an overview of financial markets

8/3/2019 An Overview of Financial Markets

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Tuesday January 17, 2012

An Overview of Financial Markets

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Flow of Funds through the Financial

System

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Structure of Financial Markets

Defining the Markets

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Debt Markets

Debt markets: e.g. bond Contractual agreement by the borrower to pay the holder of the

instrument fixed dollar amounts at regular intervals (interest +principal) until a specified time (maturity date)

Maturity: Time until expiry

Short term: Less than one year

Intermediate Term: Greater than one year and less than 10

years Long term: Greater than 10 years

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Equity markets

Equity markets e.g. common stock

Claims to a share in net income (income after expenses andtaxes)

Dividends Long term

Residual claimants

Equity holders benefit directly from increases in the

corporations profitability of asset value Differences between debt and equity position

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Primary and Secondary Markets

Primary Market; Financial market in which new issues ofstocks are bonds are sold.

Secondary Market: securities that have been previouslyissued are resold

Primary markets:

Underwriting

Investment bank

Brokers ; executes the trade on behalf of others Dealers trades business on their own behalf.

Importance of secondary markets are liquidity.

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World Stock Markets

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Rank Name Market Capitalization

1 NYSE $11,837 billion

2 Tokyo Stock Exchange $3,306 billion

3 NASDAQ $3,239 billion

4 Euro Next (Belgium, France,Holland and Portugal) $2,869 billion

5 London Stock Exchange $2,796 billion

6 Shanghai Stock Exchange $2,704 billion

7 Hong Kong Stock Exchange $2,345 billion

8 Toronto Stock Exchange $1,608 billion

9 BM&F ovespa (Brazil) $1,337 billion

10 Bombay Stock Exchange $1,306 billion


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IPO Process In Canada

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Process takes 100 days in Canada

Different but similar process in the US

Company must follow processes set out by provincial law and subject tosecurities regulations.

Process is detailed and includes specifications as to the size of the paperand the colour of the ink used in the prospectus.


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The Underwriter

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Company selects lead underwriter. Underwriter is part of an investment banking firm that

organizes a group of underwriters (known as a syndicate).

Syndicate buys shares in the IPO and sell them to the public.

Underwriter also helps prepare the description of thebusiness ( prospectus)

Prospectus includes information on history of company,future prospects, and risks

Describes the securities that will be used and how theproceeds of the sale will be used.

Content depends on provincial securities act


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Preliminary Prospectus

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Includes all provincially required information Does NOT include:

Final price of share

Underwriters commission,

The number of shares to be sold Net proceeds

That information is decided in the days prior to the offering.

Preliminary prospectus goes through provincial review which

takes up to a month. Provincial regulator could ask for more information or

revisions


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Selling the IPO

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Use the preliminary prospectus as a means of marketing thesecurities.

On Tourdog-and-pony show or a road show

Take prospectus to institutional investors and investmentdealers

Marketing IPO is also subject to strict regulation

Preliminary prospectus is also known as the red herring

Green sheet is the summary of key information from thepreliminary prospectus.

Hit many cities over a several week period


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Selling Continued

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Companies must only discuss information made public viathe green sheet and preliminary prospectus.

May not disclose any confidential information during theroad show.

Violations can result in the postponement of the offering.


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Final Prospectus

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Throughout road show underwriters try to determine levelof interest in the security.

Helps determine how much of the security and at what pricethe offering should be made.

Once those determinations have been made the finalprospectus is filed.

Securities commission issues a receipt and the selling of

shares begins.


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Exchanges and OTC Markets

Two ways to organize secondary markets Exchanges

Buyers and sellers meet in central location

TSE ($2,174 b) and InterContinental Exchange (ICE -Winnipeg)

Over-the-counter

Flexibility

Risk Counterparties?

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Money and Capital Markets

Can also distinguish between markets on basis of maturities Money market is financial market in which only short term

debt instruments (1 year) Money markets are more widely traded

Money markets are more liquid.

Short term securities have smaller fluctuations in price and

so they are safer investments. Money markets are used by corporations to earn interest on

surplus funds that they expect to have only temporarily

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Financial Market Instruments

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Money Market Instruments

Government of Canada Treasury Bills 1,3,6 & 12 month maturities to finance fed govt

Discount to face value

Most liquid

Almost no risk of default

Certificates of Deposit

Sold by bank

Can be resold on secondary markets Small ($10K) or Jumbo (+$100K)

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Money Market Instruments II

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Commercial Paper Unsecured short term debt

Issued by large corporations

Issued at a discount to face value but may trade in interest

bearing form on short maturities Repurchase Agreements (aka repos)

Short term loans (maturity < 14 days)

Secured loan

Overnight Funds Overnight loans to other banks

Fundamental part of Canadas monetary system


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Capital Market Instruments

Debt and Equity instruments with maturities greater than 1 year More price fluctuations implies greater risk

Stocks Equity claims on net income and assets

Mortgages: Loans to households Corporate Bonds: long term bonds

Government of Canada Bonds: these ones do not fluctuate in value

Canada Savings Bonds

Provincial and Municipal Bonds Government Agency Securities

Consumer and Bank Commercial Loans

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Functions of Financial Intermediaries:

Indirect Finance

Transactions Costs: time and money spent carrying out financialtransactions Economies of Scale: reduction in transaction costs as # of transaction

increases

Liquidity: make it easier for customers to conduct transactions

Risk Sharing Asset Transformation: turn risky assets into safer assets

Diversification : invest in portfolio to lower risk

Asymmetric Information: counter parties with unequal

information Adverse Selection (before the transaction)

Moral Hazard (after the transaction)

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Types of Financial Intermediaries

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Depository Institutions (Banks) Chartered Banks Trust and Mortgage Loan Companies (TMLs) Credit Unions and Caisses Populaires (CUCPs)

Contractual Savings Institutions Life Insurance Companies Property and Casualty (P&C) Insurance Companies Pensions funds and government retirement funds

Investment Intermediaries Finance Companies Mutual Funds

Money Market Mutual FundsFor a list of organization operating in Canada see:

http://www.osfi-bsif.gc.ca/app/DocRepository/1/eng/reports/osfi/ar3_e.pdf


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Regulation

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Increasing information available to investors Ensuring the Soundness of Financial Intermediaries

Restrictions on Entry

Disclosure

Restrictions on Assets and Activities

Deposit Insurance

Limits on Competition

an overview of financial markets

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