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Copyright Tarheel Consultancy Services

2

Part-01Financial Systems

Institutions, Instruments & Markets

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Role of an Economic System

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Role of an Economic System (Cont)

Efficient and free flow of funds betweeneconomic units is critical

The larger the flow and more efficient theallocation

Greater the likelihood of accommodating everyonespreferences

ConsequenceGreater the output of the economy as a whole

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Economic Decisions

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Economic Decisions (Cont)

Production of

Goods and

ServicesDistribution of the output

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Economic Decisions (Cont)

What is a successful economy?

One that maximizes wealth creation

One that makes and implements soundeconomic decisions

From what standpoints?

Production and

Distribution

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Why the focus on efficiency?

Unlimited wants

Limited and scarce resources

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What does efficiency require?

INFORMATION

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What kind of economic information?

What do people need

How best can goods and services be producedHow best can the resultant output be distributed

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Types of Economic Systems

COMMAND Economies

FREE MARKET Economies

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Command Economies (Cont)

All decisions are taken by

A CENTRAL PLANNING AUTHORITY

Role of the plannerEstimate the resource requirements of

economic agents

Rank them in order of priority

Allocate resources in descending order of need

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Why failure?

Infeasible to process the required quantum ofinformation

Poor quality of information

Central planner was supposed to be a

`BRIHASPATI

Blatant political interference

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Market Economies

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Market Economies (Cont)

Make the most profitable use of resources

Profit is determined by

Prices of inputs COSTS

Prices of outputs REVENUES

Optimal decision is the one that

MAXIMIZES PROFITS

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How is informational accuracy of thepricing mechanism ensured?

By markets that facilitate trade

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If price is low

Demand > Supply

Price will be bid up till equilibrium is reached

If price is too high

Supply > Demand

Prices will decline till equilibrium is restored

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Barter

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Barter (Cont)

In a world without markets our time and

energy would be spent in seeking

Those who have the goods/services that we

want

Those who are willing to exchange them for

what we have to offer

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Barter (Cont)

Barter transaction

Prior to the advent of money, barter was the only

means of trade.

Historically, the development of a unit of currency has

gone hand in hand with the evolution of markets.

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Barter (Cont)

Barter, orCountertrade when

The buyer is unable to pay the seller in hard or freely

convertible currency.

freely convertible currency : easily accepted as

value in other countries

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Example of Barter

AT&T

Telecom company

USA

seller

Sevtelecom

Telecom company

Russia

buyer

Telecom switches

Currency

& Apatite

Helm AG

Trading Firm

Germany

Buyer & Seller

Apatite

Currency

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Money

&Markets

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Prior toadvent ofMONEY

Consume all thegoods you have

Exchange your

goods for othergoods and thenconsume them

Could notput away goods

for later use

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With theadvent ofMONEY

Everything could be

denominated inunits of

the currency

The currency servedas the medium

of exchange

Money gave you

the freedomto

SAVE

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Money and Prices

Advantage of money

Reduces the number of prices required

Consider a 10 good barter economyWe would need 45 prices

However if we had a unit of currency

We would require only 10 prices

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Goods

FinancialAssets

PhysicalAssets

Services

MARKETS

Markets

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Economic Unitstransacting in

financial markets

Government Sector Business Sector Household Sector

Categories of Economic Units

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Government Sector

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Government Sector (Cont)

Central/Federal government

State governments

Local governments a.k.a Municipalities

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Business Sector

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Business Sector (Cont)

Sole proprietorships

Partnerships

Private Limited CompaniesPublic Limited Companies

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Household Sector

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Income and Expenditure

Income = Expenditure

Balanced Budget Units (BBU)Income > Expenditure

Surplus Budget Units (SBU)

Income < Expenditure

Deficit Budget Units (DBU)

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Function of a Financial System

SBU DBU

funds

e.g.

householdsector

e.g.

government

businessentities

nation as a

whole

claim

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Economys Relationship with ROW

Record of transactions between a countryand the Rest of the World (ROW)

Is known as the Balance of Payments (BOP)

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Balance of Payments

Is a record of a countrys trade in

Goods

Services

Financial Assets

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Balance of Payments (Cont)

BOP is divided into three major categoriesof accounts

The Current Account

The Capital Account

The Reserve Account

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The Current Account

Is a record of Imports and Exports of goods andservices

The Capital Account

Is a record of transactions that lead to changesin

Foreign assets and Foreign liabilities

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The Reserve AccountAlso deals with financial assets and liabilities

But deals only with reserve assets

What are reserve assets?Those used to settle deficits and surpluses on account

of current and capital accounts taken together

Assets acceptable as a means of payment in

international transactionsAssets held and exchanged by monetary authorities

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The BOP must always balance

A current account deficit must be matched by

A capital account surplus (increase in foreign

liabilities)Or by a depletion of reserves

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Important sub classifications of BOP

Balance of Trade

Current Account Balance

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IMPORTS EXPORTS

BALANCE OF TRADE

IMPORTS> EXPORTS= Trade Deficit

(Net borrower from abroad)

IMPORTS< EXPORTS= Trade Surplus

(Net lender and invest abroad)

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Current Account Balance

Balance of Trade pertains to merchandiseimports and exports

The current account balance is the sumtotal of

Exports of goods, services and income

Imports of goods, services and income

Net unilateral transfers

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Financial Assets

What is an asset

a claim against the income or wealth of

a business

a household

Or a government agency

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Financial Assets (Cont)

Manifestation of assets

Certificates

Receipts

Computer record files

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Financial Claims

SBU DBUfunds

claim

debt instrument

equity shares

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Why de we require financial assets?

Properties of Financial Assets

Serve as a store of value Promise future returns They are fungible

Properties of Financial Assets

Serve as a store of value Promise future returns They are fungible

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Liability

SBU DBUfunds

claim

LIABILITYASSET

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Asset Classes

Money

Equity shares

Debt securities

Preferred shares

Foreign exchange

Derivatives

Mortgages and mortgage-backedsecurities

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Money

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Money (Cont)

Money is very much a financial asset

It is not just notes and coins

One of the largest components of money

The checking account balances held by depositorswith commercial banks

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Money (Cont)

New Avataars ofmoneyCredit cards

Debit cardsSmart cards

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Money (Cont)

Functions of money

Unit of account

Every good or service can be denominated in terms

of it

Medium of Exchange

It is the only financial asset that is always acceptableas mode of payment

Store of valueIt is a reserve of future purchasing power

It is liquid

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Liquidity

What is a liquid asset?

Can be quickly converted to cash with little orno loss of value

Why is liquidity important?

Enables transactions at prices that are close tothe fair value of the asset

Otherwise buyers would have to offers a largepremium

Sellers would have to offer a large discount

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Liquidity (Cont)

In a liquid market plenty of buyers andsellers will be available

Such markets are said to have Depth

Attributes of liquid assets

Price stability

Ready marketability

Reversibility

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Liquidity (Cont)

There is a cost to liquidity

The more liquid the asset the lower is the rateof interest

Interest foregone is lost for ever

Money is the most perishable of assets

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Illustration of Perishability

Assume we have 100MM dollars in cash

If the rate of interest is 3.6% per annum

Income foregone in a week is:

100,000,000x0.036x7/360 = $70,000

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Equity

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Equity Claims

SBU DBU

funds

Ownership orequityshares

Claim on profits

Assetsremaining afterdebtors havebeen paid

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Dividends

The rate of dividends is not fixed

It is not contractually guaranteed

Dividends can fluctuate from year to year

A company is under no obligation to declaredividends

Good companies try to keep dividends atsteady levels

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Retained earnings

A firm will not pay out its entire profits for theyear as dividends

A fraction will be reinvested in the company

If a firm is forced to declare bankruptcy, then theshareholders are entitled to the residual value ifany of the businessAfter the claims of the other creditors are fully settled.

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Equity (Cont)

Equity shares never mature - they have noexpiry date.Because when a firm is created, it comes into existence

with the assumption that it will last forever.

No one starts a company with the expectation that hewill wind it up after a few years.

Shareholders are given voting rights.They can vote on various issues at the Annual General

Meetings of companies, including the election of theboard of directors.

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Equity (Cont)

Not all shares carry voting rights, however.

There are non-voting shares.

These shareholders are not entitled to vote

This category is created to restrict corporatecontrol to only certain groups of shareholders.

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Equity (Cont)

Shareholders have Limited Liability

Unlike a sole proprietorship

Or a partnership

What does this mean?

Creditors cannot make financial demands onthe shareholders

The maximum loss for a shareholder is limitedto his investment

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Debt

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Debt Claims

SBU DBU

funds

debt instrumentorIOU

Pay interestat periodicintervals

Repayprincipal at

maturity

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Long termdebt

instruments

Short term

debtinstruments

Types ofdebtinstruments

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Long term debt securities

Have a time to maturity of one year or more

Issued by the government or by corporations

Bond DebentureFirms also issue debtsecurities for which specificassets are designated as

collateral.

In the U.S a debenture is abond for which no assets ofthe firm have been specified

as collateral.Secured debt Unsecured debt

Note:In India the termsbondsand debenturesare used interchangeably and thuscould refer to securedas wellas unsecured debt

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T-bonds

T-notes

T-bills

long term

10 30 years

medium term

1 10 years

short term

13, 26, 52 weeks

time to maturity

time to maturity

time to maturity

Debt notes issued by the U.S. Dept ofTreasury

Note:Terminologyoften differsacrosscountries.e.g.T-notes in Australia,correspond to T-bills in the U.S

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Debt (Cont)

Interest payments on debt securities are

contractually guaranteed.

Not a function of the profits made by a firm

A firm is obligated to pay interest on its outstanding

debt of whether or not it has made profits

Interest payments have to be made before anypayments can be made to equity shareholders

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Debt (Cont)

In the event of bankruptcy, the claims of the

bondholders have to be settled first

If a company defaults on a scheduled interest

payment, or principal repayment, the bond holders

can stake a claim on its assets.

After liquidating the assets the claims of the

bondholders will be settled.

Only if something were to remain will the equity

shareholders be entitled to stake a claim.

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Negotiable vs. Non-negotiable

Negotiable

debt instruments

Non - Negotiable

debt instruments

Can be freely traded Cannot be traded

Can be endorsed by oneparty to another

Cannot be transferred

e.g.

Treasury Bond

e.g.

bank loans

bank time deposits

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Leverage

What is leverage?

Ability to magnify returns on investment byusing borrowed money to partly fund the

acquisition of the assetLeverage is a double-edged sword

Positive returns get magnified

So do negative returns

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Leverage (Cont)

Take two companies A and BA has a paid up capital of Rs 100,000 with no debt

B has a paid up capital of Rs 50,000 with a debt of

50,000 carrying an annual interest of 10%.We will take two cases

The first where the companies make an operating profitof Rs 25,000

And the second where they make an operating loss ofRs 25,000.

To keep matters simple assume no taxes.

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Leverage (Cont)

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Leverage (Cont)

Company A is unlevered whereascompany B is levered.

Leverage is obviously a double edgedsword.

In a booming market, a 25% return getsmagnified to 40%

But in a falling market a -25% return getstranslated to a loss of -60%.

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Balance Sheet

Assets Liabilities

CLAIMS

or

DEBT or borrowed capital

orEQUITY or owners capital

FUNDS

Total Assets = Total Liabilities

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Preferred shares

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Promise a fixed rate of

return

If firm is unable to pay as promised

then shareholders cannot seek legalrecourse

In the event of liquidation,preferred shareholdersget priority over equity

shareholders

Dividends on preferred shares canbe paid only after a company hasmade interest payments on its

outstanding debtuntil and unless their overduedividends are paid the firm usuallycannot pay dividends to equityholders

Debt EquityPreferred

shares

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Pre-Tax versus Post-Tax Payments

Equity and preferred dividends are paid out of

post-tax profits

Interest paid by the company on debt can bededucted from the profits while computing its tax

liability

This reduces the tax burden for the firm or in other

words gives it a tax shield

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Example of a Tax Shield

Consider two companies

Pre-tax profit $100,000

Company A 0 interest liability

Company B $20,000 interest expense

Tax rate 30%

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Example (Cont)

Company A Company B

PBIT 100,000 100,000

Interest 0 20,000

PBT 100,000 80,000

Tax @ 30% 30,000 24,000

PAT 70,000 56,000

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Example (Cont)

Impact of the interest expenditure on company B

= Reduction of profits by $14,000

Effective interest paid = $14,000 (not $20,000)Effective interest = 14000 = 20000(1-.3) = I(1-T)

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Derivatives

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Derivatives

These are essentially

contracts which are

based on, or the

demand for which is

derivedfrom, the

demand for an

underlying asset.

Stocks

Foreigncurrency

Stockmarketindices

Physical

assets

Bonds

Derivativecontracts

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Classes ofderivativesecurities

Forwardcontracts

Futurescontracts

Optionscontracts Swaps

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PRESENT FUTURE

deliveryofasset

pricefixed atoutset prespecified timeperiod

Forward Contracts

No moneychanges

hands

Goods aredelivered

and moneyis paid

Agreements for the future delivery of an asset atthe end of a pre-specified time period, based ona price that is fixed at the outset

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PRESENT FUTURE

After 90days

deliveryofasset

pricefixed atoutset prespecified timeperiod

Example

Mitoken agrees to buy100,000 USD from ICICIBank 90 days hence atINR 40.50 per USD. Nomoney/assets change

hands

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Example (Cont)

The contract is negotiated individually between Mitoken and ICICI

Such contracts are called OTC (Over-the-Counter) or customized

contracts

No money changes hand at the outset

The actual transaction will take place only after 90 days

But the terms are set at the start

Both the parties have an obligation to perform

ICICI Bank is obligated to deliver the dollars after 90 days

Mitoken is obligated to accept the dollars and pay the equivalent in INR

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Futures Contracts

They are similar to forward contracts in the

sense that they too are agreements for the

future delivery of an asset at terms decided upon

in advance.But forward contracts are customized or Over-The-

Counter Contracts (OTC) which are negotiated

individually between the buyer and the seller

Futures contracts are traded on organized exchangeslike stocks and bonds

These exchanges are called futures exchanges

Options

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OptionsContracts

CallOption

PutOption

Gives the buyer the right

To buyan underlyingasset

On or before a prespecified date

At a pre specified price

Gives the buyer the right

To sellan underlyingasset

On or before a prespecified date

At a pre specified price

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Forward/Futurescontract

Options

Futures/forward contractsimpose an obligation to buy

the underlying asset, on thebuyer of the contract

Call options give the holderthe right to buy the

underlying asset

Obligation has to be fulfilled Rights need be exercisedonly if such action isbeneficial

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Call option Put option

If the holder of a call optiondecides to exercise his rightto buy, the seller of theoption has an obligation to

deliver the underlying asset

If a put holder were toexercise his right, the sellerof the put has an obligationto buy the asset

Buyers of both call and put options have to pay a price toacquire the option from the sellers. This is called theOption price or Premium

If the right is subsequently exercised, the call/put holder willpay/receive a price per unit of the underlying asset. This iscalled the Strike orExercise Price

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Example of a Call Option

Kevin has bought a call option from Kathy

Gives him the right to buy 100 shares of IBM at

$75 per share after 3 months Kathy will not give this right for free

Assume that Kevin pays $6.50 per share or $650 in all

to acquire this right

This amount has to be paid at the outset and is called

the Option Price or Premium.

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Example of a Call Option (Cont)

Assume that the price of IBM after 3 months is $ 80Kevin will most certainly exercise his option and ask Kathy to

deliver the shares

This price of $ 80 per share is called the Strike Price or

Exercise PriceKathy cannot refuse since she has an obligation to perform

What if the share price after 3 months were to be $ 70

Kevin will forget the option and buy the share in the

market at $ 70 each

He is in a position to do so since an option is a right and not

an obligation

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In summary

Instrument Nature ofBuyersCommitment

Nature ofSellersCommitment

Forward/futures

contract

Obligation to acquire

the underlying asset

Obligation to sell the

underlying asset

Call Options Right to acquire theunderlying asset

Contingent obligationto deliver theunderlying asset

Put Options Right to sell theunderlying asset

Contingent obligationto take delivery of theunderlying asset.

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Swaps

These are contractual arrangements between

two parties to exchange specified cash flows at

pre-specified points in time

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Swaps

Interestrate

swaps

Currencyswaps

Notionalprincipal

Principaldenominated in

two differentcurrencies

I t t R t S

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Interest Rate Swaps

A principal amount called the Notional Principalwill be specified in such cases.

The principal amount never changes hands andconsequently the name Notional Principal.

Each party will calculate interest on this notionalamount based on a pre-decided method.For instance one party may be obliged to pay interest at a

fixed rate of 10%

The other may be required to pay at the going interest rateon T-Bonds + a spread

I t t R t S

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Interest Rate Swaps

Both the cash flows will be denominated in thesame currency

Hence they can be netted and one party will pay

the difference to the other This is an example of a fixed-rate-variable-rate

swap

In practice one can also have a variable-rate-

variable-rate swap.

Di ti R t ti

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Diagrammatic Representation

Borrower

Bank A

Fixedrate

Bank B

PayFixed

ReceiveT-bond Rate

C C S

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Cross Currency Swaps

In this case the principal is denominated in twodifferent currencies.

Consequently it is exchanged both at inception and atthe end of the contract.

One party will pay a fixed/variable rate in onecurrency while the other will pay a fixed/variablerate in the other

C t

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Cont

At the end the principal amounts will beswapped back

Since two different currencies are involved, we

can have:Fixed rate Variable rate swaps

Variable rate Variable rate swaps

Fixed rate Fixed rate swaps

F i E h

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Foreign Exchange

FOREX markets are used to buy and sell currencies

A currency is a financial commodity

Each currency will have a price in terms of anothercurrency

The price of one countrys currency in terms of that of

another is known as the exchange rate

Currencies are traded amongst a network of buyers

and sellers linked by phone/fax.

FOREX (C t )

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FOREX (Cont)

Traders do not come face to face on an organized

exchange.

Major participants are commercial banks and multinational

corporations (MNCs).

Physical currency is rarely exchanged.

Most transfers are done electronically from one bank account

to another.

M t

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Mortgagor Mortgagee

Periodicpayments

Can takeover

property

borrower lender

A mortgage is a loan backed by real estate as

collateral

Mortgage

Mortgage (Cont )

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Mortgage (Cont)

If the mortgagor defaults

The lender can foreclose the mortgage

What is foreclosure?

Takeover and sell the property to recover thedues

Mortgage (Cont )

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Mortgage (Cont)

A mortgage is an illiquid asset

To rotate their capital

Lenders will pool mortgage loans

Issue debt backed by the underlying pool

Such securities are called MBS

The process is called SECURITIZATION

Hybrid Securities

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Hybrid Securities

Convertible Bonds

Is a debt security

Can be converted into equity shares

WarrantsRight given to the investor to subscribe to

equity at a pre-determined price

These are attached to a debt securityThey can be detached and traded in the

secondary market

An investors concerns

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An investor s concerns

Riskiness

Liquidity

Timepattern

Returns

Returns

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Returns

Riskiness

Liquidity

Timepattern

Returns

Cashdividends

Capitalgains/losses

Returns (Cont )

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Returns (Cont)

Capital gains/losses arise when an asset is sold.

If selling price of an asset > The original cost of

acquisition Capital gain

If selling price < costpCapital loss In the case of bonds, the investor gets returns by

way of periodic interest payments known as

coupon payments

There can be capital gains/losses when the bond is

sold

Risk

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Risk

Riskiness

Liquidity

Timepattern

Returns

May notpaydividends

Capitalappreciationmay be

less/lossesFirm maygo intobankruptcy

Time pattern

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Time pattern

Riskiness

Liquidity

Timepattern

Returns

Cash flowsfrom bondsarepredictable

Cash flowsfrom

dividendscan bevolatile

A rational investor

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A rational investor

Riskiness

Liquidity

Timepattern

ReturnsH

IGH

L

O

W

Types of Rational Investors

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Types of Rational Investors

Young investor Retired investor

Are more likely to preferequities. May be content withthe possibilities of substantial

capital gains

Usually prefer to invest inbonds. For them, the key issueis the availability of predictable

periodic cash flows from theasset

They may not require regularcash flows immediately

The key issue is the availabilityof predictable periodic cash

flows from the assetMore inclined towards risk Risk averse

Would of course demandadequate compensation by

way of higher expected returns

Would be content with lowerreturns

Classification of Markets

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Classification of Markets

Markets

Primaryvs.Secondary

Directvs.Indirect

Moneyvs.Capital

Primary vs Secondary Markets

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Primary vs. Secondary Markets

PRIMARYMARKETS

SECONDARYMARKETS

Company offers new financialinstruments to the investingpublic. The very first issue ofshares by a company is calledan Initial Public Offering or IPO

Once an asset has beenbought by an investor from thecompany, subsequenttransactions in the instrumenttake place in the secondarymarket

Companies issue shares and

bonds

Secondary markets merely

represent the transfer ofownership of an asset from oneinvestor to another

Primary markets thereforeenable borrowers to raise funds

Primary vs Secondary Markets

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Primary vs. Secondary Markets

PRIMARYMARKETS

SECONDARYMARKETS

TCS is issuing shares for thefirst time to the public at Rs 850

per share

---

Ravi applies for 1000 sharesand is allotted 200 shares at aprice of Rs 850

Six months later Ravi sellsthese shares on the NationalStock Exchange for Rs 1250per share

Are Primary Markets Alone Sufficient?

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Are Primary Markets Alone Sufficient?

In order to facilitate savings and investment

in the economy we need both primary as

well as secondary markets

Sufficiency? (Cont )

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Sufficiency? (Cont)

What if we had only primary markets?

If we were to subscribe to a bond we would have no

option but to hold it to maturity

In the case of equity shares the problem would be

even more serious.

We and our heirs would have to hold on to the shares

forever.This will not be a satisfactory arrangement!

In real life

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In real life

We like assets which can be easily liquidated orconverted into cash.Liquidity needs can never be perfectly anticipated

Nobody invests in a single assetEveryone likes to hold a portfolio of assets.

Putting all your eggs in one basket is a very risky proposition.

Investors like to spread out or diversify their risk by investingin a pool of securities.

In real life

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In real life

Our risk propensity will not remain constant

during our lifetimes.

Young people are more risk taking, while old people

are more risk averse.

Consequently investors need the freedom to

periodically adjust their portfolios over a period of

time.

Direct versus Indirect Markets

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Direct versus Indirect Markets

In a direct market, borrowers deal directlywith individual and institutional investorswho are the ultimate lenders.

For instance, if IBM were to issue debt and youwere to subscribe to it, you would beparticipating in the direct market.

Borrowers can issue claims in the direct market

either through a Public Issue or through aPrivate Placement.

Direct & Indirect Markets (Cont )

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Direct & Indirect Markets (Cont)

In a Public Issue securities are sold to a largeand diverse body of investors, both individualand institutional.

In a Private Placement, the entire issue isplaced with a single institution or a group ofinstitutions.

Intermediaries

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Intermediaries

In either case market intermediaries areinvolved who facilitate a process of`matchmaking.

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Price Compatibility

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Price Compatibility

Every trader seeks to trade at a `goodprice.

What is a good price?

Buyers seek sellers who are willing to offersecurities at a price which is less than or equalto what they are willing to pay.

Sellers seek buyers willing to offer pricesgreater than or equal to what they expect.

Quantity Compatibility

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Quantity Compatibility

The quantity being offered should matchthe quantity being demanded.

Often a large sell order may require more than

one buyer before getting fully executed.The same is true for large buy orders.

Market Intermediaries

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Market Intermediaries

Dealers InvestmentBankers

Brokers

MarketIntermediary

Brokers

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Brokers

Brokers are intermediaries who buy and sell

securities on behalf of their clients

Arrange trades by helping clients locate suitable

counterparties.

They receive a processing fee / commission

They do not finance the transaction

Dealers

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Dealers

Dealers maintain an inventory of assets and stand ready

to buy and sell at any point in time

Dealers have funds tied up in the asset

The dealer takes over the trading problem of the client

Dealers specialize in types of markets like T-bill, Commercial

paper etc.

Dealers

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Dealers

Clientseeking to sell:

Dealer will buy the asset

Sell laterathigherprice

Clientseeking to buy:

Dealer will sell the asset

Replenish inventory laterat lowerprice

Bid price

Ask / Offer

Dealers

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Dealers

Sell@Ask - Buy@Bid = Profit = Spread

Investment Bankers

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They are people who specialize in helping

companies bring issues to the primary market.

They help issuers comply with legal and procedural

requirements.These include preparing a prospectus or offer

document

Such a document gives full details about the issue

and the potential risk factors for investors to takeinto account.

Investment Bankers (Cont)

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( )

They also provide advice on compliance with

the listing requirements of the stock exchange

where the shares are proposed to be listed fortrading

They usually underwrite the issue.

Underwriting

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g

What is underwriting?

An underwriter undertakes to buy that part of the

issue which remains unsubscribed if the issue is

under subscribed. Underwriting helps in two ways.

1. It reduces the risk for the issuer.

2. It sends a positive signal to potential investors.

1. This is because, in the case of an underwritten issue, a

potential investor knows that the banker is willing to

take whatever portion of the issue is left unsubcribed

Underwriting (Cont)

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g ( )

An investment banker may not however like

to take on the entire risk.Sometimes a group of investment bankers may

underwrite an issue.

This is called Syndicated Underwriting.

Best Efforts

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At times, an investment bank, instead of

underwriting the issue may offer to sell it on a

best efforts basis.

It will try and do everything to ensure that the issue is

fully subscribed to

It does not undertake to pick up the unsubscribed

portion in the event of undersubscription.

Thus the role of the investment bank in these cases is purely

a marketing function.

Underwritten Issue or Best Efforts?

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Most issues are underwritten in practice.

Issuers prefer this, because there is a greater

incentive for the banker to sell when there is a risk of

devolvement.

Devolvement

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What is Devolvement Risk?

It is the risk that the bank has to buy the unsold

securities in the event of undersubscription

Devolvement is a clear signal of negative market

sentiments.

It will lead to a loss for the investment banker because the

acquired shares will inevitably have to be disposed off at a

lower price.

Underwriting (Cont)

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g ( )

The fee for underwriters in the U.S. isabout 7% of the issue amount.

Sometimes the bank may also be offered

an option to buy additional shares at theoriginal issue price.

These options can become very valuable if

the issue succeeds, for the stock price willthen rise perceptibly.

These are known as Greenshoe options.

Underwriting (Cont)

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g ( )

The underwriting fee compensates theinvestment bank for the sales effort as well asfor the insurance

Since a best efforts offer does not involve

insurance the corresponding fees tend to belower.

Underwriting fees are negotiated between theinvestment bank and the client.

The fee is a function of the risks involved, and theamount of capital required to be deployed.

The Glass-Steagall Act

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g

This act, known more formally as the BankingAct of 1933 segregated investment bankingactivities and commercial banking activities.During the Great Depression of 1929-1933 many

commercial banks went bankrupt when the stockmarkets collapsed because they had significantexposure in the market.

Once the Act was enacted following the depression,

bankers were given a clear choiceBetween deposit taking and lending on one hand, and

underwriting and securities dealing on the other.

Glass-Steagall (Cont)

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The Act thereby segregated InvestmentBanking & Brokerage Operations fromCommercial Banking.

JP Morgan existed prior to the enactmentof the Act

After the Act was passedA splinter group broke off to form Morgan

Stanley an I BankJPM continued as a commercial bank

Glass-Steagall (Cont)

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The Glass-Steagall Act was repealed in 1999,

with the passage of the Financial Services

Modernization Act.

This Act is referred to as the Gramm-Leach-Bliley Act.

Bloombergs Top 20 Investment Banks

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Citigroup

Goldman Sachs

Morgan Stanley

JP Morgan Chase

Merrill Lynch

UBS

Credit Suisse

Deutsche Bank

Lehman Brothers

Bank of America

ABN AMRO Bank

Nomura Securities

RBC Capital Markets

HSBC

Rothschild

Daiwa Securities

Lazard

Wachovia

Bear Stearns

BNP Paribas

Indirect MarketsBORROWER

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Commercialbank

LENDERS

Corporateborrower

Non corporateborrowers

individual

family

Financial

claims

Financial

claims

LENDER

Indirect Markets - Risks

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Individual / family depositors are exposed to the

risk of failure of the bank

The banks are exposed to the risk that

corporate borrowers could fail

In. Market Intermediaries

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Pensionfunds Mutualfunds

Insurancecos

I. MarketIntermediary

Indirect Markets (Cont)

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The depositors have no claim on the ultimate

borrowers in this case.

How does the bank make money?

By raising deposits at a rate that is lower than the

interest rate charged by it on loans made to

borrowers.

Benefits of Direct Markets

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When a borrower and a lender interact directly,

they can share the profit

Profit will otherwise be made by the intermediary

Indirect MarketsBORROWER

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CommonwealthBank

4% pa

LENDERS

Corporateborrower

Telstra etc.

individual

family

Financial

claims

Financial

claims

LENDER

5.5% pa

Illustration (Cont)

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Assume that Telstra can directly issue bonds to

the public, with a coupon rate of 4.75%.

Investors get 0.75% extra as compared to the bank

deposit

Telstra Will save 0.75% as compared to borrowing

from the bank

Banks margin of 1.5% has been shared by the company& investors

Disadvantages of Direct Markets

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One problem is that the claims issued by theborrowers may not match the requirements of

the individual lenders

The problem

:

Denomination and/or Maturity.Borrowers like to borrow long term whereas lenders like to

lend short term.

E.g. A co. issuing 20yearbonds maynot find many

takers if it directlyapproaches thepublic

Denomination problem

E.g. A firm issuesbonds witha facevalue of $100,000

small investors willbe unable to subscribe.

Disadvantages (Cont)

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These problems do not exist for financialinstitutionsThey have access to funds deposited by many investors large denominations pose no problems for them

Deposits keep getting rolled overThese intermediaries can afford to borrow short term &

lend long term

These intermediaries are said to engage indenomination transformation as well as maturitytransformation

Disadvantages (Cont)

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Another problem with direct markets is that theyare critically dependent on active secondary

markets

The cost of a public issue can be very highProspectus printing costs

Share application printing costs

Legal fees

Fees paid to advisors

Role of Intermediaries in Indirect Mkts

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Banks, mutual funds etc. have access to largepools of money.They also accept deposits ranging from a few dollars to

a few million dollars.

They can therefore easily subscribe to largedenomination assets

They can also accept short term deposits andlend long term.

Deposits keep getting rolled over, either due to

renewals, or due to new clients.

The Role of Intermediaries (Cont)

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Financial institutions also facilitate riskdiversification.Diversification means that `dontputallyoureggs in one

basket

It is costly for an individual investor to diversify acrossassets because of transactions costs.

In practice, each time a security is bought or sold, thetrader incurs transactions costs.

Banks indirectly diversify because every deposit isinvested across a spectrum of projects.

Banks can afford to employ professionals who canassess risk related issues.

The Role of Intermediaries (Cont)

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Finally financial institutions are able to take

advantage ofeconomies of scale

The fixed costs of their operations tend to get spread

over a vast pool of transactions and assets

This leads to cost efficiency as compared to an

individual borrower/lender

Illustration

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A business operation costs $ 1000 tomount

The cost per unit is $1

If 1000 units are producedTotal cost = $ 2000

Per unit cost = $2

If 10000 units are producedTotal cost = 11000

Per unit cost = 1.10

Money Mkts. vs. Capital Mkts.

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Money Markets Capital Markets

Time to maturity at the time ofissue is one year or less

Markets for medium to long terminstruments

Money market instruments by

definition have to be debtinstruments

Capital market securities include

both long and medium term debt aswell as equities

Money markets are used to adjusttemporary liquidity imbalances. Inpractice, for any company, inflows

and outflows at any point in time willrarely match

Capital markets channelize fundsfrom those who wish to save tothose who seek to make long term

productive investments

Money markets help firms toborrow short term and also todeploy surplus funds on a shortterm basis

Capital markets are wherecompanies source funds for theirlong term investment needs

Money & Capital Markets

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Money markets tend to be wholesale markets.

These instruments have high denomination.

Hence small investors usually do not participate in such

markets

Small investors can participate indirectly by investing in

Money Market Mutual Funds (MMMFs).

These funds primarily invest in money market securities

Money & Capital Markets (Cont)

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These securities carry relatively low default risk.

The odds of a firm getting into financial difficulties in the

short run are definitely less than such an event

occurring over a longer term horizon

Money markets tend to be very liquid

The trading volumes are very high

Secondary Markets

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Financial assets are usually traded on

exchanges

What is an exchange?

It is a trading system where traders interact to buy and

sell securities

A trader, to trade, has to be a member of the exchange

Non members have to route their orders through amember

Example - Secondary Markets

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If you want to trade on the NSE, you have to

approach a registered broker or a sub-broker

He will then feed your order into the electronic system

Historically Today

Open-Outcry: Historically trading These days most exchanges are

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on exchanges has taken place

on trading rings / floorsThe BSE used to have thissystem until it introduced onlinetrading

Manyolderexchanges (e.g.

NYSE) haveacombination offloorbasedandelectronictrading

y g

electronic communications

networks and most traders no

longer interact face to face

Traditionally exchanges have

been owned by the member

brokers and dealers

Of late many exchanges arecharacterized by corporate

ownership. Such exchanges aresaid to be demutualized

TheNSE is ownedbyanumber of institutionssuchasIDBI, LICetc.

Stock Exchanges

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These are markets where shares ofcommon stocks of companies are traded

When a corporation desires that its shares

be admitted for trading, it has to first applyto have its shares listed

Thereareapproximately2,800stocks listedon theNYSE

The marketcapitalization ofNYSE listedcompanies isapproximately25 trillion dollars

Listing vs. Registration

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What is Listing?It is a process by which a company applies and gets

permission for its securities to be traded on a stockexchange.

The exchange will insist on certain minimum standardsbefore granting approval. These pertain to issues likecapital value, number of shareholders, and financialsoundness.

What is Registration?This is a process required under the Securities and

Exchange Act for most publicly held corporations.

Listing and Registration

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Listing Registration

There is no legalrequirement that a companyshould get its shares listedon an exchange

Registration is mandatoryand requires the submissionof periodic financial reportsand reports of majorcorporate events to the SEC

Most exchanges require that

the companies regularlyreport their accounts inaccordance with GenerallyAccepted AccountingPractices (GAAP)

All listed securities must be

registered with the SEC

Listing

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Benefits of listing:

1. Trading of listed shares is easier and the company will

attract a broader class of shareholders

2. Listing gives the company enhanced visibility

3. It becomes easier for the company to raise capital

Once approval is granted a company has to

pay the prescribed listing fees

Multiple Listings

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Most companies list their stocks on more than

one exchange

The main exchange where the stock is originally listed is

called the Primary Listing Market.

E.g.:

NYSE

NASDAQ

Multiple Listings (cont)

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Most listed stocks in the U.S also trade on one

or more regional exchanges.

E.g.:

The Boston StockExchange

TheChicago StockExchange

TheCincinnatiStockExchange

ThePhiladelphiaStockExchange

The Third Market

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Market in stocks that are listed on anorganized exchange

But are traded outside the exchange

By brokers representing institutional investors

The Fourth Market

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These are electronic trading systems also knownasAlternative Trading Systems (ATS).

Usually sponsored by registered broker-dealers

Computerized trading networks that match buy andsell orders entered electronically

Orders that cannot be immediately matched areposted for viewing by investors who may wish to take

an offsetting position

The Fourth Market (cont)

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ExampleA mutual fundandapension fundenter into a large

blocktrade witheach other

Bothpartiesavoid

Brokerage Exchange transaction fees

International Stock Exchanges

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Over the past two decades exchanges have

mushroomed across the globe

Happened due to the increasing acceptance of the free

market economic mechanism which has manifested

itself by the LPG process - Liberalization,Privatization,

and Globalization.

Not all emerging market exchanges have beensuccess stories

International Exchanges

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Successful exchange development requires

Strong property rights Successful privatizationprograms

Strong contract laws andsecurities regulation laws

Regulatory authorities withteeth

International Exchanges (Cont)

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EXCHANGE MARKET VALUE(Trillions of USD)

SHARE TURNOVER(Trillions of USD)

NASDAQ 4.390 12.400

Toronto 2.290 1.360

NYSE Euronext 20.700 28.700

Australian SecuritiesExchange

1.450 1.000

BSE 1.610 0.263

Hong Kong 2.970 1.700Korea 1.260 1.660

NSE 1.460 0.564

International Exchanges (Cont)

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EXCHANGE MARKET VALUE(Trillions of USD)

SHARE TURNOVER(Trillions of USD)

Shanghai 3.020 3.560

Tokyo 4.630 5.450

Frankfurt 2.120 3.640

London 4.210 9.140

Swiss 1.330 1.580

Sao Paulo 1.400 0.476

Johannesburg 0.940 0.349

Bond Markets

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The number of different corporate and municipal

bond issues far exceeds the number of available

stocks

Bond markets are not very liquid.

In practice many bonds never trade after issue,

because investors who buy them, choose to hold

them till maturity.

Bond Markets (cont)

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The number of government bond issues is less,but the issue sizes are much larger

These bonds are more actively traded

Most corporate and municipal bonds trade OTC ininvestment and commercial banks

Some stock exchanges list corporate bonds, but

trading volumes are much higher in OTC markets

E.g. Less than 0.10% ofallcorporatebond trading occurs

on theNYSEand the AMEXbond markets

Bond Markets (cont)

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Secondary trading of T-Bonds is also primarily

on OTC markets.

Many brokers however organize markets in

which large government bond dealers and

traders trade with each other

These inter dealer brokers facilitate anonymous trading.

E.g. the largest of them isCantor Fitzgerald.

Actors or Players

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Traders in the market can be divided into twocategories.

Those who trade on their

own account

Those that arrange trades for

othersProprietary traders trade ontheir own account

Agency traders act on behalfof or as agents of others whowish to trade

They are also known asbrokers, commission traders,or commission merchants (infutures markets).

Long Positions

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A trader who owns an asset is said to have a

Long position

People with long positions have the ability to sell on a

future date

They gain if prices rise and lose if prices fall

Those wanting to take long positions attempt to buy low

and sell high

Short Positions

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A trader is said to have a Short position in the

stock market when he has sold an asset that

was not owned by him

Howcan you sellsomething thatyou do notown?

Borrow it from someone else and sell it

Thus the trader has to eventually buy the asset andreturn it to the investor who lent it to him

Hopefully prices would have declined by then

Short Positions (cont)

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When a person with a short position re-acquires

the asset, he is said to be `covering his

position

The objective of a short seller is:

sellhighandbuy low

Buy Side & Sell Side

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The trading industrycan be classified into

a buy side and a sell

side

The most important ofthese services is

liquidity

The terms buyside and

sellside have nothingto do with the actual

buying and selling of

securities

Buy side Sell side

traders whoseek to buy theservices

offered by theexchange

traders whooffer theservices of the

exchange

traders arethose in search

of liquidity

traders arethose who

supply liquidity

traders on both sides regularlybuy as well as sell securities

Buy side Sell side

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y

Refers to the portion ofthe securities business inwhich primarily

institutional ordersoriginate

Consists of brokers anddealers who help buy sidetraders to trade at their

convenienceThis is selling liquidity

Funds (mutualandpension)

Firms

GovernmentsInsuranceCompanies

Charitableand LegalTrusts

Market makers

Specialists

FloorTradersLocals

DayTraders

Scalpers

Examples - The Sell Side

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Broker dealers in the U.S. include wellknown

investmentbanks like:

Goldman Sachs

Salomon Smith Barney

Morgan StanleyDean Witter

CreditSuisse First Boston

Definitions

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Who is a market maker?

A person/firm who on a continuous basis buys and sells

securities on his own account

Market makers usually try and profit from a rapid

turnover in securities positions

They do not hold open positions for long in anticipation

of gradual price movements

Definitions

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Who is a specialist?An exchange member who is a market maker in one or

more securities

The person on the exchange floor who the othermembers approach when they wish to transact or leave

an order

A specialist is assigned securities by the exchange and

is expected to maintain a fair and orderly marketA specialist is also known as anAssigned Dealer

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Clearing

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After a trade has been matched by atrading systemPost trade processes need to commence

ClearingThe term refers to all post-trade processes

other than final settlement

Settlement is the final step

Payment of cash to the sellerTransfer of ownership to the buyer

Clearing (cont)

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If the records match:The trade is said to clear

It can then be settled

If there isa discrepancy:

It will be reported to the traders

The traders will then try and resolve the problem

Trades with discrepancies are called DKs (Dont Knows)

In the futures markets they are called Out Trades

Settlement Cycles

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Normal-way settlement in the U.S occurs 3

business days after the day of trade for equities.

This is called T+3 settlement.

There are also special settlements like cash

settlements.

Cash settlement means that the trade is cleared and

settled on the day of trade itself.

Depositories

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What is a Depository? It is a centralized location in which security certificates are

placed and stored for later transfer

Such transfers usually take place by book entry rather than by

physical movement

E.g.The largest depository in the world is theDepository

TrustandClearingCorporation (DTCC), whichholds

nearly36 trillion dollars in assets

Depositories (Comparisons with a Bank)

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Commercial Bank Depository

1. Holds funds in an account 1. Holds securities in anaccount

2. Enables fund transfersbetween accounts

2. Enables transfers ofsecurities between accounts

3. Facilitates transferswithout having to handle

money

3. Facilitates transferswithout having to handle

securities

4. Facilitates safekeeping ofmoney

4. Facilitates safekeeping ofsecurities

Custodians

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Who is a custodian?

It is an organization, typically a commercial bank, that

holds in custody and safekeeping assets belonging to its

customers.

For a fee, the institution will collect dividends, interest,

and proceeds from security sales and will disburse

funds according to the clients instructions.

Custodians (Cont)

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Global custodians hold assets in multiplelocations

Use local branches or other local custodians

What is the advantage?All settlement instructions need to be sent to a

single destination

Depositories & Custodians

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They facilitate the settlement process by quickly

transferring cash and securities to settlement

agents upon receiving instructions from the

traders.

Arbitrage

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What is arbitrage?

Arbitrage may be described as the existence of the

potential to make riskless profits by transacting in

multiple markets.

NYSE LSE

IBM shares

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$180 per share

Exchange rate 2 $/

100 per share

Borrow $18,000.Buy100shares

on NYSE

Sell on LSE for10,000

Transfer$20,000 backto NY

Profit = $2000

This transaction is costless and risk-less in a perfect setting

NYSE LSEIBM shares

These opportunities cannot persist for long

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$180 per share

Exchange rate 2 $/

100 per share

Buyon NYSEPrice rises

Sell on LSEPrice falls

Equilibrium is restored

Exchange rate will come down from 2 $/

Arbitrage & Market Imperfections

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In practice investors have to incur transactions

costs.

Brokerage fees have to be paid when shares are bought

and sold.

Commissions have to be paid while buying and selling

foreign exchange.

Such costs will certainly reduce and may eveneliminate profit opportunities for small investors.

Imperfections (cont)

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Institutional investors however face muchlower transactions costs.

Since they can arrange their own trades, they

need not pay brokerage fees while trading.More importantly they have substantial capital

at their disposal which can be deployed forsuch activities.

NYSE LSE

IBM shares

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$180.75 / $181.25Exchange rate 2.05/2.15 $/

100.25 / 100.5

Borrow $18,125Buy100shares

on NYSE


Transfer$20,551.25 backto NY

Profit = $2426.25

Illustration (Cont)

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Assume that a commission of 10c per share is

payable in New York

Let the commission in London be 5p per share

Assume that the dealer charges a flat

transactions fee of25 while selling dollars.

What will be the consequences?

NYSE LSE

IBM shares

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$180.75 / $181.25Exchange rate 2.05/2.15 $/

100.25 / 100.5

Borrow $18,135Buy100shares

on NYSE


Transfer9995 x 2.05 =$20,489.75 backto NY

Profit = $2354.75

The Eurocurrency Market

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What is a Eurocurrency?A freely traded currency deposited in a bank outside its

country of origin.

The term Euro simply means outside the country of

originE.g.:

Dollars traded outside the U.S.are Eurodollars.

Yen traded outside Japan are Euroyen.

Euros traded outside Europeare Euroeuros

The rupee is not a freely convertible currency E.g.Ifabank in Dubai were to accept rupee deposits theywould

constitute Eurorupees

Eurocurrency Markets

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These deposits need not be with Europeanbanks.

Although originally most banks which acceptedsuch deposits were located in Europe.E.g. Banks in Tokyo,SingaporeandHong Kongalso

accept dollar deposits.

Theseare often called Asian Dollar markets.

Why Eurocurrency Markets?

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Why should a bank outside the U.S acceptdeposits denominated in U.S.D.?

1. After World War II, the U.S. dollar became thepreferred currency for global trade. Everyone wishedto hold dollar balances.

2. During the cold war, Warsaw Pact countries werereluctant to hold dollar balances with American banks.There was a fear that such deposits could beimpounded by the U.S. government. But they needed

such balances to finance imports3. European banks began to realize that such funds

could be profitably lent out, and consequently began toaccept such deposits.

Eurocurrency Markets (Cont)

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One of the significant reasons for theexplosive growth of Eurocurrency markets

was the existence of interest rate ceilings

and high reserve requirements in the U.S.

Interest Rate Ceiling

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An interest rate ceiling is easy to comprehend.

It precluded banks from paying interest at more than the

stipulated maximum rate

Consequently their ability to attract deposits diminished.

What is a reserve and how does it work?

Reserve

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When a bank accepts a deposit of Rs 100 inIndia, it cannot lend out the entire amount.

A fraction of the deposit has to be maintained in

the form of approved government securities andas cash with the RBI.

This amount is known as a reserve.

The objective is to bolster the safety of thedeposit holders.

Should we set reserves at a high level?

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Obviously the higher the reserve percentage,the greater is the safety for the depositors

On the flip side, the higher the reserves, the

lower is the income for the bankGovernment securities do not pay market rates of

interest

It would be more profitable for the bank to lend the

money locked up as a reserve to a borrower

Should we set reserves at a high level?

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The issue is more serious when reserves have

to be kept in the form of cash.

Cash reserves yield either nil returns or very low returns

Reserves

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StatutoryLiquidityRatio (SLR):25% of the deposit has to be maintained in the form of

approved government securities

CashReserveRatio (CRR):

8% of the deposit has to be maintained as cash with the

RBI

CRR

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The lower the CRR, the more the funds available

with the bank for productive lending

If so, higher will be the rates offered on deposits, and

lower will be the rates charged on loans.

Depositors and borrowers will both benefit.

Example - Reserves

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Due to high reserve requirements Americanbankscould not offerattractive rates on

deposits.

Matters were made worseby imposingaceiling on the

deposit rate

At thesame time theycould notattractborrowers,

because the lending rates werehigh.

ConsequentlyEuropean banksbegan attracting

both lendersas wellasborrowers leading to the

growth of the Eurodollar market

Lack of Regulations

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Eurocurrency deposits are outside the purviewof the country to which the currency belongs

E.g.The U.S. FederalReservecannot regulate

Eurodollars

There are no statutory reserve requirements

Even though there are no statutory requirements, banks

do keep voluntary reserves as a measure of caution

Petrodollars

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There was a war in the Middle East in 1973,

after which Arab countries began to use oil

prices as an economic weapon

Rising crude prices lead to large dollar balances with

Arab countries

Petrodollars (Cont)

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Why Eurobanks could attract this money?1. There were no reserve requirements

2. The transactions costs were low due to

economies of scale.3. Thus Eurobanks could offer high interest rates

to depositors

4. At the same time could lend the funds at

relatively low rates to borrowers

Floating Rate Loans

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History TodayLoans have been made on

the basis of a fixed rate

The growth of the

Eurocurrency market has

lead to loans based on

floating rates of interest

The interest rate remains

fixed for the tenure of the

loan

The interest rates on such

loans are not constant, but

are linked to a benchmark.

Consequently they vary with

changes in the level of the

benchmark.

Example - LIBOR

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The most common benchmark - LondonInterbank Offer Rate (LIBOR)

Rate at which a Eurobank is willing to lend to another

Eurobank = LIBOR

Eurobanks will quote two rates for a currency > bid&

offer

Rate at which a bank is willing to borrow = LIBID

Rate at which a bank willing to lend = LIBOR

Average of the above two = LIMEAN

LIMEAN is also sometimes used as a benchmark

Example - LIBOR

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Commercial loans made on a floating basis are

priced at LIBOR plus a spread

The spread depends on the credit worthiness of the

borrower

The more creditworthy the borrower, the lower will be

the spread

Basis Point

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What is a basis point?

A basis point is one hundredth of one percent

100 basis points = 1 percentage point

Example

$

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FIXED RATELOAN

annual interest rate =10%

Interest payable everysix months = $ 5,000

FLOATING RATELOAN

annual interest rate = LIBOR+ 50 basis points (0.50%)

current LIBOR = 8% pa

Interest payable for the next

six months:

(.08 + .005) x 0.5 x100,000 = $ 4,250

Loan amt = $ 100,000 Interest payable -> semi-annually

Example (Cont)

:

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At end of six months:

prevailing LIBOR = 8.5%,

interest for the following six monthly period:

(.085 + .005) x 0.5 x 100,000 = $ 4,500.

Interest on the loan varies positively with the

benchmark

Higher the LIBOR higher will be the interest rate

Lower the LIBOR lower will be the interest rate

Contd.

d t i d i d d id i

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determined in advanceandpaid in arrears:Interest is payable at the end of every six monthly period,

but is based on the LIBOR that was prevailing at the

beginning of the six monthly period

determined in arrearsandpaid in arrears:NOTCOMMON

International Bond Market

B i

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Borrowers issuebonds in theinternational marketto raise medium tolong term funds.Borrowers MNCs,

governments, financialinstitutions.

High Net Worth (HNW)

investors use thesemarkets for riskdiversification

InternationalBond Market

Eurobondsegment

Foreign bondsegment

Eurobonds

B d d i t d i i

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Bonds denominated in one or more currencies

other than the currency of the country in which

they are soldE.g. Bonds issued in currencies other than the Yen,

which are sold in Japan, would be called Eurobonds.

The issuer may be a Japanese or a foreign entity

Eurobonds - Illustration

S i i i b d i IBM i i i b d i

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Sony is issuing bonds in

Japan:

Issuer = Japanese

company

Principal = $10 billion

Currency of issue = USD

Currency of Japan = Yen

IBM is issuing bonds in

Japan:

Issuer = American

company

Principal = $10 billion

Currency of issue = USD


Foreign Bonds

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Bonds are issued in the currency of the country

in which they are sold

They are issued by an agency from a foreign

country

Foreign bonds - Illustration

F i B dN t F i B d

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Sony is issuing bonds in

Japan:

Issuer = Japanese

company

Principal = 100 billion

Currency of issue = Yen


IBM is issuing bonds in

Japan:

Issuer = American

company

Principal = 100 billion

Currency of issue = Yen

Currency of J

mfi-01

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