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  1. 1. Economics for Journalists Week 9: Financial Markets Jeffrey TimmermansMonday, 8 April, 13
  2. 2. Characteristics of markets ✤ Bring together buyers (demand) & sellers (supply) ✤ Anyone (usually) can participate ✤ Products traded are standardized and units of each product are interchangeable (fungible) ✤ Doesn’t matter who you trade with ✤ Trades are all (usually) processed by a central authority ✤ Information on all trades is publicMonday, 8 April, 13
  3. 3. Types of financial markets ✤ Commodities ✤ Stocks ✤ Foreign Exchange (Forex) ✤ Bonds ✤ DerivativesMonday, 8 April, 13
  4. 4. Methods of trading ✤ “Open outcry” floor trading (NYSE) ✤ “Over the counter” electronic trading (Nasdaq) ✤ “Dark pool” private markets ✤ Bilateral trading (only two participants)Monday, 8 April, 13
  5. 5. Market participants ✤ Retail investors (ordinary ✤ Companies people) ✤ Governments ✤ Institutional investors ✤ Insurance companies ✤ Brokerages ✤ Hedge funds ✤ Pension fundsMonday, 8 April, 13
  6. 6. Types of participants Investment Information Leverage size Retail investors Small Public Small Institutional Public & Large Large investors Private Public & Governments Huge Unlimited PrivateMonday, 8 April, 13
  7. 7. Why do they participate? ✤ To gain access to capital (funds) for new or existing ventures ✤ To put excess funds to use and earn money ✤ To hedge (insure) against risks ✤ To speculate (bet)Monday, 8 April, 13
  8. 8. Price formation in markets ✤ Participants wanting to buy make a “bid” at a certain price for a certain amount of an asset ✤ Those wanting to sell announce an “offer” (or “ask”) price and amount ✤ Participants revise their bids or offers until they find a matching offer or bid ✤ All participants can see this informationMonday, 8 April, 13
  9. 9. Photos: Bloomberg (left), AP (right)Monday, 8 April, 13
  10. 10. The importance of prices ✤ Market prices are set after matching bids and offers ✤ As such, they reflect the market’s consensus view on the value of assets ✤ They reflect market participants’ expectations ✤ Prices are news!Monday, 8 April, 13
  11. 11. Commodities markets ✤ Some major products traded: gold, oil, rice ✤ Almost all commodities trading done via futures contracts ✤ Futures allow participants to lock in a price for a transaction to take place in the future ✤ Multiple contracts for each commodity will be traded at any given time on a rolling basis (e.g. June, Sept., Dec. or Apr., May, June) ✤ Thus market prices for commodities represent expectations for prices at distinct dates in the futureMonday, 8 April, 13
  12. 12. Stock markets ✤ Allow companies to raise funds by selling shares to the public (“go public”) ✤ After an initial public offering (“primary market”), shares are traded daily on the market (“secondary market”) ✤ Companies typically offer investors (their owners) a quarterly or annual dividend paymentMonday, 8 April, 13
  13. 13. Indexes & Averages ✤ Summarize the aggregate change in prices of individual shares in a market or sector ✤ DJ Industrial Average, Nikkei 225 Average, Hang Seng Index, Hang Seng H-share Index ✤ Averages are just the mean of all prices adjusted by a fixed multiplier ✤ Indexes are weighted so bigger shares have a bigger impact on the change in the indexMonday, 8 April, 13
  14. 14. Market data Screenshot of a Reuters 3000 terminalMonday, 8 April, 13
  15. 15. Causes of stock market moves ✤ Corporate earnings (profits) ✤ Especially expectations of future profits ✤ Interest rates ✤ Economic outlook (GDP growth/contraction) ✤ Prices for raw materials/inputs (e.g. oil) ✤ War/terrorism/natural disastersMonday, 8 April, 13
  16. 16. Forex markets ✤ Five main global currencies ✤ US dollar, Euro, Yen, Sterling, Swiss franc ✤ Daily global volume of around US$4 trillion ✤ Forex price quotes are in pairs of currencies ✤ EUR/USD, USD/HKD, USD/JPY, HKD/JPYMonday, 8 April, 13
  17. 17. Causes of Forex moves ✤ Interest rates for short-term movements ✤ Rate increases associated with appreciation ✤ Inflation for medium-term movements ✤ High inflation associated with depreciation ✤ Current account (trade) imbalances for longer-term ✤ Surpluses associated with appreciation Source: “A Concise Guide to Macroeconomics” by David A. MossMonday, 8 April, 13
  18. 18. Interest rates ✤ If a country’s interest rate is higher than the rate in other countries, that country’s currency tends to appreciate as investors switch into the higher-yielding currency ✤ Carry trade ✤ Borrowing in a low-yielding currency to buy assets in a high- yielding currencyMonday, 8 April, 13
  19. 19. The Law of One Price ✤ A dollar should buy the same amount of goods or services in every country around the world ✤ The definition of purchasing power parity ✤ Inflation (or deflation) can throw parity out of whack ✤ If prices rise faster in the U.S. than in Japan, Japanese goods become more affordable in the U.S.Monday, 8 April, 13
  20. 20. Trade imbalances ✤ Demand for a country’s goods & services from overseas will tend to lead to a trade surplus and an appreciation in that country’s currency as overseas consumers need that currency to buy those goodsMonday, 8 April, 13
  21. 21. What’s a bond? ✤ Debt issued by governments, corporations and “supranationals” like the Asian Development Bank ✤ Maturity (duration) of debt varies from short-term (30 days) to long- term (30 years or longer) ✤ A bond’s coupon determines the interest rate paid to buyers of the bond ✤ Bonds can be, and often are, traded before they mature ✤ Bonds are typically given a credit rating by S&P or Moody’sMonday, 8 April, 13
  22. 22. Bond markets ✤ Bonds are quoted in prices and yields ✤ Prices and yields move in opposite directions: if the price goes up, the yield goes down ✤ The coupon represents the regular interest payment received by bond purchasers ✤ The coupon is fixed, but the yield will vary based on price ✤ Most bonds are issued at a price of 100 ✤ Therefore, at issue yield and coupon are equalMonday, 8 April, 13
  23. 23. Causes of bond moves ✤ Interest rates ✤ As coupons of bonds are fixed, their price tends to decline as interest rates rise (meaning new bonds will likely have a higher coupon) ✤ Inflation ✤ Inflation raises real interest rates, and reduces the value of the principle returned ✤ Financial health of issuerMonday, 8 April, 13
  24. 24. Typical maturities of govt. bonds ✤ One month ✤ Five years ✤ Three months ✤ Seven years ✤ Six months ✤ Ten years ✤ One year ✤ Twenty years ✤ Two years ✤ Thirty years ✤ Three yearsMonday, 8 April, 13
  25. 25. Curves & Spreads ✤ The yield curve of a bond issuer reflects expectations of future changes in rates ✤ For government bonds, the yield curve reflects expectations of inflation ✤ The higher inflation is likely to be, the more yield investors will demand ✤ A spike in the curve can reflect the time horizon of any market concern ✤ Spreads measure the risk premium of a particular bond over a risk- free bond of the same maturityMonday, 8 April, 13
  26. 26. Yield curves Yield Yield Normal Inverted Maturity Maturity Yield Yield Humped Flat Maturity MaturityMonday, 8 April, 13
  27. 27. Yield curve for U.S. Treasurys Yield Maturity Source: Bloomberg, 8 Apr. 2012Monday, 8 April, 13