Financial Markets Flashcards
Types of Financial Markets
Classified by term to maturity
- MONEY MARKET
- inter-bank market
- Commercial bill market
- Treasury bill market
- CAPITAL MARKET
- bond market
- stock market
Classified by function
PRIMARY MARKET
-securities for the first time being sold to public investors; raise funds; funds go to the company or old shareholders exit funds go to exiting shareholders, ultimate fund users
SECONDARY MARKET
-Trade existing securities
- Participants for trading purposes rather than fund raising or exit
- Not ultimate fund users
Classified by trading venue
ORGANIZED MARKET
-Physical, tangible location; centralised e.g LSE, NYSE
OVER THE COUNTER OTC
-electronic network; decentralised e.g OTC bulletin board
Classified by trading mechanism ORDER DRIVEN MARKET (AUCTION) - Buyers meet sellers directly QUOTE DRIVEN MARKET (DEALER MARKET) - Dealer, market maker e.g LSE - Bid ask - profit for market makers, transaction cost - Bid price, ask price
Classified by trading frequency
CONTINUOUS
BATCH
Money Market Securities
- Debt securities
- Low risk
- Low expected returns
- Examples; treasury bills, commercial bills
Capital Market Securities
- Debt and equity
- Higher risk
- Higher expected return
- Examples; notes and bonds, corporate bonds, shares
Derivative Securities
- Derived from underlying basic securities
- Highly risky
- Expected return is high
- Examples; futures, options
Treasury Bills
- money market securities
- common maturity: 1 month, 3 month, 6 month, 1 year
- Issued by Government
- Investors: Households, companies, financial institutes
- Secondary market: active
Certificates of deposits CDs
- money market or capital market: fixed interest and maturity
- Common maturity: 1 month - 5 years
- Issued by: commercial banks
- investors: households
- secondary market: no organised market
Commercial bills
- money market security
- common maturity: 1-270 days
- Issued by companies
- investors: companies
- Secondary market inactive
Treasury notes and bonds
- capital market security
- common maturity: 3-30 years
- issued by central government
- Investors: households, companies, financial institutions
- Secondary market active
Municipal Bonds
- capital market security
- common maturity: 1-30 years
- issued by: governments
- investors: households, companies
- Secondary market active
Corporate bonds
- capital market security
- Common maturity: 10-30years
- Issued by: companies
- Investors: households, companies
- Secondary market active
Securitised Mortgages
- Capital market
- Maturity: 15-30 years
- Issued by: households and companies
- Investors: Financial institutions
- Inactive after crisis
Equity
- Capital market security
- common maturity: indefinite
- Issued by companies
- Investors: households, companies, institutions
- Secondary market; active for listed exchange customers
Principles of Security valuation
- Claim to a future series of cash flows
- Present value of the series of future cash flows; appropriate discount rate
Examples;
- Stock - Dividends, selling price
- Bonds - Coupon payment, principle payment
Activities in Financial Markets
Speculation
- Predict the price movement, take position accordingly in order to make profit from the price movement
Hedging
- Reduce costs associated with the price movements by take opposite positions in assets
- Often involves derivatives
Arbitrage
- Exploit the price differences of identical or similar claims
- EG different prices between LSE and NYSE
Efficient Market Hypothesis
Market efficiency is the extent to which a financial market incorporates information Why is Market efficiency important - fair price - investment decisions - resource allocation
EMH - financial markets correctly incorporate the information that is available
