Global capital management


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Global capital management

  1. 1. Capital markets GCM
  2. 2. Market ParticipantsGovernment• Federal Government• GSE• State Government• Local Governments
  3. 3. Other Popular Intermediaries• Finance Companies• Insurance• Depositories• AMC• Investment Banks
  4. 4. Other Popular Intermediaries• Non Profit Organizations - Foundations or EndowmentsGeneral or Operating Foundations• Foreign Investors – Central Banks, Super national Institutions
  5. 5. Role of Financial Institutions• Maturity Intermediation• Risk diversification• Reduction of costs – Information Processing and Contracting Cost• Providing a payment mechanism
  6. 6. ALM - Law of large numbers• Type - I Amount Known, Timing Known – Guaranteed Investment Product• II – known, Unknown – Any Insurance product• III – Unknown, Known - CDs• IV – Unknown, Unknown – Pension Funds
  7. 7. Regulation – Prevent market FailureForms• Disclosure Regulation - SEC• Financial Activity Regulation – Insider Trading Information• Regulation of financial institutions – Risk based Capital
  8. 8. Financial Innovation• Market Broadening Instruments – liquidity, new participants• Risk Management Instruments• Arbitraging Instruments – Difference in cost and return between markets
  9. 9. BIS• Price risk transferring innovation• Credit risk transferring innovation• Liquidity generating innovation• Credit generating Innovation• Equity generating Innovation
  10. 10. Schumpter• Innovation: Product or processProcess• New trading strategies• New Pricing strategies• New distributing strategies• New Procedure for executing and clearing trade
  11. 11. Stephen Ross• New products - Inflation adjusted bonds• Strategies which use these products
  12. 12. Why Innovation• Increased Volatility• Technology• New breed of professionals
  13. 13. Why Innovation• Getting around regulation and tax• Securitization – greatest financial innovation• Competition among intermediaries
  14. 14. Depository Institutions• Credit Risk• Regulatory Risk• Funding Risk• Liquidity Risk• Market Risk• Legal Risk
  15. 15. GARP on operational Risk• Employee• Business Process• Relationship with client, regulator and third party• Technology• External
  16. 16. Commercial Banks• National Bank Act – 1963• Office of Controller of Currency (CoC)• Dual Banking System Glass – Steagall Act (1833) to Gramm Leach Bliley Act (1999)
  17. 17. Commercial Banks• Federal Reserve Act: Lender of last resort for all banks who are in the Federal Reserve System (1913)• Bank Insurance Fund under Federal Deposit Insurance Corporation 1930s
  18. 18. Banking• Individual• Institutional• Global banking
  19. 19. Reserve Requirements• Reserve Ratio: Percentage of deposits’ parked in any if the 12 federal Reserve Banks• Amount – Required reserve• Higher for non – checkable deposits and lower for checkable deposits
  20. 20. Reserve Requirements• Fortnightly deposit computation period• Required reserve and actual reserve• Bank borrow and lend reserve – federal fund market and federal fund rate• Fed discount window and fed discount rate
  21. 21. CAR• Tier 1 capital – core capital• Tier II capital – supplementary capital
  22. 22. BIS Risk weights• 0 – fed and US Treasury• 20 – Municipal general obligation funds, MBS by fed• 50 – Municipal revenue bonds and residential mortgages• 100 – Commercial loans
  23. 23. Misc• FDIC – 1 Lakh dollar per account. Mixture of increase in cost of living and also to encourage savings• S and L’s – mutually owned
  24. 24. Insurance• Mutually owned or stock companies• Types• Property and Causality• Life• Health• Liability• Disability – own occ vs any occ
  25. 25. Insurance Types• Long Term care• Structured settlements• Investment oriented products• Annuities
  26. 26. Regulation• Individual states but sec• National Association of Insurance Commissioners – all states• Reserves marinated by insurance companies reflecting assets over liabilities known as salutary surplus or STAT for better ratings
  27. 27. Structure• Manufacturer or Guarantor Company• Investment Company• Distribution company – banc assurance
  28. 28. Policy• Universal Life – Flexible Premiums• Survivorship Insurance• Participating policies• General accounts policy Vs separate Account policy
  29. 29. Asset Management• AUM• Performance Based Management fees• Open ended Funds Vs Close ended Funds• ETFs
  30. 30. Fees• Annual exchange Fees• Sales Charge• Front end load (Class A Shares), Back End Load (B Shares) level load (C shares)
  31. 31. Fund based on investment objective• Passive• Active – Market Cap (Mid Cap/small cap/large cap)• Style (Growth/ Value and Blend)• Sector Specialization
  32. 32. Popular Terms• Fund of fund and family of funds• Popular ETFs- Standard and Poor’s Depository Receipts SPDRS OR Spiders• World equity Benchmark shares (WEBS) renamed as iShares (MSCI)
  33. 33. HNI• Separately Managed Accounts or Individually Managed Accounts – Customizing
  34. 34. Hedge Funds• Organised as private investment partnership or offshore investment corporations• Use wide variety of strategies• Use Leverage, arbitration, derivatives and short selling often• Pay performance fees• Wealthy investor base
  35. 35. Styles• Market Directional hedge fund• Corporate Restructuring hedge fund• Convergence hedge fund – misalignment• Opportunistic Hedge fund – Macroeconomic variables
  36. 36. Pension Plan: Retirement Benefit• Corporate plan• Public Plan• Individually Sponsored Plan• Taft Hartley plan
  37. 37. Pension Plan: Retirement Benefit• Defined benefit plan• Defined Contribution plan• Hybrid Pension Plan
  38. 38. Investment Banking• Boutique Investment banking Vs Full Service investment Banking• IPOs• Underwriting – Firm commitment and Best effort underwriting• Gross Spread and Underwriters discount• Underwriting Syndicate• Arbitrage – risk less Vs risk Arbitrage• Proprietary Trading
  39. 39. Investment Banking• Private Placement• M and A• Merchant Banking• Financial Restructuring• Securities Finance and securities lending• Prime Broking• Creating Derivatives instruments
  40. 40. Primary and Secondary Markets• Registration Statement• Rule 415: Shelf Registration• All Listed Companies: Continues Reporting• Private Placement of Equity: Rule 144 A : 2 year Lock in period
  41. 41. Primary and Secondary Markets• Auction system: Dutch auction or Multiple Pricing Auction• Pre-emptive Rights Offering• Order Driven vs Quote Driven Market• Trading Location: OTC Vs exchange• Repo Vs Term Repo• Efficiency: Operational and Pricing Efficiency
  42. 42. Common stock MarketsTrends• Institutionalization• Deregulation• Technology leading to innovation
  43. 43. Exchanges• Trading Floors• Mechanism – Auction system• Central auction Specialist System
  44. 44. OTC• Telecommunication• Negotiated System• Multiple Market Maker System
  45. 45. Stock exchanges• US Two national stock exchanges• NYSE (Gig Board) - Euronext 2000 stocks• AMEX (curb) – 700 stocks
  46. 46. Markets• Regional Stock exchanges – Boston, Chicago, Philadelphia, Pacific Stock Exchange• OTC – Nasdaq – Nasdaq – Amex Market Group Inc – 4000 odd stocks
  47. 47. Markets• Listed stocks – Exchange traded• None listed – Nasdaq or Non- Nasdaq
  48. 48. Markets• First Market – Exchange listed stocks• Second Market – OTC Market and not listed• Third Market – OTC and Listed• Fourth Market – Private Transaction without broker or dealer
  49. 49. Markets• Stock exchanges: Members buy - SEATWhy RSE?• Dual Listing• Did not Qualify• Compete with big bourses on smaller trades and by offering lower transaction cost
  50. 50. NYSE• NYSE – 1792• Centralised continuous Auction market / Order continuous market and Call Auction or auction market (orders are batched or grouped together for simultaneous execution) – Hybrid
  51. 51. NYSE• Call Auction – Opening and closing• Post• Specialist- market maker, only one company• Orders come through SuperDot and through floor traders
  52. 52. NYSE• Largest members of NYSE – Commission brokers (500)/ Securities houses/stock brokers. Wire houses). Trade for own as well as others• Independent floor brokers –Execute orders for other exchanges• Registered traders – own account
  53. 53. NYSE Specialist• Maintain orderly market• Both a broker and dealer• Give precedence to public• Limit order book to open book – 2002. Transparency
  54. 54. NYSE Specialist• Roles• 1. Dealers• 2. Agents• 3. Catalyst• 4. Auctioneers• Revenues only out of principal trades
  55. 55. NYSE Specialist• Maintain reasonable spread between bids and ask• Maintain liquidity and continuity of price• Role during market opening• Can discontinue trading until able to arrive at price that is a balance between buyer and seller
  56. 56. Commission• Minimum commission per tradeBut• Discount broker
  57. 57. OTC Market• 3 types – 2 under NASD and 1 truly unlisted• Viral trading floor across geographies• Stocks are listed and adhere to stringent rules• Sometimes also listed on NYSE. Rules differ no need for profitability
  58. 58. OTC• Divided into Nasdaq National Market and Small Capitalization MarketThe NIM market makers must• Continuously quote 2 way quotes for at least 1000 shares• Be subject to automatic execution on their quotes via small order execution system
  59. 59. OTC• Integrate customer limit order into propriety quote• Report trade properly• Give precedence to customers
  60. 60. OTCInternalized trades allowed but not on exchanges
  61. 61. Other OTC Markets• OTC Bulletin Board on unlisted stock. Give real time quote. Last sales price and volume data on 5500 stocks• Pink Sheets. Quotes given on pink sheet. Pink sheet stocks. Even now weekly published on pink sheets
  62. 62. Third market• Dealers could not be members of NYSE RULE 390• Fixed minimum commissions
  63. 63. Fourth Market• Alternate Trading Systems• 2 parties meet directlyElectronic Communication Network• Limit order book that are widely disseminated and are open for continuous trading to subscriber who can enter and access orders displayed on ECNs
  64. 64. Fourth market• Large – instinet NYSE Euronext• Brut – NasdaqCrossing Networks• Batch processing which allows order execution at a specified time• Investment Technology Group (ITG) – Posit
  65. 65. Order Processing• Broker has a choice of which stock exchange. RSE attract – Payment for Order flow. The client should be informed• OTC - ECN or internalizing• Client has the right to know
  66. 66. Other Types of ordersOffshore TradingRule 144a securities• Only for QINs above 100 mn dollars invested in securities• Permits the issue of unregistered securities
  67. 67. SEC Intervention• Inter Market Trading System (ITS)• Consolidated Quotation System (CQS)
  68. 68. GDRs•GDRs – Sponsored and None sponsored
  69. 69. Types of OrdersMarket Order• Best price: seller low price and buyer high price• Time given preference
  70. 70. Limit OrderDesignates a price threshold for execution of trade• Buy limit order/sell limit order• Order Limit Book
  71. 71. Stop Oredr• Buy Stop order not executed unless the market price reaches above the designated price then becomes market order• Sell stop order
  72. 72. Other Orders• Opening Vs Closing Order• Fill or Kill Order• Open order or good until cancel order• Round lot (100 shares)• odd lot or• Block order (2, o0, 000 dollars or 10,000 shares)
  73. 73. Margin Requirement• Buying on maroon provided by the broker which are connected to the call money rate (Broker loan rate)
  74. 74. Costs• Explicit• Implicit: Opportunity cost due to failed execution, Soft dollar cots, impact costs, Timing costs
  75. 75. Research• Implicit are economically significant• Equity trading costs vary significantly• Market design, investment style, trading ability and reputation play the role in transaction costs• Trading costs vary even among managers
  76. 76. Retail stock trading:• Full service broker or discount broker but the line is blurring• AdvantagesLow impact costs and shorter time lag
  77. 77. Institutional Investor• Institutional investor looks for• Low costs• Low market impact• Program trade Vs Block Trade
  78. 78. Upstairs Market• Communication across trading desks1. Provide liquidity2. Through arbitrage integrate the fragmented stock market• Block trade about 5000 per day on NYSE
  79. 79. Salesperson Routing• Nasdaq system• Upstairs market• Market maker: Firm buys• Use the services of competing market makers• NYSE Floor
  80. 80. Routing• Rule 127 of NYSE• 27 percent of block deals settled upstairs
  81. 81. • Secondary Distribution: Off the floor and not exceeding the price prevailing at the time of execution• Rule 393: allows but only after permission of NYSE upon being convinced that it cannot take the block deal within reasonable time and amount
  82. 82. Program Trade• Program Trade/ Basket Trade: 15 stocks and exceeding 1 million dollars• Enable asset allocation and index arbitrage• Execution both on agency basis and principal basis
  83. 83. Trading Limits or price limitsCircuit Filters:• Level 1: 1250 points drop in DJIA – 1 Hr before 2 pm,0.5 hrs before 2:30 pm and nothing after that• Level II: 2450 drop if decline before 1 pm and 1 hr before 2 and the rest of the day afterwards• Level III: 3700 points down, rest of the day
  84. 84. Trading Collar• Trading Collar Rule: 2 percent. Index arbitrage
  85. 85. Stock market indicators• NYSE Composite• DJIA – 30 stocks, Dow Jones publisher of WSJ• S&P 500 (Standard and Poor’s Corporation)• VLCA P Value Line stocks from AMEX. NYSE and OTC• Indices: style based, sector based and broad bases
  86. 86. Popular Exchanges• TSE = TOPIX• Nikkei 225• London FTSE 100• DAX Frankfurt stock exchange 30 stocks• FAZ 100 stocks• Paris – CAC - 40
  87. 87. Popular Exchanges• SPI- Swizz performance Index – 400• Hong Kong – Hang Seng• MSCI 28000 Indices• Active/ Passive investing (indexing)• Diversification becomes difficult – correlation and alignment of behaviour