financial markets. an overview

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FINANCIAL MARKETS FINANCIAL MARKETS An overview An overview

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Page 1: Financial markets. an overview

FINANCIAL MARKETS FINANCIAL MARKETS An overviewAn overview

Page 2: Financial markets. an overview

Financial MarketFinancial Market MARKET:

In economics, typically, the term market means the aggregate of possible buyers and sellers of a certain good or service and the transactions between them.

FINANCIAL MARKET:

A market for the exchange of capital and credit, including the money markets and the capital markets.

The term “financial market" is sometimes used for what are more strictly exchanges (organizations that facilitate the trade in financial securities, e.g., a stock exchange or foreign exchange). This may be in a physical location, like the KSE or virtually (electronically) , like AKD Securities.

Financial markets can be domestic like KSE or they can be international NASDAQ

Page 3: Financial markets. an overview

CAPITAL MARKETCAPITAL MARKET

The market for relatively long-term (greater than one year original maturity) financial instruments. OR

A capital market is a market for securities (debt or equity), where business enterprises (companies) and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets. The capital market includes the stock & bond market (debt).

MONEY MARKETMONEY MARKET

The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. It provides liquidity funding for the global financial system. T. Bills, Banker’s Acceptance etc

Financial Market, Contd:Financial Market, Contd:

Page 4: Financial markets. an overview

PRIMARY MARKET

The primary market is where securities are created.

It's a market in which firms sell new stocks and bonds to the public for the first time.

Primary market is synonym with an initial public offering (IPO). Simply IPO occurs when a private company sells stocks to the public for the first time.

OR

The primary market is that part of the capital markets that deals with the issuance of new securities.

Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue.

This is typically done through a syndicate of securities dealers.

The process of selling new issues to investors is called underwriting. In the case of a new stock issue, this sale is an initial public offering (IPO). Dealers earn a commission that is built into the price of the security offering. Primary markets creates long term instruments through which corporate entities borrow from capital market.

Primary Market VS Secondary MarketPrimary Market VS Secondary Market

Page 5: Financial markets. an overview

Features of primary markets are:

This is the market for new long term equity capital. The primary market is the market where the securities are sold for the first time. Therefore it is also called the new issue market (NIM).

In a primary issue, the securities are issued by the company directly to investors.

The company receives the money and issues new security certificates to the investors.

Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business.

The primary market performs the crucial function of facilitating capital formation in the economy.

Methods of issuing securities in the primary market are:

Initial public offering (IPO)

Rights issue (for existing companies);

Preferential issue.

Primary Market VS Secondary MarketPrimary Market VS Secondary Market

Page 6: Financial markets. an overview

Bond: A bond is like a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure

Underwriting: The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt).

Initial Public Offering (IPO). An initial public offering (IPO), referred to simply as an "offering" or "flotation", is when a company (issuer) issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately owned companies looking to become publicly traded. In an IPO the issuer obtains the assistance of an underwriting firm, which helps determine what type of security to issue (common or preferred), best offering price and time to bring it to market.

Right Issue. A rights issue is a way in which a company can sell new shares in order to raise capital. Shares are offered to existing shareholders in proportion to their current shareholding, respecting their pre-emption rights

Primary Market VS Secondary MarketPrimary Market VS Secondary Market

Page 7: Financial markets. an overview

Primary Market VS Secondary MarketPrimary Market VS Secondary MarketPre-emption Rights. Pre-emption rights are the rights of shareholders to be offered any new issue of shares before the shares are offered to non-shareholders.

Preferential issue. An issue of shares set aside for designated buyers, for example, the employees of the issuing company.

SECONDARY MARKET

A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The national exchanges - such as the New York Stock Exchange and KSE are secondary markets. OR

The secondary market, also called aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, and futures are bought and sold.

In the secondary market, securities are sold by and transferred from one investor or speculator to another. It is therefore important that the secondary market be highly liquid. To create this liquidity the investors and speculators to meet at a fixed place regularly; this is how stock exchanges originated.

As a general rule, the greater the number of investors that participate in a given marketplace, and the greater the centralization of that marketplace, the more liquid the market.

Page 8: Financial markets. an overview

Primary Market VS Secondary MarketPrimary Market VS Secondary Market• Futures: In finance, a futures contract is a standardized contract between two

parties to exchange a specified asset of standardized quantity and quality for a price agreed today (the futures price or the strike price) with delivery occurring at a during specified future date, the delivery date. It’s a derivative

• Derivative: A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in underlying assets like stocks, bonds, commodities, currencies, interest rates etc.

NASDAQ, is an American stock

exchange. "NASDAQ"

originally stands for "National

Association of Securities

Dealers Automated Quotations"

Page 9: Financial markets. an overview

Organized VS Over the Counter Market (OTC) Organized Market: A central physical location where exchange of securities

takes place under a set of rules and regulations. This type of market is also referred to as Auction Market. OR

An organized securities exchange is defined as "A securities marketplace where purchasers and sellers regularly gather to trade securities according to the formal rules adopted by the exchange.

Stock exchange is an organized market for buying and selling corporate and other securities. Here, securities are purchased and sold out as per certain well defined rules and regulations.

Page 10: Financial markets. an overview

Organized VS Over the Counter Market (OTC)OVER THE COUNTER MARKET (OTC): A security traded in some context other than on a formal exchange such as the NYSE, KSE, etc. phrase "over-the-counter" can be used to refer to stocks that trade via a dealer network as opposed to on a centralized exchange. It also refers to debt securities and other financial instruments such as derivatives, which are traded through a dealer network. In general, the reason for which a stock is traded over-the-counter is usually because the company is small, making it unable to meet exchange listing requirements or are offered by companies with bad credit records.Also known as "unlisted stock", these securities are traded by broker-dealers who negotiate directly with one another over computer networks and by phone.Although Nasdaq operates as a dealer network, Nasdaq stocks are generally not classified as OTC because the Nasdaq is considered a stock exchange.Instruments such as bonds do not trade on a formal exchange and are, therefore, also considered OTC securities.

Page 11: Financial markets. an overview

INVESTIMENT BANKING An investment bank is a financial institution that assists individuals,

corporations and governments in raising capital by underwriting and/or acting as the client's agent in the issuance of securities.

An investment bank may also assist companies involved in mergers and acquisitions, and provide additional services such as market making, trading of derivatives, fixed income instruments, foreign exchange, commodities, and equity securities. Or

A specific division of banking related to the creation of capital for other companies.

Investment banks underwrite new debt and equity securities for all types of corporations.

Investment banks also provide guidance to issuers regarding the issue and placement of stock.

They also help to facilitate mergers and acquisitions, reorganizations and broker trades for both institutions and private investors.

They can also trade securities for their own accounts.

Page 12: Financial markets. an overview

Investment BankInvestment BankFUNCTIONS OF INVESTMENT BANKING

•Investment banking helps public and private corporations in issuance of securities in the primary market. They also act as intermediaries in trading for clients.

•Investment banking provides financial advice to investors and helps them by assisting in purchasing and trading securities as well as managing financial assets

•Investment banking differs from commercial banking as investment banks don't accept deposits neither do they grant retail loans.

Page 13: Financial markets. an overview

Small firms which provide services of investment banking are called boutiques. They mainly specialize in bond trading, providing technical analysis or program trading as well as advising for mergers and acquisitions

Research is the division of investment banks which reviews companies and makes reports about their prospects, often with "buy" or "sell" ratings. Although the research division generates no revenue, its resources can be used to assist traders in trading, can be used by the sales force in suggesting ideas to the customers, and by the investment bankers for covering their clients.

In Pakistan

BMA Capital Management Ltd

JS Investment Bank Limited

Investment BankInvestment Bank

Page 14: Financial markets. an overview

Underwriting Operations: The firm that is selling new securities through the services of an investment banker can do so either on a NEGOTIATED BASIS or on a COMPETITIVE BIDDING BASISNegotiated Basis.

The firm identities a suitable investment banker. Both discuss the type of issue, the amount involved, the

characteristics of the issue, and the marketing effort required.

A negotiated agreement is reached that specifies the investment banker’s compensation.

Competitive Bidding Basis. The purpose of competitive bidding is to find a investment

bank with the lower cost of underwriting services.

Investment BankInvestment Bank

Page 15: Financial markets. an overview

After deciding the amount and the characteristics of the issue, the firm call for sealed bids on the issue.

Interested investment banks submit bids indicating the amount of net proceeds they will guarantee.

Selected bidder is committed to provide the firm with the guaranteed net proceeds

The difference between the actual selling price of the issue and the guaranteed proceeds to the firm constitute profits or losses to the underwriter.

Formations of Underwriting Syndicate: Temporary alliance of a number of investment bankers who jointly

underwrite the new issue

The purpose of syndicate is to increase the marketability of new issue and to distribute the risk on the large number of investment banks

At the time of agreement with issuing firm the original investment banker becomes the managing investment bank

Investment BankInvestment Bank

Page 16: Financial markets. an overview

SEC Registration Soon after agreement with issuing firm the, the firm files a

registration statement with the Securities and Exchange Commission of Country

Formation of Selling Groups The underwriting syndicate arranges with brokerage firms

and dealers to sell the new securities to be issued. The selling group members sell the securities directly to the

investors against commission Selling groups stays in operation for a specified time period,

after which it is dissolved Due Diligence Meeting.

At this stage the final selling price for the securities is determined based on prevailing capital market conditions

At the end of the meeting the prospectus is printed and the issue is released for sale to investors

Investment BankInvestment Bank

Page 17: Financial markets. an overview

Selling the new securities

Stabilizing the market Or Price Pegging

It reflects the efforts by the syndicate to try to maintain the price of The issue in the secondary markets below the issue price.

If secondary market prices are allowed to drop below the issue price, investors would not buy the issue from the selling groups.

On a rare occasions market condition have changed sufficiently during the offering period to require syndicate members to repurchase large amounts of the issue in secondary market.

Price Pegging on a large scale implies heavy losses for the underwriter.

At the Completion of Offering, market stabilization activities are ceased and syndicate and selling group are dissolved

Investment BankInvestment Bank

Page 18: Financial markets. an overview

Issuing firm

Investment Banker in syndicate

Investment Banker in syndicate

Managing Investment

Banker

Investors

Underwriting syndicate

Selling groups

The Investment Banking ProcessThe Investment Banking Process

Page 19: Financial markets. an overview

Definition

Organized and regulated financial market where securities (bonds, notes, shares) are bought and sold at prices governed by the forces of demand and supply.

A stock exchange is an entity that provides services for stock brokers and traders to trade stocks, bonds, and other securities.

Securities traded on a stock exchange include shares issued by companies, unit trusts, derivatives, pooled investment products and bonds

Unit Trust: A unit trust is a form of collective investment constituted under a trust deed to earn profit (NIT)

Pooled Investment: A pooled investment allows an individual to invest in a large portfolio of assets with many other investors. The risk is therefore reduced due to the wider spread of investments in the portfolio.

Stock ExchangeStock Exchange

Page 20: Financial markets. an overview

To be able to trade a security on a certain stock exchange, it must be listed there.

Usually, there is a central location at least for record keeping, but trade is increasingly less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of increased speed and reduced cost of transactions.

The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market.

Supply and demand in stock markets is driven by various factors that, as in all free markets, affect the price of stocks.

There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that derivatives and bonds are traded. Increasingly, stock exchanges are part of a global market for securities.

Stock ExchangeStock Exchange

Page 21: Financial markets. an overview

Stock ExchangeStock Exchange

A bond issued by the Dutch East India Company, dating from 7 November 1623, for the amount of 2,400 florins (The Italian florin was a coin struck from

1252 to 1533)

Page 22: Financial markets. an overview

Bull market

1 )A bullish market trend in the stock market often begins before the general economy shows clear signs of recovery. A bull market is associated with increasing investor confidence, and increased investing in anticipation of future price increases capital gains.

2) India's Bombay Stock Exchange Index, SENSEX, was in a bull market trend for almost five years from April 2006 to January 2008 as it increased from 2,900 points to 21,000 points.

Stock Exchange – Stock Exchange – Market TrendsMarket Trends

Page 23: Financial markets. an overview

Bear Market

A bear market is a general decline in the stock market over a period of time.

A bear market is a downward primary market trend. It is accompanied by widespread investor fear and pessimism. Investors anticipate further losses and are motivated to sell.

The most famous bear market in history followed the Wall Street Crash of 1929 and erased 89% (from 386 to 40) of market capitalization by July 1932, marking the start of the Great Depression.

Stock Exchange – Stock Exchange – Market TrendsMarket Trends

Page 24: Financial markets. an overview

To provide liquidity to the investors. (Sale the Security when U want)

To guarantee the legal and economic security of the agreed contracts. (Financial nature)

To provide official information about the quantities that are negotiated and of the quoted prices.

To fix the prices of the securities according to the fundamental law of the offer and the demand

FUNCTIONS IN FAVOR OF INVESTOR

It permits him the access to the profitable activities of the big companies.

It offers liquidity to the security investments, through a place in which to sell or buy securities.

Stock Exchange - Stock Exchange - FunctionsFunctions

Page 25: Financial markets. an overview

It permits for the investor to have a political power (voting right) in the companies in which he invests its savings

It offers the possibility of diversifying investors portfolio by enlarging the field of strategy of investments

FUNCTIONS IN FAVOR OF COMPANIES

It supplies them with the obtaining of long-term funds that permits the company to make profitable activities or to do determine projects that otherwise wouldn’t be possible to develop for lack of financing. Also, this funding signifies a less cost than if obtained at other channels.

The securities quoted at the stock exchange market usually have more fiscal purpose advantages for the companies.

It offers to the company’s free publicity, which in other way would suppose considerable expenses.

Stock Exchange - Stock Exchange - FunctionsFunctions

Page 26: Financial markets. an overview

Stock exchanges have multiple roles in the economy. This may include the following

Raising Capital for businesses

The Stock Exchange provide companies with the facility to raise capital for expansion through selling shares to the investing public

Mobilizing savings for investment

When people draw their savings and invest in shares, it leads to a more rational allocation of resources to promote business activity with benefits for several economic sectors such as agriculture, commerce and industry, resulting in stronger economic growth and higher productivity levels of firms.

Stock Exchange - Stock Exchange - ROLEROLE

Page 27: Financial markets. an overview

Facilitating company growth

Companies view acquisitions as an opportunity to expand product lines, increase distribution channels, increase its market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock market is one of the simplest and most common ways for a company to grow by acquisition.

Profit sharing

Both casual and professional stock investors, through dividends and stock price increases that may result in capital gains, will share in the wealth of profitable businesses.

Creating investment opportunities for small investors

Investing in shares is open to both the large and small stock investors because a person buys the number of shares they can afford. It provides the opportunity for small investors to own shares of the same companies as large investors.

Stock Exchange - Stock Exchange - ROLEROLE

Page 28: Financial markets. an overview

Government capital-raising for development projects

Governments at various levels may decide to borrow money in order to finance infrastructure projects by selling securities like bonds. These bonds can be raised through the Stock Exchange whereby members of the public buy them, thus loaning money to the government.

Barometer of the economy

At the stock exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability and growth. An economic crisis could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indexes can be an indicator of the general trend in the economy.

Stock Exchange - Stock Exchange - ROLEROLE

Page 29: Financial markets. an overview

The operators who buy and sell securities on stock exchange are :

Brokers:

A broker is a member of the stock exchange.

He buys and sells the securities on the behalf of the outsiders who are not the members.

He charges brokerage for his services.

He does not specialize in any particular security.

He buys sells all types of securities according to the orders placed by his clients. 

Jobbers:  

The jobber is a member of stock exchange but he buys and sells securities on his own behalf.

Main Player/Operators of S.EMain Player/Operators of S.E

Page 30: Financial markets. an overview

He is a dealer in securities and usually specializes in one type of security.

His income comes from the profit or price difference in the purchase and sale of securities.

A jobber normally deals for himself but he is not prohibited from buying and selling securities on the behalf of others. 

Bulls: 

A bull is a speculator who expects a rise in prices.

Therefore, he buys securities with a view to sell them in future at a higher price thereby make profit.

When the conditions in the stock exchange are dominated by bulls, it is called a “bullish market”.

When the prices fall and bulls have to sell at loss, it is called “bull liquidation”. 

Main Player/Operators of S.EMain Player/Operators of S.E

Page 31: Financial markets. an overview

Bears:

A bear is a speculator expects fall in prices.

Therefore, he sells securities for future delivery. He sells securities, which he does not possess.

He sells with the hope to buy the securities at lower price before the date of delivery.

The efforts of bears to bring down the prices artificially are known as “bear raids”.

When bears dominate the market, it is called a “bearish market”.

When prices are rise and bears have to make purchases to meet their commitments, it is called “bear covering”.

Main Player/Operators of S.EMain Player/Operators of S.E

Page 32: Financial markets. an overview

First Method

The buying and selling of stocks at the exchange is done on an area which is called the floor.

All over the floor are positions which are called posts.

Each post has the names of the stocks traded at that specific post.

If a broker wants to buy shares of a specific company they will go to the section of the post that has that stock.

If the broker sees at the price of the stock is not quite what the broker is authorized to pay, a professional called the specialist may receive an order.

The specialist will often act as a middle man between the seller and buyer.

How Does a Stock Exchange work?How Does a Stock Exchange work?

Page 33: Financial markets. an overview

The specialist enters the information from the broker into a book.

If the stock reaches the required price, the specialist will sell or buy the stock according to the orders given to them by the broker.

The transaction is then reported to the investor.

Second Method

If a broker approaches a post and sees that the price of the stock is what they are authorized to pay, the broker can complete the transaction themselves.

As soon as a transaction occurs, the broker makes a memorandum (note) and reports it to the brokerage office by telephone instantly.

How Does a Stock Exchange work?How Does a Stock Exchange work?

Page 34: Financial markets. an overview

At the post, an exchange employee writes down on a special card the details of the transaction including the stock symbol, the number of shares, and the price of the stocks.

The employee then puts the card into an optical reader.

The reader puts this information into a computer and transmits the information of the buy or sell of the stock to the market.

This means that information about the transaction is added to the stock market and the transaction is counted on the many stock market tickers and information display devices that investors rely on all over the world.

Today, markets are instantly linked by the Internet, allowing for faster exchange.

How Does a Stock Exchange work?How Does a Stock Exchange work?

Page 35: Financial markets. an overview

How Does a Stock Exchange work?How Does a Stock Exchange work?

Investors on the trading floor of the London Stock Exchange

Investors on the trading floor of the Karachi Stock Exchange

Page 36: Financial markets. an overview

Ownership of Stock Exchange Stock exchanges originated as mutual organizations,

owned by its member stock brokers.

There has been a recent trend for stock exchanges to demutualize, where the mutual organization becomes a corporation, with shares that are listed on a stock exchange.

Examples are

Australian Securities Exchange (1998),

Euro next (merged with New York Stock Exchange),

NASDAQ (2002),

the New York Stock Exchange (2005),