Global Financial Market

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Dec 3, 2013 (3 years and 10 months ago)

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Global Financial Market

Gautam Goswami

Fordham University

Private Financial Intermediaries
(FIs)


Private FIs: profit
-
seeking firms whose
assets are predominantly financial.


Financial Intermediaries (FIs) are the
professionals that guide us through our
risk shifting and cash flow timing
transactions in financial markets.

Broker/Dealer Operations


Broker:



FI that brings together buyers and sellers without
acting as a principle in the transaction.


Dealer:



FI that makes a market in a financial security,
thereby participating as a principal in the
financial transaction.


Market Maker or Specialists:


Dealers that make a market in one or more
number of securities and who maintain a “fair
and orderly” market by dealing personally in the
market.

Other Operations of Private FIs


Underwriting:

the process whereby the FI
brings to market a newly issued financial
security.


Asset Transformation
: the FI’s creation of new
financial securities by selling financial securities
that are different from the financial securities it
buys.


Securitization
: the packaging of non
-
traded
financial securities into a newly created tradable
financial security.

The Structure of Financial
Markets


Two settings
: 1. Formal Financial Exchanges


2. Over
-
the
-
counter (OTC) Markets


Financial Exchanges

are formalized Trading
Institutions. Only members have the right to trade in Fin.
Exchanges. Each Financial Exchange has detailed and
explicit rules governing the conduct of the trade of
securities.




Examples:


NYSE: New York Stock Exchange


CBOT: Chicago Board of Trade


CME: Chicago Mercantile Exchange


LIFFE: London International Financial Futures
Exchange


LSE: London Stock Exchange

The Structure of Financial
Markets (cont.)


Over The Counter (OTC)

covers all other
financial market transactions. In an OTC trade
buyer or seller are free to negotiate all
contractual details. Modern OTC markets rely on
telephone and computer screens to link buyers
and sellers with market dealers. Dealers quote
both bid and ask prices to prospective buyers
and sellers.


Examples: NASDAQ, FX Market




NASDAQ
: National Association of Securities
Trader Automated Quotation


FX Market
: Foreign Exchange Inter
-
bank Market

The Structure of Financial
Markets (cont.)


Drivers of Liquidity:
Manual vs. Automated trading
systems



Example 1: Trade in German Govt. Bond futures

moved from LIFFE derivatives market to Swiss
-

German derivatives exchange EUREX



Example 2: Flight from BBB to AA bonds in 1998

after Russian Default


Liquidity can also be created through the removal of
credit (counterparty) risk. In the money market use of
“Sale and Repurchase of Agreement’ or REPO is such
an example.


Repo is a short
-
term contract when one party agrees to
sell a security to another party (the lender) and then
repurchase subsequently at a higher price.

Clearing & Settlement Service



Process:

Each party (say A&B) keeps cash in a
Bank Account, known as Clearing Bank) and
keeps his/her own securities in “securities
accounts”. To settle a trade, the securities are
taking out of party A’s account and deposited
into party B’s account, while the cash is taking
out of party B’s account and deposited into party
A’s account.


Oldest method


messengers sent for
confirmation (up to 50’s).

Clearing & Settlement Service
(cont.)


Depository Trust Company (DTC) in 60’s.


All parties have securities accounts with DTC and DTC
keeps records of all transfers.


Other than the recording a trade, a trade confirmation is
also required. In last 30 years, all clearing houses are
consolidated as:


For equity trades: National Security Clearing Corporation
(NSCC)


For all Fixed Income: Fixed Income Clearing Corporation
(FICC)


Both NSCC and FICC, as well as DTC are subsidiaries
of Depository Trust & Clearing Corporation (DTCC).


Today most trades are handled in an automated fashion
from organization to settlement (called Straight through
Processing, STP).

Clearing & Settlement Service
(cont.)


Regulations:



There are two types of regulation in securities market,
one by legislation (through US government) and the
other is self governing. After Great Depression and 1929
market crash, the Security Act helped to create SEC or
Security Exchange Commission and Commodity Futures
Trading Commission (CFTC in 1972) which are
government agencies.


Non
-
government agencies/ self regulatory
organizations:



National Association of Security Dealers (NASC)



National Futures Association (NFA)



Bond Markets Association ( BMA)


Regulation and Compliance:



Whether self regulated or regulated by government,
compliance is an important issue in every firm.

Clearing & Settlement Service
(cont.)


Type of PFI




1. Buy
-
side companies:



Professional Asset Management Companies (invest
client’s

money): Blackrock, PIMCO, BGI,
Deutsche Asset Mgmt



Mutual Fund Co.


2. Flagship Sell
-
side companies are:




Goldman Sachs




Morgan Stanley




Lehman Bros




Bear Sterns


3. Mutual Fund or Asset management companies.




Fidelity




Vanguard


Clearing & Settlement Service
(cont.)

Commercial Bank and Investment Bank



1930’s Glass Steagal Act d separated the Commercial
Banking activity and Investment Banking activity. In
1990’s it changed and


Citibank bought Salomon Brothers


Chase bought JP Morgan


UBS


HSBC


Deutsche Bank


Credit Swiss

Clearing & Settlement Service
(cont.)

Money is made in Private Financial Intermediaries


Investment Banking fees


Asset Management fees


Brokerage fees


Market making revenues


Proprietary trading revenues


Hedge Funds make money from asset management and
proprietary trading


Dealers make money from Market making revenues and
Proprietary trading revenues


Brokers make money from Brokerage fees.

Global Financial Markets


1700’s:


London, Amsterdam, Paris, Antwerp


Mid
-
1800’s: London, Amsterdam, Paris and New York


Mid
-
1900’s: mainly New York


1990: London is back with New York, Tokyo


1990’s: PIMCO, BAI


west coast




Florida, California


USA Europe


Asia


Australia

New York

London


Tokyo



Sydney

Chicago

Paris


Singapore




Frankfort

Hong Kong

+California Amsterdam

Shanghai

+Florida



Bombay

Global Financial Markets (cont.)


Investment Banking


Underwriting









Bringing new securities






to market










Advising on Mergers &






Acquisitions





Retail Brokerage


buy/sell securities for clients







Maintain accounts for individual




investments


Prime Brokerage


buy & sell to other brokers/ dealers


Asset Management


buy side activity


Equities / Fixed Income / Securities


Trading

Global Financial Markets (cont.)


Trading groups are organized by type of customers.


Hedge Funds, Banks, Asset Managers, Corporations


Trading group include a Trader, Trading Assistants, Interns +
some Quants And Technology people for support.


Trade Solicitation vs. Pricing securities vs. Closing Trade


Trading Books and manage p&L of the trading Desk


Bank Office or operations

-

reconciliation/clearing






-

netting






-

settling trades


Traders are supported by research group



1. Understand the existing Pricing Model



2. Develop programs that traders could run on their
computers


All have Market Data Platforms (Bloomberg or Reuters)


Recent trend is Quantitative Risk Management

Global Financial Markets (cont.)


Other Market Players


1. Portfolio Managers


data mining task


2. Hedge Funds


Use models and take risks



(smaller operations) typically hires


quant traders


Quant traders need expertise in Excel modeling but knowledge of
quantitative modeling and the knowledge of particular products are
necessary.




Desk Quants


creates and maintains quantitative models that are
used in day to day trading activity. Desk Quants are an intermediary
between trader and technology units.


Sales and Market Research


They provide research support to the sales people. Broader analysis
of economic / political / and issues driving market.

Global Financial Markets (cont.)


Positions of hiring:



Analysts vs. Associates


VP vs. Directors


Managing director

Sell Side Financial Intermediaries:
Participants in Secondary Markets

Dealer

Dealer


Dealer


Inter

Broker

Dealer


Exchanges

NYSE


Exchanges

NASDAQ


Exchanges

FCN


Broker


Broker


Broker


I

N

V

E

S

T

O

R

S

TOP
MANAGEMENT

Legal /
Compliance

Revenue /
Producing

Technology

Risk
Management


Investment
Banking


Asset
Management


Retail / Prime
Brokarage


Equity


Fixed Income


Organization Structure of a Sell Side Financial Intermediaries:


Foreign
Exchange


Rates


Credit


Risk
Management


Mortgages


Munis


Treasuries


Int. Rate
Derivatives


Swaps


Structured
Products


Market Participants:

Firms


Government


Agencies


Other FIs

General
Motors

US Treasury

FNMA

World Banks

Goldman
Sachs


Lehman Bros.


Citi Group

I

N

V

E

S

T

O

R

S

Global Financial Markets




Size of Different Global
Financial Markets



(Source: RPM Handbook)

Table 1. Key Statistics for the Principle Global Equity Market

2002

Market Cap (End Yr)
$ Trillion

Average Daily
Turnover

$ Billion

Average Transaction
Value

$ Thousand

NYSE

9.0

40.9

19

NASDAQ

2.0

28.8

12

London Stock
Exchange

1.8

15.9

105

Euronext

1.5

7.8

31


Tokyo

2.1

6.4

n/a

Deutsche Borse

0.7

4.8

17

Other N. America

0.6

6.3

Other Europe

2.1

10.1

Emerging Markets

3.0

13.1

Total

22.8

134.0

Table 2. Stock of International and Domestic Market Debt, Sept.
2003 (US$ Trillion)

All Maturities

Remaining Maturities <
12M

Domestic

Internat’l

Total

Domestic

Internat’l

Total

Government

18.1

1.1

19.2

4.1

0.1

4.2

Financial Institutions

15.5

7.8

23.2

4.0

1.4

5.4

Corporate Sector

4.9

1.4

6.3

0.6

0.2

0.8

Total

38.5

10.2

48.7

8.7

1.7

10.4

Table 3. Market Capitalization of Bonds Listed on Principal
Exchanges (US $ Trillion)

Luxembourg

London

Osaka

NYSE

Italy

Domestic
Public
Sector

0.0

0.0

3.6

1.1

1.1

Domestic
Private
Sector

0.1

0.1

0.1

0.2

0.1

Foreign

4.8

0.6

0.0

0.1

0.0

Total

4.9

0.7

3.7

1.4

1.2

Table 4. Daily Foreign Exchange Turnover April 2001 (US$ Billion)

Different Foreign Exchange
Markets

Turnover Volume (US$ Billion)

Spot

387

Forward

131

Foreign Exchange Swap

656

Total

1173

Table 5. Major OTC Derivatives June 2003

Notional Amounts

(US$ Trillion)

Gross Market Values

(US$ Billion)

Interest Rate Swaps

94.6

1126

Interest Rate Options

16.9

434

Forward Rate Agreements

10.3

20

Currency Forwards and

Currency Swaps

12.3

476

Currency Swaps

5.2

419

Currency Options

4.6

101

Equity Derivatives

2.8

260

Commodity Derivatives

1.0

110

Other Including Credit

Derivatives

22.0

1083

Total

169.7

4029

Table 6. Principal Exchanges for Equity Derivatives


Notes: EUREX was formed joining DTB and SOFEX Euornext is a combination of
Dutch and Paris exchanges


DTB: Deutsche TerminBorse


SOFEX: Swiss Options and Financial Futures Exchanges

Millions of Contracts Traded
2002

Individual Stock

Equity Index

Options

Futures

Options

Futures

AMEX

150.7

32.7

BOVESPA (Sao Paolo
Stock Exchange)

89.7

1.1

Chicago Board Options
Exchange

173.2

94.4

Chicago Mercantile
Exchange

5.4

212.2

International Securities
Exchange

152.3

EUREX

143.3

0.1

90.3

120.4

Euronext

323.6

7.6

108.3

51.9

Pacific SE

72.7

12.7

Philadelphia SE/BOT

84.9

3.6

World
-
Wide

1300.0

57.1

420.2

531.3

Table 7. Principal Exchanges for Fixed Income Derivatives

Millions of Contracts Traded
2002

Government Debt

Interest Rate

Options

Futures

Options

Futures

Chicago Board Options
Exchange (CBOT)

54.7

205.6

7.7

Chicago Mercantile Exchange
(CME)


105.6

202.5

EUREX

31.6

415.0

Euronext

8.1

42.7

149.2

Korean Futures Exchange

12.8

Sydney Futures Exchange

1.6

21.7

Singapore Exchange

21.7

BM & P

2.5

48.6

World
-
Wide

89.1

677.5

151.2

532.5

Table 8. Principal Exchanges for Currency and Commodity Derivatives

Millions of Contracts Traded
2002

Currency

Commodity

Options

Futures

Options

Futures

Chicago Board Options
Exchange (CBOT)

12.6

54.1

Chicago Mercantile
Exchange (CME)


2.2

22.1

0.8

6.8

New York Mercantile
Exchange

26.4

107.3

London Metal Exchange

2.3

56.3

Zhenzhou Commodity
Exchange

14.6

Tel Aviv SE

12.0

BM & P

2.0

16.1

World
-
Wide

16.7

41.1

47.8

265.2

Brokers

Dealers

Underwriters

Investment bankers

Mutual funds

Pension funds

Banks

Insurance comp

Non
-
intermediated

Transactions

(direct financing)

Funds Surplus

Units

Funds Deficit

Units

Transparent FIs

Opaque FIs

Financial

Securities

Financial

Securities

Financial

Securities

Financial

Securities

Financial

Securities

Financial

Securities

Shares

Financial

Securities

Deposits

Loans

Policies

Financial

Securities

IOUs

IOUs

Figure 2.1

Private Financial Intermediaries (FIs)