FINANCIAL MARKETS

FINANCIAL MARKET

A market where financial assets are exchanged Financial Assets are created and traded in financial markets Financial assets are intangible

Represent a claim to future cash flow The entity that has agreed to make future cash payment The holder of a financial asset

Issuer

Investor

Funds Deposits/Shares

Financial Institutions
Commercial Banks
Insurance Companies Mutual Funds Provident Funds

Funds Loans agreement

Non Banking Financial Companies

Suppliers of Funds
Individuals Businesses Governments

Funds

Demanders of Funds

Private Placement

Individuals Securities Businesses Governments

Financial Markets
Funds Securities

Money Market/ Capital Markets

Funds Securities

ROLE OF FINANCIAL INSTITUTIONS

Maturity Intermediation

Investors/lender are willing to invest/lend for short term Issuers/borrowers want funds for long term FI are able to offer more choices to both Allow small investors to overcome constraints imposed to buying assets imposed by large minimum denomination size Transforming more risky asset into less risky asset through diversification Information processing and contracting cost
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Denomination Intermediation

Diversification

Reduced Cost

TYPES OF FINANCIAL MARKETS

By Nature of Claim
Debt

Market Equity Market

By Maturity of Claim
Capital

Market Money Market

By Seasoning of Claim
Primary

Market Secondary Market

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TYPES OF FINANCIAL MARKETS

By Time of Delivery
Cash

or Spot Market Forward Market

By Organizational Structure
Over-the-Counter

Market

Stock

Exchange

BY NATURE OF CLAIM

Debt Market
Deals

in fixed income securities issued by corporate and government May be short term or long term Represent borrowings of the Issuer

Equity Market
Deals

in shares issued by corporate entities Shares are perpetual in nature Ownership Securities
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BY MATURITY OF CLAIM

Money Markets

Markets that trade debt securities with maturities of one year or less
Treasury

Bills Negotiable Certificates of Deposits Commercial Papers

Capital Markets

Markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year
Government

Securities (Debt) Corporate Securities (Debt and Equity)

BY SEASONING OF CLAIM

Primary Markets

Markets in which users of funds (e.g. corporations, governments) raise funds by issuing financial instruments (e.g. stocks and bonds) Markets where previously issued financial instruments are traded among investors (e.g. NYSE, NASDAQ, BSE, NSE)

Secondary Markets

BY SEASONING OF CLAIM

In Primary market the issuer of the financial claim receives the funds while in secondary market the seller of the claim receives the funds Secondary Markets provide liquidity
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BY TIME OF DELIVERY

Cash Market or Spot Market

Financial

Assets are traded for immediate settlement Assets are traded for settlement in

Forward Markets
Financial

future As the financial asset derives its value from an underlying asset, also called derivative market

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BY ORGANIZATIONAL STRUCTURE

Over-The-Counter (OTC Market)

Market

based on tailor made products designed specifically to meet individual needs where trading of standardized, homogenous financial claims takes place
Screen

Exchange
Market

Based Trading Floor Based Trading

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TRADING PLATFORMS

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FOREIGN EXCHANGE MARKETS

FX markets deal in trading one currency for another (e.g. dollar for yen) The spot FX transaction involves the immediate exchange of currencies at the current exchange rate The forward FX transaction involves the exchange of currencies at a specified date in the future and at a specified exchange rate
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INSTRUMENTS

Equity Shares

Common Stock or Ordinary Shares Ownership Securities Voting Rights No fixed rate of dividend Perpetual Last preference in repayment of capital in case of liquidation

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DEPOSITARY RECEIPTS

Negotiable certificate issued by a depositary bank DR represent the beneficial interest in shares issued by a company Shares are deposited with a local custodian appointed by the depositary
Overseas
Issues DR in foreign currency

Local
Issues shares in local currency

Investors

Depositary

Local Custodian

Issuer

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DEPOSITARY RECEIPTS
Each DR represents beneficial interest in a predetermined number of underlying shares The issuer transacts with one entity Depositary

Global

Depositary Receipt (GDR)

listing on non-US exchanges e.g. London

Formal

American
Issued

Depositary Receipt (ADR)

by a US Depositary in US

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MONEY MARKET INSTRUMENTS

Issuance and trading of short-term debt obligations of large corporations, Financial Institutions and government Short duration (< 1 yr) Only High-Quality Entities Transaction size is large Investors include corporations and Financial Institutions with idle cash and a short-term investment horizon

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TREASURY BILLS

Short-term obligations issued by the government In India, the RBI acts as an issuer 91 days, 182 days and 364 days Credit Risk Free as guaranteed by the government Highly liquid instruments Discount security issued at a discount to the face value, redeemed at par 19

COMMERCIAL PAPERS
Short-term unsecured promissory notes issued by a company to raise short-term cash Issued by financially sound companies with good credit rating Discount security issued at a discount to the face value, redeemed at par Maturity less than 1 year Weak secondary market; Most Commercial Papers are held to maturity

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CERTIFICATE OF DEPOSITS
Issued

by a deposit accepting institution

(Bank)

Negotiable with specific interest rate/maturity

security issued at a discount to the face value, redeemed at par Maturity : 14 days to < 1 year Large denomination CDs Institutions
Discount

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INTER-BANK MARKET (CALL MARKET)

Market where banks and financial institutions can lend and borrow money Short term market

Overnight

to 14 days

To overcome short term liquidity mismatches

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REPURCHASE AGREEMENTS (REPO)

Sale of a security with a commitment by the seller to repurchase the security at a specified price at a future date Often used by the Central Bank to suck or infuse liquidity in the market (Open Market Operations) Equivalent to a collateralized loan with the security as a collateral The lender earns interest at the `repo rate. Most repos are for less than three months Reverse repurchase agreement Involves the purchase of securities between parties with the promise to sell them back at a given date in the future

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BOND MARKETS
A bond is a promise to make periodic coupon payments and to repay principal at maturity Carry original maturities greater than one year so bonds are instruments of the capital markets Issuers are corporations and government units

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GOVERNMENT SECURITIES
Issued by government Serve as benchmark for the cost of funds for corporations and other borrowers Also called gilt-edged as they are credit risk free Issued with a face value with a given coupon rate Repayment of principle is guaranteed by the government

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CORPORATE BONDS
Issued by corporate borrowers Maturity greater than one year

10 years Medium Term More than 10 years Long Term

Upto

Often secured by a specific pledge against company assets

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CREDIT RATING

Credit Rating by independent credit rating agencies like CRISIL/ ICRA/ CARE Comment upon ability to pay interest and repayment of principle Credit rating is issue specific Higher the rating, lower the rate of interest on borrowings
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RATING SYMBOLS
AAA Highest Safety AA High safety A Adequate Safety BBB Moderate Safety BB Inadequate Safety B - High Risk C - Substantial Risk D - Default

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TYPES OF BONDS

Convertible Bonds
Grants

the bondholder and/or the issuer the right to convert the bond into a predetermined number of ordinary shares
Non

Convertible Partially Convertible Fully Convertible

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BONDS WITH WARRANTS

The warrant grants the holder the right to purchase a specified amount of a security (generally ordinary shares) at a predetermined price Warrants can be detached and traded separately

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CALLABLE/ PUTABLE BONDS

Call provision
Gives

the issuer an option to buy back a part or all prior to maturity Generally at a premium

Put provision
Grants

the bondholder a right to sell the bonds back to the issuer on designated dates at the predetermined price

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FLOATING RATE BONDS

Coupon rate is reset periodically in line with some predetermined benchmark

Benchmark

Spread
Adjustment

Interval

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JUNK BONDS
High yield bond issued by a corporation with a low credit rating (below BB) Trade-off between risk and return

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ZERO-COUPON BOND/ DEEP DISCOUNT BOND

No coupon rate of interest Issued at a discount to the face value Redeemable at Par Interest is built-in the difference between issue price and redemption price

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FOREIGN BOND

Bond issued in the domestic currency of the country by a foreign entity

Bond Issue of a dollar bond by a British Company in US Samurai Bonds for Yen - Issue of a Yen bond by a non-Japanese company in Tokyo Bulldogs for Sterling - A sterling denominated bond that is issued in London by a company that is not British
Yankee
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EURO-BONDS

Euro-Bonds Bonds issued by an issuer government or company in a currency different from country where the bond is issued A dollar bond sold in London Dollar Eurobond A sterling bond issued in Germany Sterling Eurobond Majority of the issues for under 10 years maturity (Medium Term Bonds)
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MARKETS ARE FUN

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MARKETS ARE FUN

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THANK YOU

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