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Global Financial Market

Global Financial Market. Gautam Goswami Fordham University. Private Financial Intermediaries (FIs). Private FIs: profit-seeking firms whose assets are predominantly financial.

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Global Financial Market

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  1. Global Financial Market Gautam Goswami Fordham University

  2. 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.

  3. 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.

  4. 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.

  5. 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

  6. 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

  7. 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.

  8. 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).

  9. 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).

  10. 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.

  11. 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

  12. 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

  13. 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.

  14. 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

  15. 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

  16. 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

  17. 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.

  18. Global Financial Markets (cont.) Positions of hiring: • Analysts vs. Associates • VP vs. Directors • Managing director

  19. Sell Side Financial Intermediaries: Participants in Secondary Markets Dealer Dealer Dealer Inter Broker Dealer

  20. Exchanges NYSE Exchanges NASDAQ Exchanges FCN Broker Broker Broker I N V E S T O R S

  21. Organization Structure of a Sell Side Financial Intermediaries: TOP MANAGEMENT Legal / Compliance Revenue / Producing Technology Risk Management Investment Banking Equity Asset Management Fixed Income Retail / Prime Brokarage Foreign Exchange Rates Credit Risk Management Mortgages Treasuries Int. Rate Derivatives Munis Swaps Structured Products

  22. Market Participants: Firms Government Agencies Other FIs General Motors US Treasury FNMA World Banks Lehman Bros. Goldman Sachs Citi Group I N V E S T O R S

  23. Global Financial Markets Size of Different Global Financial Markets (Source: RPM Handbook)

  24. Table 1. Key Statistics for the Principle Global Equity Market

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

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

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

  28. Table 5. Major OTC Derivatives June 2003

  29. 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

  30. Table 7. Principal Exchanges for Fixed Income Derivatives

  31. Table 8. Principal Exchanges for Currency and Commodity Derivatives

  32. Figure 2.1Private Financial Intermediaries (FIs) Brokers Financial Securities Financial Securities Dealers Financial Securities Financial Securities Transparent FIs Underwriters Investment bankers Financial Securities Financial Securities Funds Deficit Units Funds Surplus Units Financial Securities Shares Mutual funds Pension funds Opaque FIs Loans Deposits Banks Financial Securities Policies Insurance comp Non-intermediated Transactions (direct financing) IOUs IOUs

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