Financial markets. an overview

FINANCIAL MARKETS
An overview

Financial Market
x MARKET:
x In economics, typically, the term market means the
aggregate of possible buyers and sellers of a certain good
or service and the transactions between them.
x FINANCIAL MARKET:
x A market for the exchange of capital and credit, including
the money markets and the capital markets.
x The term “financial market" is sometimes used for what
are more strictly exchanges (organizations that facilitate
the trade in financial securities, e.g., a stock exchange or
foreign exchange). This may be in a physical location, like
the KSE or virtually (electronically) , like AKD Securities.
x Financial markets can be domestic like KSE or they can be
international NASDAQ

Financial Market, Contd:
CAPITAL MARKET
x The market for relatively long-term (greater than one year
original maturity) financial instruments. OR
x A capital market is a market for securities (debt or equity),
where business enterprises (companies) and governments
can raise long-term funds. It is defined as a market in which
money is provided for periods longer than a year, as the
raising of short-term funds takes place on other markets. The
capital market includes the stock & bond market (debt).
x MONEY MARKET
x The money market is a component of the financial markets
for assets involved in short-term borrowing and lending with
original maturities of one year or shorter time frames. It
provides liquidity funding for the global financial system.
T. Bills, Banker’s Acceptance etc

Primary Market VS Secondary Market
PRIMARY MARKET
x The primary market is where securities are created.
x It's a market in which firms sell new stocks and bonds to the public for the
first time.
x Primary market is synonym with an initial public offering (IPO). Simply IPO
occurs when a private company sells stocks to the public for the first time.
OR
x The primary market is that part of the capital markets that deals with the
issuance of new securities.
x Companies, governments or public sector institutions can obtain funding
through the sale of a new stock or bond issue.
x This is typically done through a syndicate of securities dealers.
x The process of selling new issues to investors is called underwriting. In the
case of a new stock issue, this sale is an initial public offering (IPO). Dealers
earn a commission that is built into the price of the security offering. Primary
markets creates long term instruments through which corporate entities
borrow from capital market.

Features of primary markets are:
x This is the market for new long term equity capital. The primary market is
the market where the securities are sold for the first time. Therefore it is also
called the new issue market (NIM).
x In a primary issue, the securities are issued by the company directly to
investors.
x The company receives the money and issues new security certificates to the
investors.
x Primary issues are used by companies for the purpose of setting up new
business or for expanding or modernizing the existing business.
x The primary market performs the crucial function of facilitating capital
formation in the economy.
x Methods of issuing securities in the primary market are:
x Initial public offering (IPO)
x Rights issue (for existing companies);
x Preferential issue.

x Bond: A bond is like a loan: the issuer is the borrower (debtor), the holder is
the lender (creditor), and the coupon is the interest. Bonds provide the
borrower with external funds to finance long-term investments, or, in the
case of government bonds, to finance current expenditure
x Underwriting: The process by which investment bankers raise investment
capital from investors on behalf of corporations and governments that are
issuing securities (both equity and debt).
x Initial Public Offering (IPO). An initial public offering (IPO), referred to simply
as an "offering" or "flotation", is when a company (issuer) issues common stock
or shares to the public for the first time. They are often issued by smaller,
younger companies seeking capital to expand, but can also be done by large
privately owned companies looking to become publicly traded. In an IPO the
issuer obtains the assistance of an underwriting firm, which helps determine
what type of security to issue (common or preferred), best offering price and
time to bring it to market.
x Right Issue. A rights issue is a way in which a company can sell new shares in
order to raise capital. Shares are offered to existing shareholders in proportion to
their current shareholding, respecting their pre-emption rights

xPre-emption Rights. Pre-emption rights are the rights of shareholders to be
offered any new issue of shares before the shares are offered to non-shareholders.
xPreferential issue. An issue of shares set aside for designated buyers, for
example, the employees of the issuing company.
SECONDARY MARKET
xA market where investors purchase securities or assets from other investors,
rather than from issuing companies themselves. The national exchanges - such as
the New York Stock Exchange and KSE are secondary markets. OR
xThe secondary market, also called aftermarket, is the financial market where
previously issued securities and financial instruments such as stock, bonds, and
futures are bought and sold.
xIn the secondary market, securities are sold by and transferred from one investor
or speculator to another. It is therefore important that the secondary market be
highly liquid. To create this liquidity the investors and speculators to meet at a fixed
place regularly; this is how stock exchanges originated.
x As a general rule, the greater the number of investors that participate in a given
marketplace, and the greater the centralization of that marketplace, the more liquid
the market.

• Futures: In finance, a futures contract is a standardized contract between two
parties to exchange a specified asset of standardized quantity and quality for a
price agreed today (the futures price or the strike price) with delivery occurring at
a during specified future date, the delivery date. It’s a derivative
• Derivative: A security whose price is dependent upon or derived from one or
more underlying assets. The derivative itself is merely a contract between two or
more parties. Its value is determined by fluctuations in underlying assets like
stocks, bonds, commodities, currencies, interest rates etc.

NASDAQ, is an
American stock
exchange.
"NASDAQ"
originally stands
for "National
Association of
Securities
Dealers
Automated
Quotations"

Organized VS Over the Counter Market (OTC)
 Organized Market: A central physical location where exchange of securities
takes place under a set of rules and regulations. This type of market is also
referred to as Auction Market. OR
 An organized securities exchange is defined as "A securities marketplace
where purchasers and sellers regularly gather to trade securities according
to the formal rules adopted by the exchange.
 Stock exchange is an organized market for buying and selling corporate and
other securities. Here, securities are purchased and sold out as per certain
well defined rules and regulations.

Organized VS Over the Counter Market (OTC)
OVER THE COUNTER MARKET (OTC): A security traded in some
context other than on a formal exchange such as the NYSE, KSE, etc.
phrase "over-the-counter" can be used to refer to stocks that trade via
a dealer network as opposed to on a centralized exchange.
It also refers to debt securities and other financial instruments such as
derivatives, which are traded through a dealer network.
In general, the reason for which a stock is traded over-the-counter is
usually because the company is small, making it unable to meet
exchange listing requirements or are offered by companies with bad
credit records.
Also known as "unlisted stock", these securities are traded by broker-
dealers who negotiate directly with one another over computer networks
and by phone.
Although Nasdaq operates as a dealer network, Nasdaq stocks are
generally not classified as OTC because the Nasdaq is considered a
stock exchange.
Instruments such as bonds do not trade on a formal exchange and
are, therefore, also considered OTC securities.

INVESTIMENT BANKING
 An investment bank is a financial institution that assists individuals,
corporations and governments in raising capital by underwriting and/or
acting as the client's agent in the issuance of securities.
 An investment bank may also assist companies involved in mergers and
acquisitions, and provide additional services such as market making, trading
of derivatives, fixed income instruments, foreign exchange, commodities,
and equity securities. Or
 A specific division of banking related to the creation of capital for other
companies.
 Investment banks underwrite new debt and equity securities for all types of
corporations.
 Investment banks also provide guidance to issuers regarding the issue and
placement of stock.
 They also help to facilitate mergers and acquisitions, reorganizations and
broker trades for both institutions and private investors.
 They can also trade securities for their own accounts.

Investment Bank
FUNCTIONS OF INVESTMENT BANKING
•Investmentbanking helps public and private
corporations in issuance of securities in the primary
market. They also act as intermediaries in trading for
clients.
•Investment banking provides financial advice to
investors and helps them by assisting in purchasing
and trading securities as well as managing financial
assets
•Investment banking differs from commercial
banking as investment banks don't accept deposits
neither do they grant retail loans.

Investment Bank
x Small firms which provide services of investment banking
are called boutiques. They mainly specialize in bond
trading, providing technical analysis or program trading as
well as advising for mergers and acquisitions
x Research is the division of investment banks which
reviews companies and makes reports about their
prospects, often with "buy" or "sell" ratings. Although the
research division generates no revenue, its resources can
be used to assist traders in trading, can be used by the
sales force in suggesting ideas to the customers, and by
the investment bankers for covering their clients.
x In Pakistan
x BMA Capital Management Ltd
x JS Investment Bank Limited

Investment Bank
Underwriting Operations:
The firm that is selling new securities through the
services of an investment banker can do so either on a
NEGOTIATED BASIS or on a COMPETITIVE BIDDING
BASIS
xNegotiated Basis.
x The firm identities a suitable investment banker.
x Both discuss the type of issue, the amount involved, the
characteristics of the issue, and the marketing effort
required.
x A negotiated agreement is reached that specifies the
investment banker’s compensation.
xCompetitive Bidding Basis.
x The purpose of competitive bidding is to find a investment
bank with the lower cost of underwriting services.

Investment Bank
x After deciding the amount and the characteristics of the issue, the
firm call for sealed bids on the issue.
x Interested investment banks submit bids indicating the amount of
net proceeds they will guarantee.
x Selected bidder is committed to provide the firm with the
guaranteed net proceeds
x The difference between the actual selling price of the issue and the
guaranteed proceeds to the firm constitute profits or losses to the
underwriter.
x Formations of Underwriting Syndicate:
x Temporary alliance of a number of investment bankers who jointly
underwrite the new issue
x The purpose of syndicate is to increase the marketability of new
issue and to distribute the risk on the large number of investment
banks
x At the time of agreement with issuing firm the original investment

Investment Bank
x SEC Registration
x Soon after agreement with issuing firm the, the firm files a
registration statement with the Securities and Exchange
Commission of Country
x Formation of Selling Groups
x The underwriting syndicate arranges with brokerage firms
and dealers to sell the new securities to be issued.
x The selling group members sell the securities directly to the
investors against commission
x Selling groups stays in operation for a specified time period,
after which it is dissolved
x Due Diligence Meeting.
x At this stage the final selling price for the securities is determined
based on prevailing capital market conditions
x At the end of the meeting the prospectus is printed and the issue is
released for sale to investors

Investment Bank
x Selling the new securities
x Stabilizing the market Or Price Pegging
x It reflects the efforts by the syndicate to try to maintain the
price of The issue in the secondary markets below the issue
price.
x If secondary market prices are allowed to drop below the
issue price, investors would not buy the issue from the
selling groups.
x On a rare occasions market condition have changed
sufficiently during the offering period to require syndicate
members to repurchase large amounts of the issue in
secondary market.
x Price Pegging on a large scale implies heavy losses for the
underwriter.
x At the Completion of Offering, market stabilization activities are
ceased and syndicate and selling group are dissolved

The Investment Banking Process
Issuing firm

Underwriting syndicate

Investment Managing Investment
Banker in Investment Banker in
syndicate Banker syndicate

Selling
groups

Investors

Stock Exchange
x Definition
x Organized and regulated financial market where securities
(bonds, notes, shares) are bought and sold at prices governed
by the forces of demand and supply.
x A stock exchange is an entity that provides services for stock
brokers and traders to trade stocks, bonds, and other
securities.
x Securities traded on a stock exchange include shares issued by
companies, unit trusts, derivatives, pooled investment products
and bonds
x Unit Trust: A unit trust is a form of collective investment
constituted under a trust deed to earn profit (NIT)
x Pooled Investment: A pooled investment allows an individual to
invest in a large portfolio of assets with many other investors. The
risk is therefore reduced due to the wider spread of investments in
the portfolio.

Stock Exchange
x To be able to trade a security on a certain stock exchange, it must be
listed there.
x Usually, there is a central location at least for record keeping, but
trade is increasingly less linked to such a physical place, as modern
markets are electronic networks, which gives them advantages of
increased speed and reduced cost of transactions.
x The initial offering of stocks and bonds to investors is by definition
done in the primary market and subsequent trading is done in the
secondary market.
x Supply and demand in stock markets is driven by various factors that,
as in all free markets, affect the price of stocks.
x There is usually no compulsion to issue stock via the stock exchange
itself, nor must stock be subsequently traded on the exchange. Such
trading is said to be off exchange or over-the-counter. This is the
usual way that derivatives and bonds are traded. Increasingly, stock
exchanges are part of a global market for securities.

Stock Exchange

A bond issued by the Dutch East India Company, dating from 7 November
1623, for the amount of 2,400 florins (The Italian florin was a coin struck from 1252
to 1533)

Stock Exchange – Market Trends
Bull market
A bullish market trend in the stock market often begins before (1
the general economy shows clear signs of recovery. A bull market
is associated with increasing investor confidence, and increased
.investing in anticipation of future price increases capital gains
2) India's Bombay Stock Exchange Index, SENSEX, was in a bull
market trend for almost five years from April 2006 to January 2008
as it increased from 2,900 points to 21,000 points.

Stock Exchange – Market Trends
Bear Market
xA bear market is a general decline in the stock market over a
period of time.
xA bear market is a downward primary market trend. It is
accompanied by widespread investor fear and pessimism.
Investors anticipate further losses and are motivated to sell.
xThe most famous bear market in history followed the Wall Street
Crash of 1929 and erased 89% (from 386 to 40) of market
capitalization by July 1932, marking the start of the Great
Depression.

Stock Exchange - Functions
x To provide liquidity to the investors. (Sale the Security when U
want)
x To guarantee the legal and economic security of the agreed
contracts. (Financial nature)
x To provide official information about the quantities that are
negotiated and of the quoted prices.
x To fix the prices of the securities according to the fundamental
law of the offer and the demand
FUNCTIONS IN FAVOR OF INVESTOR
x It permits him the access to the profitable activities of the big
companies.
x It offers liquidity to the security investments, through a place in
which to sell or buy securities.

Stock Exchange - Functions
x It permits for the investor to have a political power (voting
right) in the companies in which he invests its savings
x It offers the possibility of diversifying investors portfolio by
enlarging the field of strategy of investments
FUNCTIONS IN FAVOR OF COMPANIES
x It supplies them with the obtaining of long-term funds that
permits the company to make profitable activities or to do
determine projects that otherwise wouldn’t be possible to
develop for lack of financing. Also, this funding signifies a less
cost than if obtained at other channels.
x The securities quoted at the stock exchange market usually
have more fiscal purpose advantages for the companies.
x It offers to the company’s free publicity, which in other way
would suppose considerable expenses.

Stock Exchange - ROLE
Stock exchanges have multiple roles in the economy. This
may include the following
xRaising Capital for businesses
The Stock Exchange provide companies with the facility
to raise capital for expansion through selling shares to the
investing public
xMobilizing savings for investment
When people draw their savings and invest in shares, it
leads to a more rational allocation of resources to
promote business activity with benefits for several
economic sectors such as agriculture, commerce and
industry, resulting in stronger economic growth and higher
productivity levels of firms.

x Facilitating company growth
Companies view acquisitions as an opportunity to expand product
lines, increase distribution channels, increase its market share, or
acquire other necessary business assets. A takeover bid or a
merger agreement through the stock market is one of the simplest
and most common ways for a company to grow by acquisition.
x Profit sharing
Both casual and professional stock investors, through dividends and
stock price increases that may result in capital gains, will share in
the wealth of profitable businesses.
x Creating investment opportunities for small investors
Investing in shares is open to both the large and small stock
investors because a person buys the number of shares they can
afford. It provides the opportunity for small investors to own shares
of the same companies as large investors.

x Government capital-raising for development projects
Governments at various levels may decide to borrow money in
order to finance infrastructure projects by selling securities like
bonds. These bonds can be raised through the Stock
Exchange whereby members of the public buy them, thus
loaning money to the government.
x Barometer of the economy
At the stock exchange, share prices rise and fall depending,
largely, on market forces. Share prices tend to rise or remain
stable when companies and the economy in general show
signs of stability and growth. An economic crisis could
eventually lead to a stock market crash. Therefore the
movement of share prices and in general of the stock indexes
can be an indicator of the general trend in the economy.

Main Player/Operators of S.E
The operators who buy and sell securities on stock exchange
are :
xBrokers:

x A broker is a member of the stock exchange.
x He buys and sells the securities on the behalf of the
outsiders who are not the members.
x He charges brokerage for his services.
x He does not specialize in any particular security.
x He buys sells all types of securities according to the
orders placed by his clients.
xJobbers:

x The jobber is a member of stock exchange but he buys
and sells securities on his own behalf.

x He is a dealer in securities and usually specializes in one
type of security.
x His income comes from the profit or price difference in the
purchase and sale of securities.
x A jobber normally deals for himself but he is not prohibited
from buying and selling securities on the behalf of others.
x Bulls:
x A bull is a speculator who expects a rise in prices.
x Therefore, he buys securities with a view to sell them in
future at a higher price thereby make profit.
x When the conditions in the stock exchange are dominated
by bulls, it is called a “bullish market”.
x When the prices fall and bulls have to sell at loss, it is called
“bull liquidation”.

x Bears:
x A bear is a speculator expects fall in prices.
x Therefore, he sells securities for future delivery. He sells
securities, which he does not possess.
x He sells with the hope to buy the securities at lower price
before the date of delivery.
x The efforts of bears to bring down the prices artificially are
known as “bear raids”.
x When bears dominate the market, it is called a “bearish
market”.
x When prices are rise and bears have to make purchases
to meet their commitments, it is called “bear covering”.

How Does a Stock Exchange work?
First Method
x The buying and selling of stocks at the exchange is
done on an area which is called the floor.
x All over the floor are positions which are called posts.
x Each post has the names of the stocks traded at that
specific post.
x If a broker wants to buy shares of a specific company
they will go to the section of the post that has that stock.
x If the broker sees at the price of the stock is not quite
what the broker is authorized to pay, a professional
called the specialist may receive an order.
x The specialist will often act as a middle man between
the seller and buyer.

x The specialist enters the information from the broker
into a book.
x If the stock reaches the required price, the specialist will
sell or buy the stock according to the orders given to
them by the broker.
x The transaction is then reported to the investor.
Second Method
x If a broker approaches a post and sees that the price of
the stock is what they are authorized to pay, the broker
can complete the transaction themselves.
x As soon as a transaction occurs, the broker makes a
memorandum (note) and reports it to the brokerage
office by telephone instantly.

x At the post, an exchange employee writes down on a special
card the details of the transaction including the stock symbol,
the number of shares, and the price of the stocks.
x The employee then puts the card into an optical reader.
x The reader puts this information into a computer and
transmits the information of the buy or sell of the stock to the
market.
x This means that information about the transaction is added to
the stock market and the transaction is counted on the many
stock market tickers and information display devices that
investors rely on all over the world.
x Today, markets are instantly linked by the Internet, allowing
for faster exchange.


Investors on the
trading floor of the
London Stock
Exchange

Investors on the
trading floor of the
Karachi Stock
Exchange

Ownership of Stock Exchange
x Stock exchanges originated as mutual organizations,
owned by its member stock brokers.
x There has been a recent trend for stock exchanges to
demutualize, where the mutual organization becomes
a corporation, with shares that are listed on a stock
exchange.
x Examples are
x Australian Securities Exchange (1998),
x Euro next (merged with New York Stock Exchange),
x NASDAQ (2002),
x the New York Stock Exchange (2005),

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