Intro to Financial Markets Flashcards
Why has finance evolved?
Globalisation, - integration of financial markets into global markets
Tech Advancements
Institutionalisation - funds now managed by institutes on behalf of investors
Characteristics of financial centre
Host domestic and foreign banks with active international lending
Conduct large forex transactions
Provide services - insurance, legal
Present in derivative market
What is a financial market?
They facilitate the trade of financial instruments
Key features in financial markets?
Liquidity means that assets can be sold quickly
Securities depend of future performance of issuer
How does globalisation help us?
Globalisation is increasing integration and interdependence of world economies.
Enables borrowers to access international markets and investors to diversify their portfolios. It also allows financial institutes to grow by serving international clients
Pros and cons of emerging markets
Pros - High growth potential and attractive returns.
Cons - Poor governance, politically unstable, forex risk and high transaction costs
What is securitisation?
The process of turning illiquid assets with cash flows into liquid assets by combining cash flows from illiquid assets into a security for investors.
Pros and cons of securitisation
Pros - Provides income for investors, frees up capital for originator
Cons - Risk of default on underlying loans, lack of transparency
What are financial intermediaries
They bridge surplus agents (savers) and deficit agents (borrowers).
Functions of financial intermediaries
Payment systems
Maturity transformation (turning short term liabilities into long term assets)
Risk transformation (low risk deposits into risky loans/ assets)
Liquidity provision ( surplus agents require high levels of liquidity)
Types of Financial Markets
Primary - Where new securities are issued.
Secondary - Trading existing securities to provide liquidity and help price discovery
What is underwriting
The process by which investment banks guarantee companies and governments that they will receive the funds they seek
What is systematic risk
Market-wide risk , non-diversifiable.
e.g. earnings correlating with business cycle.
What is non-systematic risk
Firm or industry-specific risks, diversifiable by portfolio diversification.
e.g. BA negative correlation with oil prices but BP have positive correlation
What is nominal inflation (I)
The interest rate before inflation adjustments have occurred.
What is the Fischer Equation
(1 + i) = (1 + r) Γ (1 + Ο)
or 1 + πΌ = 1 + π
+ πΈπΌ + (π
β πΈπΌ)
where i is nominal ir
where r is real ir
and Ο is expected inflation rate
What is Expected Real ir (R)
Interest rate adjusted to remove effects of inflation
What is Expected inflation (EI)
The rate at which prices are predicted to rise in the future. It compensates lenders for currency depreciation
What is liquidity premium
Reflects loan maturity and lender preference for short-term lending
I = R + EI + LP
What is Expected Risk Premium
Higher returns for higher-risk exposure
Who are participants in financial markets
Individuals
Institutional investors
Governments
Brokers - facilitate transactions for clients
Arbitrageurs - buy and sell securities to make riskless profits
Hedges - protect against financial risks
Speculators - bet on price movement to make profits
How do you draw the yield curve?
FInd answer in notes.
Y axis = interest rate
X axis = years
