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Introduction to global financial markets

  1. PAPER ONE: Introduction to Global Financial Markets Paper Delivered By Dr. Tunde Adeyemi To Participant offering “Certificate in Introduction to Investment Banking; December 2019
  2.  The financial system plays the key role in the economy by stimulating economic growth, influencing economic performance of the actors, affecting economic welfare. This is achieved by financial infrastructure, in which entities with funds allocate those funds to those who have potentially more productive ways to invest those funds. A financial system makes it possible a more efficient transfer of funds. As one party of the transaction may possess superior information than the other party, it can lead to the information asymmetry problem and inefficient allocation of financial resources. By overcoming the information asymmetry problem the financial system facilitates balance between those with funds to invest and those needing funds.  According to the structural approach, the financial system of an economy consists of three main components:  1) financial markets;  2) financial intermediaries (institutions);  3) financial regulators. FINANCIAL SYSTEMS 2
  3.  A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, and precious metals.  The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This may be a physical location (such as the NSE, NYSE, LSE, JSE, BSE) or an electronic system (such as NASDAQ). Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell stock from the one to the other without using an exchange.  Financial markets refer broadly to any marketplace where the trading of securities occurs, including the stock market, bond market, forex market, and derivatives market, among others. Financial markets are vital to the smooth operation of capitalist economies FINANCIAL MARKETS 3
  4.  Intermediary functions: The intermediary functions of financial markets include the following:  Transfer of resources: Financial markets facilitate the transfer of real economic resources from lenders to ultimate borrowers.  Enhancing income: Financial markets allow lenders to earn interest or dividend on their surplus invisible funds, thus contributing to the enhancement of the individual and the national income.  Productive usage: Financial markets allow for the productive use of the funds borrowed. The enhancing the income and the gross national production.  Capital formation: Financial markets provide a channel through which new savings flow to aid capital formation of a country.  Price determination: Financial markets allow for the determination of price of the traded financial assets through the interaction of buyers and sellers. They provide a sign for the allocation of funds in the economy based on the demand and to the supply through the mechanism called price discovery process.  Sale mechanism: Financial markets provide a mechanism for selling of a financial asset by an investor so as to offer the benefit of marketability and liquidity of such assets.  Information: The activities of the participants in the financial market result in the generation and the consequent dissemination of information to the various segments of the market. So as to reduce the cost of transaction of financial assets. FUNCTIONS OF THE FINANCIAL MARKETS 4
  5.  Financial Functions  Providing the borrower with funds so as to enable them to carry out their investment plans.  Providing the lenders with earning assets so as to enable them to earn wealth by deploying the assets in production debentures.  Providing liquidity in the market so as to facilitate trading of funds.  Providing liquidity to commercial bank  Facilitating credit creation  Promoting savings  Promoting investment  Facilitating balanced economic growth  Improving trading floors FUNCTIONS OF THE FINANCIAL MARKETS 5
  6.  Based on market levels  Primary market: A primary market is a market for new issues or new financial claims. Therefore, it is also called new issue market. The primary market deals with those securities which are issued to the public for the first time.  Secondary market: A market for secondary sale of securities. In other words, securities which have already passed through the new issue market are traded in this market. Generally, such securities are quoted in the stock exchange and it provides a continuous and regular market for buying and selling of securities.  Simply put, primary market is the market where the newly started company issued shares to the public for the first time through IPO (initial public offering). Secondary market is the market where the second hand securities are sold (security Commodity Markets). COMPONENTS OF THE FINANCIAL MARKETS 6
  7.  Based on security types  1. Money market: Money market is a market for dealing with the financial assets and securities which have a maturity period of up to one year. In other words, it's a market for purely short-term funds.  2. Capital market: A capital market is a market for financial assets which have a long or indefinite maturity. Generally, it deals with long-term securities which have a maturity period of above one year. The capital market may be further divided into (a) industrial securities market (b) Govt. securities market and (c) long- term loans market.  3. Equity markets: A market where ownership of securities are issued and subscribed is known as equity market. An example of a secondary equity market for shares is the New York (NYSE) stock exchange.  4. Debt market: The market where funds are borrowed and lent is known as debt market. Arrangements are made in such a way that the borrowers agree to pay the lender the original amount of the loan plus some specified amount of interest. COMPONENTS OF THE FINANCIAL MARKETS 7
  8.  Based on security types  5. Derivative markets: A market where financial instruments are derived and traded based on an underlying asset such as commodities or stocks.  6. Financial service market: A market that comprises participants such as commercial banks that provide various financial services like ATM. Credit cards. Credit rating, stock broking etc. is known as financial service market. Individuals and firms use financial services markets, to purchase services that enhance the workings of debt and equity markets.  7. Depository markets: A depository market consists of depository institutions (such as banks) that accept deposits from individuals and firms and uses these funds to participate in the debt market, by giving loans or purchasing other debt instruments such as treasury bills.  8. Non-depository market: Non-depository market carry out various functions in financial markets ranging from financial intermediary to selling, insurance etc. The various constituencies in non-depositary markets are mutual funds, insurance companies, pension funds, brokerage firms etc. COMPONENTS OF THE FINANCIAL MARKETS 8
  9. 1. Inadequate skills for financial products development (Capital Market); 2. Inadequate collaboration of regulators and stakeholders; 3. Unavailability of investible fund for long term financial products; 4. Weak risk management; 5. Physical insecurity and prevalence of financial fraud; 6. Low level of financial literacy and inclusion; 7. Low acceptability of mobile money at merchant locations; 8. Non-existence of sound collateral management; 9. Inadequate legal and regulatory framework for the commodities market and the NIFC; 10. 10. Unwillingness of Private companies to go public; 11. 11. Inadequate Foreign Direct Investment and non-existence of an Integrated Credit Scoring System. Challenges Facing The Financial Markets 9
  11. Why Do We Have Capital Markets?  Capital markets bring together investors and borrowers  investors - corporations with surplus cash, individuals, and non-bank financial institutions  borrowers - individuals, companies, and governments  markets makers - the financial service companies that connect investors and borrowers, either directly (investment banks) or indirectly (commercial banks)  capital market loans can be equity or debt 11
  12. Who Are The Main Players in Capital Markets? The Main Players in a Generic Capital Market 2015 SPECIAL BOOTCAMP- DGSF/ BABCOCK UNIVERSITY 12
  13. What Makes The Global Capital Market Attractive? Today’s capital markets are highly interconnected and facilitate the free flow of money around the world Borrowers benefit from the additional supply of funds global capital markets provide lowers the cost of capital the price of borrowing money or the rate of return that borrowers pay investors Investors benefit from the wider range of investment opportunities diversify portfolios and lower risk But, volatile exchange rates can make what would otherwise be profitable investments, unprofitable 13
  14. Why Is The Global Capital Market Growing?  Two factors are responsible for the growth of capital markets 1. Advances in information technology  the growth of international communications technology and advances in data processing capabilities  24-hour-day trading  so, shocks that occur in one financial market spread around the globe very quickly 2. Deregulation by governments  has facilitated growth in international capital markets  governments have traditionally limited foreign investment in domestic companies, and the amount of foreign investment citizens could make  since the 1980s, these restrictions have been falling 14
  15. Why Is The Global Capital Market Growing?  deregulation began in the U.S., then moved to Great Britain, Japan, and France  many countries have dismantled capital controls making it easier for both inward and outward investment to occur  The 2008-2009 global financial crisis raised questions as to whether deregulation had gone too far  Question: Are new regulations for the financial services industry needed? 2015 SPECIAL BOOTCAMP- DGSF/ BABCOCK UNIVERSITY 15
  16. What Are The Risks Of The Global Capital Markets?  Question: Could deregulation of capital markets and fewer controls on cross-border capital flows make nations more vulnerable to the effects of speculative capital flows?  can have a destabilizing effect on economies  Speculative capital flows may be the result of inaccurate information about investment opportunities  if global capital markets continue to grow, better quality information is likely to be available from financial intermediaries 2015 SPECIAL BOOTCAMP- DGSF/ BABCOCK UNIVERSITY 16
  17. What Is A Eurocurrency?  A eurocurrency is any currency banked outside its country of origin  About two-thirds of all eurocurrencies are Eurodollars  dollars banked outside the U.S.  Other important eurocurrencies are the euro-yen, the euro-pound, and the euro-euro  The eurocurrency market is an important source of low- cost funds for international companies 17
  18. Why Has The Eurocurrency Market Grown?  The eurocurrency market began in the 1950s when the Eastern bloc countries feared that the United States might seize their dollars  so, they deposited them in Europe  additional dollar deposits came from Western European central banks and companies that exported to the U.S. could earn a higher rate of interest in London  In 1957, the market surged again after changes in British laws  under the new laws, British banks had to attract dollar deposits and loan dollars rather pounds to finance non-British trade  London became the leading center of the eurocurrency market  continues to hold this position today 18
  19. Why Has The Eurocurrency Market Grown?  In the 1960s, the market grew once again  Changes in U.S. regulations discouraged U.S. banks from lending to non-U.S. residents  would-be borrowers of dollars outside the U.S. turned to the euromarket as a source of dollars  The next big increase came after the 1973-74 and 1979-80 oil price increases  Arab members of OPEC accumulated huge amounts of dollars  avoided potential confiscation of their dollars by the U.S. by depositing them in banks in London 19
  20. What Makes The Eurocurrency Market Attractive?  The eurocurrency market is attractive because it is not regulated by the government  banks can offer higher interest rates on eurocurrency deposits than on deposits made in the home currency  banks can charge lower interest rates to eurocurrency borrowers than to those who borrow the home currency  The spread between the eurocurrency deposit and lending rates is less than the spread between the domestic deposit and lending rates  gives eurocurrency banks a competitive edge over domestic banks 20
  21. What Makes The Eurocurrency Market Unattractive?  The eurocurrency market has two significant drawbacks: 1. Because the eurocurrency market is unregulated, there is a higher risk that bank failure could cause depositors to lose funds  can avoid this risk by accepting a lower return on a home- country deposit 2. Companies borrowing eurocurrencies can be exposed to foreign exchange risk  can minimize this risk through forward market hedges 21
  22. What Is The Global Bond Market?  Bonds are an important means of financing for many companies  the most common bond is a fixed rate which gives investors fixed cash payoffs  The global bond market grew rapidly during the 1980s and 1990s and continues to grow today  There are two types of international bonds  Foreign bonds are sold outside the borrower’s country and are denominated in the currency of the country in which they are issued and are used by companies when they think it will reduce the cost of capital  Eurobonds are underwritten by a syndicate of banks and placed in countries other than the one in whose currency the bond is denominated  Foreign bonds sold in the United States are called Yankee bonds.  Foreign bonds sold in Japan are Samurai bonds.  Foreign bonds sold in Great Britain are bulldogs 22
  23. What Makes The Eurobond Market Attractive?  The eurobond market is attractive because 1. It lacks regulatory interference  since companies do not have to adhere to strict regulations, the cost of issuing bonds is lower 2. It has less stringent disclosure requirements than domestic bond markets  it can be cheaper and less time consuming to offer eurobonds than dollar-denominated bonds 3. It is more favorable from a tax perspective  eurobonds can be sold directly to foreign investors23
  24. What Is The Global Equity Market?  The global equity market allows firms to: 1. Attract capital from international investors  many investors buy foreign equities to diversify their portfolios 2. List their stock on multiple exchanges  this type of trend may result in an internationalization of corporate ownership 3. Raise funds by issuing debt or equity around the world  by issuing stock in other countries, firms open the door to raising capital in the foreign market  gives the firm the option of compensating local managers and employees with stock  provides for local ownership  increases visibility with local stakeholders24
  25. How Do Exchange Rates Affect The Cost Of Capital?  Adverse exchange rates can increase the cost of foreign currency loans  While it may initially seem attractive to borrow foreign currencies, when exchange rate risk is factored in, that can change  firms can hedge their risk by entering into forward contracts  but this will also raise costs  Firms must weigh the benefits of a lower interest rate against the risk of an increase in the real cost of capital 2015 SPECIAL BOOTCAMP- DGSF/ BABCOCK UNIVERSITY 25
  26. What Do Global Capital Markets Mean For Managers?  Growth in global capital markets has created opportunities for firms to borrow or invest internationally  firms can often borrow at a lower cost than in the domestic capital market  firms must balance the foreign exchange risk associated with borrowing in foreign currencies against the costs savings  Growth in capital markets offers opportunities for firms, institutions, and individuals to diversify their investments and reduce risk  again though, investors must consider foreign exchange rate risk  Capital markets are likely to continue to integrate providing more opportunities for business 26
  27. The Future of the Financial System and the Money and Capital Markets McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.
  28. Introduction  Powerful forces are reshaping today’s financial marketplace  Forces for change  Powerful new trends within the financial marketplace itself  Major changes in the structure and functioning of the economy  New social and demographic trends  Altering the public’s need for new financial services 4-28 28
  29. Financial Forces: Reshaping the Money and Capital Markets Today  Financial innovation - the development of many new financial services and instruments  Service proliferation - the expansion of the menu of financial services offered  Competition - the intense struggle for the customer’s business  Consolidation - mergers and acquisitions have created financial giants out of numerous smaller financial-service providers  Deregulation - the lightening or elimination of government rules brought about by a strategy of privatization of the financial sector 4-29 29
  30. Financial Forces: Reshaping the Money and Capital Markets Today  Convergence - the blurring of the traditional distinctions among different types of financial-service institutions  Homogenization - the growing similarity in the service menus offered by financial institutions  Globalization - the global expansion of operations and the falling of geographical barriers  Market broadening - the expansion of traditionally local markets to become regional, national, or even international in scope  Securitization - the pooling of loans and the issuance of securities as claims against the loan pool 4-30 30
  31. Forces Affecting the Financial System of the Future 4-31 31
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