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 public
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6. Types of participants
Investment
Information Leverage
size
Retail investors Small Public Small
Institutional Public &
Large Large
investors Private
Public &
Governments Huge Unlimited
Private
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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)
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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 information
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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!
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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 future
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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 payment
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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 index
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14. Market data
Screenshot of a Reuters 3000 terminal
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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 disasters
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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/JPY
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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. Moss
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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 currency
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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.
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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 goods
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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’s
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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 equal
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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 issuer
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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 years
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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 maturity
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26. Yield curves
Yield Yield
Normal Inverted
Maturity Maturity
Yield Yield
Humped Flat
Maturity Maturity
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27. Yield curve for U.S. Treasurys
Yield
Maturity
Source: Bloomberg, 8 Apr. 2012
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