What financial market means

2

General market structure

Commodities m. Real estate market Labour marketFinancial market

Market

3

Security

• Special kind of commodity bought for expected profit only

• Securities and currencies have two very specific features:

- there is no utilitarian value, no cost of storage, transportation and glut effect

- no other reason to buy than profit expectation• Therefore securities are extreme mobile, which

results unusually dynamics and sensibility to market information demand

4

Outstanding features of securities

• High mobility• High sensibility to economic

events, information, opinions• High susceptibility to

manipulations• Complex dependency on

market instruments, events, information

5

Targeting financial market operations

• Speculation

• Hedging

• Controlling the material processes

6

Speculations

• Acceptable – based on autonomic market moves

• Non-acceptable – based on artificial market activity and illegal information use

• Non-acceptable speculations are punished

7

Speculation advantages and disadvantages

• Advantages

- sustaining market liquidity

- enlarging allocations dynamic• Disadvantages

- macroeconomic: „bubble” effect

- microeconomic: jeopardising to bankruptcy

8

Control over the market

• Each country has special government body to control financial market participants

• Main task of these bodies – elimination fraud practices and artificial market activities, improving market efficiency

• Efficiency of the market – high level of regulatory function performance

9

Ideal market opportunities

• Full, equal and common information

• Large number of participants on demand and supply side

• Full independency of participants

• No privileges for some participants

10

Money and capital market

• Money market – all deals on instruments with life time (maturity) less then one year

• Capital market – all deals on instruments with life time over then one year

• Capital market operations are subordinated to restricted rules and special control bodies

11

• Public offer - offer addressed to over then 100 participants

Facility of information obligation- when price of security is more then 50 000 €- yearly value of issue is lower then 100 000 €- all participants are professional ( like of brokerage houses, financial institutions, big enterprises)

• Private offer – all offers other then public• Without restrictions applied to the public offer there are

issued and traded - securities of the central bank and government (tressure)- all kinds of bills

Public and private market

12

Basic job of security and exchange commission

• Admitting securities by analysing

- legality of issuer and securities issue (statute, registration correctness, general assembly resolutions)

- prospectus of issue• Keeping control on the public market, especially on

- transparency

- abusing market roles

- proper quality of the market institutions activity

13

Segmentations of the financial market

Stock exchange market

OTC market

Official market Non official market

Derivatives market

Cash market

Primary market Secondary market

Financial market

14

Primary and secondary market

• Primary market – operations resulting first owner appearance

• Secondary market – all other operations

• The both kinds of operations take place on the other, bellow mentioned markets

15

Official and non-official market• Official market – transactions taking place

on official platform, registered in European Commission

• Non-official market – all other transactions on publik market

16

Stock exchange and OTC market

• Stock exchange m. – trading on platforms with official name: stock exchange. These platforms should ensure a proper concentration and liquidity of trade, honest rules, well performance and efficiency of transactions (on the best price, firmly clearing and settlement)

• OTC – all other form of trade- non organised (person to person transactions)- organised: MTF (Multilateral Trade Facility)

17

Cash- and derivatives market

• Cash (spot) market – where the transaction and clearings take place in the same time

• Derivatives market – where significant period of time exists between transactions and its clearing

18

Cash securities

Cash market

Shares Debt instruments

Stock Bills, notes bonds, REPO, RREPO

Residual Residual

Deposit receipts Investment units ETF units Bills of exchange

Certificates of deposits

Collateral bonds

19

Shares and debt instruments

• Shares – securities giving ownership rights like stock (equities), deposit receipts, mutual funds units

• Debt instruments – responding creditor rights like bills, bonds, certificate of deposits, bills of exchange

20

Stock

• Stock (equity) – basic unit of common ownership, usually with nominal (face) value, representing equal rights to other units on General Assembly and to the company authorities

• Ordinary stock – non registered shares, without any limits and privileges in trade

• Blue chips – not formal category of stock, contains shares of the largest companies, with high liquidity and relatively stable prices

21

Stock cont.

• Prefer stock- US-UK model: owners have limited privilege to get dividend but contemporary their voting rights are limited to the resolutions concerning profit distribution only- continental model: one equity represents multiply voting power

• Golden share – equity giving owner veto rights against important (pointed in the statute) resolutions of GA

22

Stock cont.

• Registered shares – owners are registered by the company; sale of stock is limited on different way

• Penny stock – colloquial name of very chip stocks

• Non voting shares – stock with no voting rights in GA

23

Deposits receipts

• Scheme of issue- issuer buy some number of stock and put it in the custodial bank- his resource is the base to issue special receipts, each of them represent given number of stock- these receipts are sold to investors

• Investor in Deposit Receipt has the ownership rights close to stock owner

• Well know in the world there are ADR and GDR

24

Mutual funds

• There are special purpose vehicles, managed by investment fund companies

• Mutual funds are establish to make profit on given assets. All assets are buying from money collected by sale of special units

• There are open and closed mutual funds. Number of open m. funds units is floated and non-limited. In case of closed m. funds – number is stable

25

• Units are sold by the funds at each working day in number desired by investors

• Funds are oblige to buy each number of units on the self quoted price

• Time of existence open m. funds is not limited and usually not determine

Open mutual funds

26

Closed mutual funds

• They issue given numbers of units, one time. Next issue are rare and need a special procedure

• Generally such funds are not allowed to buy own units

• Time of fund existence should be given• These units often are traded on stock

exchange like equities

27

Exchangeable Trade Fund

• Closed m. fund, which assets are stock in the structure represented by the given stock index

• Issuer are usually big investment banks• Advantage of these funds is comfort to

control price moving. It changes exactly like given index

28

Debt securities

• Municipal bonds. Issued by the local government. Usually long term type

• Mortgage (backed) bonds. Issued by the mortgage credit institutions (banks, securitisation funds), collateraled on large assemblage of real estates

• Tressure bills (T-Bills, up to 1 year), notes (T-Notes, 1-5 years), bonds (T-Bonds, over 5 years). Issued by the government

• Corporate bills, bonds. The first group is issued much often then the second. Reason - high credit risk (except bank bonds)

29

Debt securities cont.

• Fixed rate bonds – coupon value is the same during whole life time

• Floating rate bonds – coupon value is changed and depends on given index value (LIBOR, inflation rate etc.)

• Zero coupon bonds – without any coupon, sold with deep discount

30

Debt securities cont.

• Convertible bonds – investors are allowed to change their into stock by given relation

• Sinking bonds. The random drown sub-series have earlier maturity

• Income bonds – without guaranty to get coupon money. Payment depends on company profits

• Junk bonds. Non formal category. There are bonds with high credit risk

31

Certificate of Deposit

• Special paper represent the right to deposit written on the bearer

• Owner of long term deposit can issue CD (with the bank approvement) and sell it on the market

• The advantage of CD is the possibility to get cash without loses on the deposit interest

32

Bill of exchange

• Paper with special right for the owner to execute money obligations

• This instrument is never establish on the bearer. It could be sold to the next person only if his name is write down on the paper.

• If the last owner can’t execute his obligation from the issuer, he can demands payments from any body from the list of previous owners

33

Derivatives. What for?

• Majority of derivatives i used to hedge the risk

• Each derivative instrument has own basic instrument

• Small part only is used for speculation. Reason – high financial leverage

• Number of traded derivatives series is extremely huge

34

Forward and Futures• An agreement concerning delivery of fixed amount of

commodities or financial instrument in determined time, price and place

• Some times the supplier demands from his counter partner some margin as protection against contract break off

• Elements of forward agreement are partially standardized• Forward is offered on primary market only. The position

on this instrument is kept to maturity• Forward is an instrument OTC market• Futures is almost the same like forward. There are traded

on the sock exchanged. Investor in futures is obliged to pay margin to secure against his credit risk

35

• In many cases the forward operations don’t need the real delivery. Position closing is done by cash settlement

• Most popular forward's basic instruments there are: commodities (crude oil, metals, mass agricultures product etc., ), currency, interest rate.

• Contracts traded as futures crowd out forwards• Most popular contracts (thanks speculators)

base on the stock exchange indexes. Contract is created as: index value cash amount

Forward/Futures cont.

36

Swap. Definition

• Swap – the agreement between two sides, determined periodical payments depending on the value of chosen market indices (swap coupon)

• Swap agreement contain the basic value of contract (notional principal), times of settlements and source of information about swap coupon value.

37

Position in swap contract

• Swap is mostly used by the for fixing credit rate value• „Swap buyer” is in the position „fixed leg”, because

his counter partner („floating leg” ) pays him the positive difference between swap coupon and market interest rate

• If this difference is negative, „fixed leg” is paying to „floating leg” („swap seller”).

• Thanks this agreement borrower is protected against interest rate movement (if it rises – gets money, if drops – pays)

38

Swap. An Example

fixed leg floating leg

fixed leg

I settlement periodContract value (Market int. rate – swap coupon)

fixed leg floating leg

III settlement periodContract value (Market int. rate – swap coupon)

II settlement periodContract value (swap coupon - market int. rate)

Swap coupon

Market interest rate

floating leg

39

Options

• Option plain vanilla type is the right to make transaction upon defined opportunities:

- price- time- kind of operation (sell or buy)- system (American or European)

• The rights of both sides of transaction are not equivalent:• options owner has right (not obligation), • option writer – is oblige to make operation if it is required

40

Derivatives. Use for hedging risk

forward (currency -, market, interest rate risk

futures (market-, currency risk) option (currency -, market, interest rate risk) swap (currency- , interest rate-, market-,

credit-, catastrophe risk)