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Financial markets
- 2. Future Markets Spot Markets Foreign Exchange Markets Interbank Lending Markets Financial Markets
- 3. Spot Markets are markets in which assets are bought or sold for “on-the-spot” delivery or immediate delivery (literally, within a few days). In spot markets, spot trades are made with spot prices.
- 4. • Spot market is also referred to as the “physical market” or the “cash market • The purchases are settled in cash at the current prices fixed by the market as opposed to the price at the time of distribution
- 5. • Spot Trade is the purchase of financial instruments done on the spot or immediately. • These trades are settled instantly and do not follow a set date in the future.
- 6. • Spot Price is current price of a financial instrument. • The price which a particular instrument can be sold or bought during a particular time and specified place.
- 7. Spot markets • An example of a spot market commodity that is often sold is crude oil. It is sold at the existing prices, and physically supplied later. • A commodity is basic goods, which is substitutable with other similar commodities such as grains, gold, oil, electricity and natural gas. • The foreign exchange (FOREX) market is one of the largest spot markets in the world.
- 8. Types of Spot Markets: 1. Organized Markets or Exchanges 2. Over the counter (OTC)
- 9. Organized Markets or Exchanges • It is where the security or commodity is traded on an exchange using and changing the current market price • Exchanges are highly organized markets that bri ng together dealers and brokers who buy and s ell commodities, securities, currencies, futures, o ptions and other financial instruments
- 10. Over-the-counter markets • provide trades that happen directly between a buyer and a seller. • In OTC, the trades are based on contracts which are done openly between two parties, and not subject to the guidelines of an exchange. The contract terms are approved between the parties and might be non-standard .
- 11. Futures Markets are markets in which participants agree today to buy or sell an asset at some future date.
- 12. Futures Market is a central financial exchange where people can trade standard ized futures contracts that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future.
- 13. Futures contract is a financial contract giving the buyer an obligation to purchase an asset (and the seller an obligation to sell an asset) at a set price at a future point in time. • Futures contracts are made in attempt by producers and suppliers of commodities to avoid market volatility. These producers and suppliers negotiate contracts with an investor who agrees to take on both the risk and reward of a volatile market.
- 14. For example: a farmer may enter into a futures contract in which he agrees today to sell 5,000 bushels of soybeans six months from now at a price of $5 a bushel. On the other side, an international food producer looking to buy soybeans in the future may enter into a futures contract in which it agrees to buy soybeans six months from now.
- 15. Two kinds of participants in futures markets: 1. Hedgers 2. Speculators.
- 16. Hedgers do not usually seek a profit by trading commodities futures but rather seek to stabilize the revenues or costs of their business operations. Speculators are usually not interested in taking possession of the underlying assets. They essentially place bets on the future prices of certain commodities.
- 17. Foreign exchange market is the market in which participants are able to buy, sell, exchange and speculate on currencies.
- 18. Foreign exchange market – also called forex, FX, or currency market – trades currencies. Aside from buying, selling, exchanging and speculation of currencies, the forex market also enables currency conversion for international trade and investments.
- 19. Foreign Exchange Market- is not a financial market for borrowing and lending but for buying and selling. Forex are: • Foreign notes and coins • Foreign deposits and investments
- 20. • Foreign notes and coins are bought for the purpose of spending in foreign country • Foreign deposit is a deposit made at, or money put in to, domestic banks outside of the country.
- 21. The interbank market is the financial system of trading currencies among banks and financial institutions, excluding retail investors and smaller trading parties. Interbank Market is where the biggest banks exchange currencies with each other. -a network of banks that trade currencies with each other.
- 22. • Participants in Foreign Exchange Markets 1. Wholesale Level -major banks 2. Retail Level- business customers
- 23. Two Types of Transactions in Foreign Exchange Markets 1. Spot Market:- immediate transaction - recorded by 2nd business day 2. Forward Market:- transactions take place at a specified future date
- 24. Interbank lending market is a market in which banks extend loans to one another for a specifi ed term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate (also calle d the overnight rate if the term of the loan is overnight).
- 25. • Banks are required to hold an adequate amount of liquid assets, such as cash, to manage any potential bank runs by clients. • If a bank cannot meet these liquidity requirement s, it will need to borrow money in the interbank market to cover the shortfall. • Some banks, on the other hand, have excess liquid assets above and beyond the liquidity requirements. These banks will lend money in the interbank market, receiving interest on the assets.
- 26. The interbank rate is the rate of interest charged on short-term loans made between banks. • Banks borrow and lend money between each other in the interbank market in order to manage liquidity and meet the reserve requirements placed on them by regulators; • the rate depends on maturity, market conditions and credit ratings
- 27. Interbank rates, includes the • federal funds rate (USA), • LIBOR (UK) • Euribor (Eurozone).
- 28. Role of interbank lending in the financial system • To support the fractional reserve banking model • A source of funds for banks • Funding liquidity risk
- 30. THANK YOU!!!
Editor's Notes
- Spot markets differ from futures markets in that delivery takes place immediately. For example, if you wish to purchase Company XYZ shares and own them immediately, you would go to the cash marketon which the shares are traded (the New York Stock Exchange, for example). If you wanted to buy gold on the spot market, you could go to a coin dealer and exchange cash for gold. The foreign exchange (FOREX) market is one of the largest spot markets in the world. People and companies all over the world are constantly exchanging one currency for another as transactions occur all over the globe.
- Financial instruments like securities and commodities are bought and sold on exchanges that use, make or change the present market price of the product. Exchanges are highly organized markets that bring together dealers and brokers who buy and sell commodities, securities, currencies, futures, options and other financial instruments. Exchanges are divided according to objects sold and type of trade. Under objects sold, exchanges are divided according to stock exchange, commodities exchange, and foreign market exchange. Under type of trade, exchanges are divided according to classical exchange and future exchange. Trades under classical exchanges are for spot trades, while future exchanges are for derivatives.
- On one hand, exchanges have the benefit of managing liquidity. This lowers risks involved in the possibility of one party not completing the trade. Exchanges provide traders transparency and follow the current market price. On the other hand, OTC markets do not necessarily follow the common rules of an exchange market. Because of this, buyers and sellers get to create contracts that may be nonstandard. The prices of the products involved may also be unpublished. These trades are done on the spot as well. Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price. Market liquidity refers to the extent to which a market, such as a country's stock market or a city's real estate market, allows assets to be bought and sold at stable prices. Cash is considered the most liquid asset, while real estate, fine art and collectibles are all relatively illiquid. Cash is considered the standard for liquidity, because it can most quickly and easily be converted into other assets. If a person wants a $1,000 refrigerator, cash is the asset that can most easily be used to obtain it. If that person has no cash but a rare book collection that has been appraised at $1,000, s/he is unlikely to find someone willing to trade them the refrigerator for their collection. Instead, s/he will have to sell the collection and use the cash to purchase the refrigerator. That may be fine if the person can wait months or years to make the purchase
- Futures markets or futures exchanges are where these financial products are bought and sold for delivery at some agreed-upon date in the future with a price fixed at the time of the deal. For instance, if a coffee farm sells green coffee beans at $4 per pound to a roaster, and the roaster sells that roasted pound at $10 per pound and both are making a profit at that price, they’ll want to keep those costs at a fixed rate. The investor agrees that if the price for coffee goes below a set rate, then the investor agrees to pay the difference to the coffee farmer. If the price of coffee goes higher than a certain price, then the investor gets to keep profits. For the roaster, if the price of green coffee goes above an agreed rate, then the investor pays the difference and the roaster gets the coffee at a predictable rate. If the price of green coffee is lower than an agreed upon rate, the roaster pays the same price and the investor gets the profit. volatility refers to the amount of uncertainty or risk about the size of changes in a security's value. A higher volatility means that a security's value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security's value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.
- Speculation involves trying to make a profit from a security's price change, whereas hedging attempts to reduce the amount of risk, or volatility, associated with a security's price change. Hedgers reduce their risk by taking an opposite position in the market to what they are trying to hedge. The ideal situation in hedging would be to cause one effect to cancel out another. For example, assume that a company specializes in producing jewelry and it has a major contract due in six months, for which gold is one of the company's main inputs. The company is worried about the volatility of the gold market and believes that gold prices may increase substantially in the near future. In order to protect itself from this uncertainty, the company could buy a six-month futures contract in gold. This way, if gold experiences a 10% price increase, the futures contract will lock in a price that will offset this gain. As you can see, although hedgers are protected from any losses, they are also restricted from any gains. Speculators trade based on their educated guesses on where they believe the market is headed. For example, if a speculator believes that a stock is overpriced, he or she may short sell the stock and wait for the price of the stock to decline, at which point he or she will buy back the stock and receive a profit. Speculators are vulnerable to both the downside and upside of the market; therefore, speculation can be extremely risky.
- Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price. Market liquidity refers to the extent to which a market, such as a country's stock market or a city's real estate market, allows assets to be bought and sold at stable prices. Cash is considered the most liquid asset, while real estate, fine art and collectibles are all relatively illiquid. Banks are required to hold an adequate amount of liquid assets to accommodate withdrawals from and payments by clients. Day-to-day liquidity needs are generally managed by borrowing to cover any shortfall and lending any excess liquid assets.
- federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight, on an uncollateralized basis. London Inter-bank Offered Rate is the average of interest rates estimated by each of the leading banks in London that it would be charged were it to borrow from other banks.[1] It is usually abbreviated to Libor or more officially to ICE LIBOR (for Intercontinental Exchange Libor). It was formerly known as BBA Libor (for British Bankers' Association Libor or the trademark bba libor) before the responsibility for the administration was transferred to Intercontinental Exchange. It is the primary benchmark, along with the Euribor, for short-term interest rates around the world. Euro Interbank Offered Rate (Euribor) is a daily reference rate, published by the European Money Markets Institute, based on the averaged interest rates at which Eurozone banks offer to lend unsecured funds to other banks in the euro wholesale money market (or interbank market).
- To support the fractional reserve banking model The creation of credit and transfer of the created funds to another bank, creates the need for the 'net-lender' bank to borrow to cover short term withdrawal (by depositors) requirements. This results from the fact that the initially created funds have been transferred to another bank. If there was (conceptually) only one commercial bank then all the new credit (money) created would be redeposited in that bank (or held as physical cash outside it) and the requirement for interbank lending for this purpose would reduce. A source of funds for banks Interbank loans are important for a well-functioning and efficient banking system. Since banks are subject to regulations such as reserve requirements, they may face liquidity shortages at the end of the day. The interbank market allows banks to smooth through such temporary liquidity shortages and reduce 'funding liquidity risk'. Funding liquidity risk Funding liquidity risk captures the inability of a financial intermediary to service its liabilities as they fall due. This type of risk is particularly relevant for banks since their business model involves funding long-term loans through short-term deposits and other liabilities. The healthy functioning of interbank lending markets can help reduce funding liquidity risk because banks can obtain loans in this market quickly and at little cost. When interbank markets are dysfunctional or strained, banks face a greater funding liquidity risk which in extreme cases can result in insolvency. Liquidity risk is the risk that a company or bank may be unable to meet short term financial demands. This usually occurs due to the inability to convert a security or hard asset to cash without a loss of capital and/or income in the process.