where financial instruments are traded in order
to raise capital.
Short
Term
Capital

Medium
Term
Capital
Long
Term
Capital

Few Facts

Financial market determines the growth of the economy by allowing

the transfer of money between savers and borrowers.

A Financial Market is a place where financial instruments are traded.

Financial Instruments would be stock, bond, insurance policy,

government securities and debentures.

A financial market facilitates transactions between buyers and sellers, as

well as between producers and consumers.

Functions of Financial Market

Financial markets provide the following three major economic
functions:
Price Discovery

It means that
transactions
between buyers
and sellers of
financial
instruments in a
financial market
determine the
price of the
traded asset.

Liquidity

It provides an
opportunity for
investors to sell a
financial
instrument, since
it is referred to as
a measure of the
ability to sell an
asset at its fair
market value at
any time.

Reduction of
transaction costs

It is performed
when financial
market
participants are
charged and/or
bear the costs of
trading a
financial
instrument.

Top Financial Centres as of 2013

New York
London
Hong Kong
Singapore
Zurich
Tokyo
Seoul
Boston
Beijing
Mumbai

Types of Financial Markets

Order Driven
Market

Quote Driven
Market

Capital
Market

Money
Market

Primary
Market

Secondary
Market

Order Driven Market

Buyers and sellers display the prices and quantities at which they
wish to buy or sell a particular security

Key feature is that the counterparties are unknown

The biggest advantage of an order driven market is transparency,

since the order book is displayed for investors who wish to access
this information.

Order Driven Market

An order driven market may not have the same degree of liquidity
as a quote driven market

Order execution is not guaranteed

E. g. National Stock Exchange (Ind)

Quote Driven Market

A market in which prices are determined from bid and ask quotations
provided by market makers, dealers or specialists
Also known as a price driven market in which market makers or dealers
quote the prices at which the public market participants are trading
Market makers provide a bid quote (to buy) and an ask quote (to sell)

Market makers or dealers earn profit from the spread between the two
quotes and the turnover of the shares
Here the counterparties are Known

Quote Driven Market

Once the player quotes the prices, it means that they will have to buy and/or
sell the underlyer

This is the opposite of a order driven market, where the orders are placed to
only Buy or only Sell the underlyer
Order Execution is guaranteed in a quote driven market because market
makers are required to meet the bid and ask prices they quote.

Hybrid Market
A unique type of market which combines the features of both quote
driven and order driven markets.
The market is predominantly a order driven market, but then takes
quotes from market makers/dealers incases of low liquidity
The NYSE and Nasdaq are both considered hybrid markets

Order and Quote Driven Market

Order
Driven Displays all of the bids
and asks.
Market

Focuses only on the bids and

asks of market makers and
other designated parties.

Orders of both buyers

and sellers are
displayed, detailing the
quantity & price at
which they are willing
to buy or sell a security.

You will not know the

quantity and amount others
are bidding for the
underlyer you want to trade

Price Transparency

No Price Transparency

No guarantee of order
execution

There is the guarantee of

order execution.

Counterparty is
Unknown

Counterparty is Known

Quote
Driven
Market

Capital Market

Capital Market

A Capital market is a market where instruments with long term securities

are traded
Maturities are usually more than a year

Companies, governments or public sector institutions can trade equities

or bonds
Vital to the functioning of the industry as the instruments help raise
capital

Importance of Capital Market

A market that works as a

conduit for demand and
supply of debt and
equity capital.

Channels the money

provided by savers and
depository institutions
(banks, credit unions,
insurance companies, etc.)
to borrowers and investees
through a variety of
financial instruments
(bonds, notes, shares)
termed as securities.

Structure of Capital Market

Primary market
Capital Market

IPO

Equity
Secondary
market
Debt

Money Market

Money Market

Money market is a market where instruments with short term securities

are traded
Maturities are usually upto a year

Highly liquid market

Main instruments include Treasury Bills, Certificates of Deposit,

Commercial Paper, Repo, Interbank Lending

Primary Market

Primary Market

The primary market is that part of the capital markets that deals with
the issuance of new securities.
Usually also referred to as the Initial Public Offering (IPO) market.

Companies, governments or public sector institutions can issue equities

or bonds through a new issue.
This is typically done through a syndicate of securities dealers.

One of the main functions in the issuance of new securities to investors

is called underwriting

Dealers earn a commission that is built into the price of the security
offering, though it can be found in the prospectus

Secondary Market

Secondary Market

Also known as Aftermarket, a secondary market is a financial

market where previously issued financial instruments are
brought and sold (traded).

The term "secondary market" is also used to refer to the market for any
used goods or assets, or an alternative use for an existing product or
asset where the customer base is the second market (for example, corn
has been traditionally used primarily for food production and feedstock,
but a "second" or "third" market has developed for use in ethanol
production).

Secondary Market

Exchanges such as the New York Stock Exchange, London Stock Exchange
and Nasdaq (National Association of Securities Dealers Automated
Quotations) provide a centralized, liquid secondary market for the
investors who own stocks that trade on those exchanges.
Most bonds and structured products are traded over the counter, or by
phoning the bond desk of ones broker-dealer.

How Financial System Work?

Indirect Finance
Financial
Intermediaries

Funds
Lender Savers
Households
Business
Governments
Foreigners

Funds

Funds
Funds

Financial
markets
Direct Finance

Funds

Borrowers Spenders
Households
Business firms
Governments
Foreigners

Functions of Financial System

Financial markets:
Facilitate the flow of funds in order to finance investments by
corporations, governments and individuals.
Play the role of intermediaries and thus determine the flow of funds.

Monitor and regulate the participants in the financial system.

Stock market
Firms

Banking sector

Bond market
Short term fixed securities market

Governments

Structure of Financial System

Financial System
Financial
Market

Stocks

Foreign
Exchange

Financial
Instruments

Bonds

Derivatives

Financial
Participants

Insurance &
Pension

Warrants

Financial
Regulator

Govt.
securities

Money Market
Instruments

Financial
Services

Debentures

Commodities

Structure of Financial System

Financial System
Financial
Market

Investment
Banks

Retail
Investors

Financial
Instruments

Retail/Corporate
Banks

Insurance
& Pension
Cos

Financial
Participants

Mutual/Hedge
Funds

Registrars

Financial
Regulator

Government

Clearing
Houses

Financial
Services

Stock
Exchanges

Brokers

Depository

Custodian

Structure of Financial System

Financial System
Financial
Market

Financial
Instruments

Financial
Participants

India

US

Banks:
Reserve Bank
of India

Banks:
Federal
Reserve

Banks: Bank
of England /
FCA

Markets:
Securities &
Exchange
Board of
India

Markets:
Securities
Exchange
Commission

Markets: FCA
/ Prudential
Regulatory
Authority

UK

Financial
Regulator

Hong Kong

Switzerland

Financial
Services

Singapore

Russia

Brazil

Australia

Find out the regulators for the above

countries

Structure of Financial System

Financial System
Financial
Market

Mergers &
Acquisition

Financial
Instruments

Research &
Advise

Asset
Management

Financial
Participants

Underwriting

Financial
Regulator

Sales &
Trading

Specialized
Financial Solutions

Financial
Services

Market
Making

Investment Bank

What is an Investment Bank?

A Global financial institution that assists corporations and

governments in raising capital by underwriting and acting as
the agent/underwriter in the issuance of securities.
It also assists companies involved in Mergers and Acquisitions.

In addition, they provide ancillary services such as research, market

making and the trading of derivatives, fixed income instruments,
foreign exchange, commodities and equity securities.
Find out the Top 10 Investment Banks

What is an Investment Bank?

It has departments such as:
Operations
Private Wealth Management
Legal & Compliance
Client Onboarding
Anti-Money Laundering
KYC
Risk Management
Audit

Role of an Investment Bank

CAPITAL
PROVIDERS

INVESTMENT BANKS
Seeking Returns

Money Managers
Hedge Funds
Pension Funds
Insurance Co.
Mutual Funds
High Net Worth Individuals

Provide Ideas on how/

when to use capital
Research

Understands clients needs

& builds relationships Sales
Executes transactions in
the marketplace based on
the clients investment
strategy --Trading
Returns

Role of an Investment Bank

CAPITAL
USERS

INVESTMENT BANKS
Seeking Capital

Corporations
Municipalities
Governments

Provide strategic advice on

how to optimise their business
and on raising capital - Advisory,
Equity / Debt Capital Market
Builds interest with capital
providers seeking to investEquity / Debt Capital Market,
Sales, Research

Capital

Executes the capital raising

process - Debt Origination,
Equity Origination, Sales,
Trading

Sell Side and Buy Side of IB

Sell Side (Need

Capital)

Sell side firms usually require capital

and hence sell their products and
services in order to gain capital.

Sell side is selling research, advice and

securities it created for the companies
and investors.

Whenever you see a report that

advises you to buy, sell, or hold the
stock, thats coming from the sell side
of the business. Investment banks falls
in the category of the sell side.

Buy Side (Have

Capital)

Buy side firms usually have money,

and hence are able to buy the
products and services.

Buy side consists of institutions such

as hedge funds, mutual funds, pension
funds, and insurance companies that
are buying large quantities of
securities for money management
purposes.
Their goal is to make investments that
align with investors expectations.

Interplay Between Sell and Buy Side

Sell Side
INVESTMENT BANKING
COMMERCIAL BANKING

Buy Side
ASSET MANAGEMENT
HEDGE FUNDS
MUTUAL FUNDS
PENSION FUNDS
INSURANCE COMPANIES
INSTITUTIONAL INVESTORS
RETAIL INVESTORS

Difference between IB & Commercial/Retail Bank

Investment Bank
Dont take deposits

Commercial / Retail Bank

Take deposits

Dont provide loans

Provide a lending service to their

customers

Provide a very bespoke service

Provide a very standardized

service

Have a few hundred core

customers or less

Dont provide transactional dayto-day services

May have millions of customers

Provide transactional day-to-day

services
Current / checking / savings
accounts
Credit and debit cards
Mortgages and personal loans
Insurance

Difference between IB & Commercial/Retail Bank

Investment Bank

Commercial / Retail Bank

Provide strategic advice to

companies, e.g. on their structure,
acquisitions, divestments and
capital markets products such as
debts and equity instruments

Dont provide strategic advice to

companies. A retail bank will
explain all the services available to
a company but its not usually
within their remit to provide
strategic advice on what the
company should do.

Difference between IB & Merchant Bank

Investment Banks
IPOs, Public and Private share
offering.
Helps large corporate,
governments etc to raise capital.

Provides expertise services in

terms of M & A.
Deals with complex financial
products like derivatives, etc.

Merchant Bank
Helps small enterprises who are
too small to raise capital using
large exchanges.
Helps small enterprises to raise
capital
Does not have the expertise to
provide the same.
Does not deal with complex
financial products.

Difference between Mutual Fund and Hedge Fund

Mutual Fund

Hedge Fund

Common Investors.

HNI Customers.

Single currency and multiple

products.

Multiple currency and multiple

product

Amount invested is lower.

Mutual funds are less risky.

Amount invested is higher.

Hedge Funds are more risky.

Commodity Market

Commodity Market
Commodity market refers to physical or virtual transactions of
buying and selling involving raw or primary commodities.
Commodities are split into two types: hard and soft commodities.

Hard commodities are typically natural resources that must be

mined or extracted (gold, rubber, oil, etc.), whereas soft
commodities are agricultural products or livestock (corn, wheat,
coffee, sugar, soybeans, pork, etc.)

A soft commodity generally refers to commodities harvested as

products like wheat coffee, cocoa, sugar, corn, wheat, soybean and
fruit traded in the commodity market.

Commodity Market
Hard commodities usually refer to commodities that are extracted
such as (gold, rubber, oil).

While commodities may be grouped for regulation purposes etc., in

large classes such as energy, agricultural including livestock,
precious metals, industrial metals, other commodity markets, these
are broken down into about a hundred primary commodities
(soybean oil, recycled steel).

Commodity Market
Investors access about 50 major commodity markets worldwide
uses growing numbers of exchanges with virtual transactions
increasingly replacing physical trades.

Derivatives trading employs various techniques to increase profit

and manage risk.

Derivatives in the commodity market are assets that are either

exchange-traded derivatives or over-the-counter (OTC) derivatives.

Commodity Market is governed by FMC (Forward Market

Commission).
The FMC allows for both Cash & Physical delivery

Thank You
For Your
Attention

&