Topic 1 Introduction to Financial markets

8/7/2019 Topic 1 Introduction to Financial markets

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Apna Sapna MoneyApna Sapna Money--MoneyMoney


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Overview of Indian FinancialOverview of Indian Financial

System and EconomicSystem and Economic

DevelopmentDevelopment


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Our Strategy for LearningOur Strategy for Learning

Concepts, Practice and Class DiscussionConcepts, Practice and Class Discussion

Punctuality, Participation and PreparationPunctuality, Participation and Preparation

Judgment challengeJudgment challengeLearning to communicate ideasLearning to communicate ideas

Learning from each otherLearning from each other

Learning through discoveryLearning through discovery

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OutlineOutline

Overview offinancial marketsOverview offinancial markets

Institutional in

frastr

uct

ureInstit

utional in

frastr

uct

ure

Role and functions of stockRole and functions of stock

exchangeexchange

Comparison between FinancialComparison between Financial

and Non Financial Institutionsand Non Financial Institutions


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The Financial SystemThe Financial System

Financial SystemFinancial System set of markets, individualsset of markets, individuals

and institutions which trade in those marketsand institutions which trade in those markets

Channels funds from lenders to borrowersChannels funds from lenders to borrowers

Creates liquidity and moneyCreates liquidity and money

Provides a payments mechanismProvides a payments mechanism

Provides financial services such as insurance andProvides financial services such as insurance and

pensionspensions

Offers portfolio adjustment facilitiesOffers portfolio adjustment facilities


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Financial SystemFinancial System

EEBEEB 77


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Constituents of FinancialConstituents of Financial

SystemSystem


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Regulation of the FinancialRegulation of the Financial

SystemSystemTo increase the information available to investors:To increase the information available to investors:To ensure the soundness offinancial intermediaries (andTo ensure the soundness offinancial intermediaries (andthe overall financial system):the overall financial system):

Restrictions on entryRestrictions on entry DisclosureDisclosure

Restrictions on Assets and Activities (e.g. Basel II)Restrictions on Assets and Activities (e.g. Basel II)

Deposit InsuranceDeposit Insurance

Limits on CompetitionLimits on Competition

Restrictions on Interest RatesRestrictions on Interest Rates


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Financial MarketsFinancial Markets

Markets in which funds are transferred fromMarkets in which funds are transferred from

people who have an excess of availablepeople who have an excess of available

funds to people who have a shortage offunds to people who have a shortage of

fundsfunds

Example: lenders/savers andExample: lenders/savers and

borrowers/investorsborrowers/investors

Important effects on economic performanceImportant effects on economic performance


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OverviewOverview ofofFinancialFinancial

MarketsMarketsTypes offinancial markets

Money markets

Capital markets

Debt Market

Hybrid


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The Hierarchy of Markets

Money market

Government bond

market

Corporate bonds &

equities

Asset backedsecurities &

derivatives

Govt TBills


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InstrumentsInstruments

EquitiesEquities

DebtDebt

Most popular investing

instruments

Stocks and sharesBonus issues

Rights issues

Corporate

Government


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Financial Market

Money market Capitalmarket

Primary

marketSecondary

market

Commercial

banks

Firms raise

capitalInvestors

trade

securities

issued in

primary

market

debt

equity

PublicPrivate

placement

Short term

instruments

PrimaryMkt Inst

Stock

exch

ange

Credit

unions

Insurancecos

NIS


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RiskRisk--Return Trade offReturn Trade off


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IndiaIndia-- Young and RestlessYoung and Restless


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Indian EconomyIndian Economy A SnapshotA Snapshot

OneOne ofof thethe fastestfastest growinggrowing inin thethe worldworld

ConsumptionConsumption growthgrowth fuellingfuelling economiceconomic growthgrowth consumptionconsumption

expenditureexpenditure formingforming 7878%% ofof GDPGDP

ServicesServices sectorsector contributingcontributing overover 6060%% toto GDPGDP

EmergingEmerging asas aa hubhub of of manufacturingmanufacturing excellenceexcellence.. newnew growthgrowth

enginesengines ofof IndianIndian economyeconomy includeinclude IT,IT, ITes,ITes, pharmaceuticals,pharmaceuticals, biobio--

technology,technology, nanonano technology,technology, agriagri.. businessesbusinesses

WhereWhere forcesforces ofof competitioncompetition areare atat workwork

InnovationInnovation drivingdriving enterprisesenterprises

EconomicEconomic reformsreforms wellwell onon coursecourse enteringentering secondsecond phasephase


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Indian Economy and CapitalIndian Economy and Capital

Market at a GlanceMarket at a Glance

9040 brokers in cash segment and 1064 in9040 brokers in cash segment and 1064 in

derivative segment of the marketderivative segment of the market

122investment bankers in the market122investment bankers in the market

58 under writers to support primary issues58 under writers to support primary issues

34 foreign venture capital funds34 foreign venture capital funds

120 Portfolio managers120 Portfolio managers


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Market at a GlanceMarket at a GlanceBusiness Week says that of100 emergingBusiness Week says that of100 emerging

market firms which are rapidly globalisingmarket firms which are rapidly globalising

21 are Indian firms21 are Indian firms

Economists project India to become theEconomists project India to become the

third largest economy in the world by 2040third largest economy in the world by 2040

Indian capital market regulator hasIndian capital market regulator has

acquired international credibility in theacquired international credibility in the

least possible timeleast possible time


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Market at a GlanceMarket at a GlanceIndia has a disclosure based regime ofIndia has a disclosure based regime of

regulationregulation

Disclosu

re and Investor ProtectionDisclosu

re and Investor Protectionguidelines availableguidelines available

Indias accounting standards are closer toIndias accounting standards are closer to

international standardsinternational standards

India has a well laid down legal frameworkIndia has a well laid down legal framework


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Market at a GlanceMarket at a GlanceIndia has T+2 rolling settlement asIndia has T+2 rolling settlement as

opposed to T+3in NYSE.opposed to T+3in NYSE.

In India the transactions are totallyIn India the transactions are totallyelectronic on a real time basis.electronic on a real time basis.

India has several protective safeguards forIndia has several protective safeguards for

the retail investor such as grading systemthe retail investor such as grading system

of public offering, retail quota at 25 perof public offering, retail quota at 25 per

cent etc.cent etc.


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Market at a GlanceMarket at a GlanceAs an integral part of risk managementAs an integral part of risk managementtrading and exposure limits,trading and exposure limits, variousvariousmargins and mark to market margins aremargins and mark to market margins are

in voguein vogueClearing housesClearing houses inin placeplace

Almost 100 per cent risk free electronicAlmost 100 per cent risk free electronic

settlement through depository systemsettlement through depository systemSEBI has a surveillance and enforcementSEBI has a surveillance and enforcementsystem in placesystem in place


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India - one of10 fastest-growing population of HNWIs globally

There are at least 23Indian citizens amongst the richest people on

the planet

Non Resident Indians can invest in all Indian Asset Classes

Salary increases in India 13.9% is the highest in the world

Increasing Investment avenues Art, Realty Funds, Commodities

The number of companies listed on the Bombay Stock Exchange,

at more than 6,000, is second only to NYSE.

Each year2,500 tonnes of gold is mined (fifth of the world's gold

output.) and 3,500 tonnes is consumed, of which 1,000 tonnes is

consumed in India alone.

Indian Economy and Capital Market at a Glance


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Sustained GDP Growth

High GDP Growth

Growth Gap Over The World

DemographicsHalf the population below 25 yrs

ConsumerismRetail credit, low interest rates,

changing aspirations

InfrastructureDevelopment of roads, ports,

telecom

ReformsFDI, Tax reforms

Global

competitiveness

Exports

Outsourcing

Indian Equities

Long term prospects are intact


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Market infrastructureMarket infrastructure

Stock exchangeStock exchange

Clearing and settlementClearing and settlement

Education and trainingEducation and training

Investors protectionInvestors protection

Rating agencyRating agency


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IntermediariesIntermediaries

Financial intermediaries may stand in betweenFinancial intermediaries may stand in between

ultimate lenders and ultimate borrowersultimate lenders and ultimate borrowers

Merchant BankersMerchant Bankers

Stock brokersStock brokers

AdvisorsAdvisors

BanksBanks

Mutual Funds etcMutual Funds etc


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Function of FinancialFunction of Financial

Intermediaries: Indirect FinanceIntermediaries: Indirect FinanceWhy is there indirect finance, i.e., what is theWhy is there indirect finance, i.e., what is therationale forfinancial intermediation?rationale forfinancial intermediation?

1.1. Lower transaction costsLower transaction costs

2.2. Risk managementRisk management

3.3. Asymmetric informationAsymmetric information


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1. Transaction Costs1. Transaction Costs

Transaction CostsTransaction Costs resources (time/money)resources (time/money)used in carrying out the exchange of assets,used in carrying out the exchange of assets,goods or servicesgoods or services

Economies of scaleEconomies of scale Reduction in transaction costs per dollar ofReduction in transaction costs per dollar of

transactiontransaction

Example: legal costs for blueprint contractExample: legal costs for blueprint contract

Liquidity servicesLiq

uidity services Coordination across depositCoordination across deposit--taking and lendingtaking and lending

activitiesactivities


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2. Risk Management2. Risk Management

Risk sharingRisk sharing

Asset transformationAsset transformationRisk transformation: sell lowRisk transformation: sell low--risk assets and userisk assets and use

acquired funds to buy riskier assetsacquired funds to buy riskier assetsMaturity transformation: convert funds lent for aMaturity transformation: convert funds lent for ashortshort--period into loans of longer durationperiod into loans of longer duration

DiversificationDiversification the holding of multiplethe holding of multiple

(not perfectly correlated) assets(not perfectly correlated) assets Take advantage of portfolio effectsTake advantage of portfolio effects


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3. Asymmetric Information3. Asymmetric Information

Asymmetric distribution ofinformation between agentsAsymmetric distribution ofinformation between agents Example: borrower has betterinformation about investmentExample: borrower has betterinformation about investment

project than the lenderproject than the lender

Economic incentives matterEconomic incentives matter

Adverse SelectionAdverse Selection (before the transaction)(before the transaction) Example: more likely to select risky borrowerExample: more likely to select risky borrower

Moral HazardMoral Hazard (after the transaction)(after the transaction) Example: activities making loan repayment by borrower lessExample: activities making loan repayment by borrower less

likelylikely


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Role and Functions ofRole and Functions of

a stock exchangea stock exchangeEstablished for the purpose ofEstablished for the purpose of

assisting, regulating andassisting, regulating and

controlling business of buying,controlling business of buying,

selling and dealing in securitiesselling and dealing in securities


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a stock exchange contda stock exchange contd

Provides a market for the trading ofProvides a market for the trading of

securities to individuals andsecurities to individuals and

organizations seeking to invest theirorganizations seeking to invest theirsaving or excess funds through thesaving or excess funds through the

purchase of securitiespurchase of securities


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Role and Functions of

a stock exchange contdProvides a physical location

for buying and selling

securities that have been

listed for trading on that

exchange


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Role and Functions of

a stock exchange contdEstablishes rules for fair

trading practices and

regulates the tradingactivities of its members

according to those rules


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a stock exchangea stock exchange contdcontd

The exchange itself doesnot buy or sell the

securities, nor does it set

prices for them


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FairFair

TheThe exchangeexchange assuresassures thatthat

nono investorinvestor willwill havehave anan

undueundue advantageadvantage overover otherother

marketmarket participantsparticipants


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Efficient marketEfficient market

This means that ordersThis means that ordersare executed andare executed andtransactions are settledtransactions are settledin the fastest possiblein the fastest possible

wayway


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TransparencyTransparency

Investor make informed andInvestor make informed and

intelligent decision aboutintelligent decision about

the particular stock basedthe particular stock based

on informationon information


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Transparency contdTransparency contd

Listed companies mustListed companies must

disclose information indisclose information in

timely, complete andtimely, complete and

accurate manner to theaccurate manner to the

Exchange and the public onExchange and the public ona regular basisa regular basis


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Transparency contdTransparency contd

Required information includeRequired information include

stock price, corporate conditionsstock price, corporate conditions

and developments dividend,and developments dividend,mergers and joint ventures, andmergers and joint ventures, and

management changes etcmanagement changes etc


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Doing businessDoing business

People who buy or sell

stock on an exchange do

so through a broker


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Doing business contdDoing business contd

The broker takes your order

to the floor of the exchange

looks for a brokerrepresenting someone

wanting to buy/sell

If a mutually agreeable price

is found the trade is made


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PricePrice

At any point in time, theprice of previouslyissued stock isdetermined by the ebb

and flow of supply anddemand


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Listing requirementsListing requirements

There are specificThere are specific

requirements for allowing arequirements for allowing a

public company to list itspublic company to list itssecurities on the Stocksecurities on the Stock

Exchange these are set outExchange these are set out

in the legislationin the legislation


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Benefits of listing

Visibility

Market support

Investors confidence Increased demand for products and

services

Overall increase in profitability


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Once tradedOnce traded

Aura of reliabilityAura of reliability

Accuracy in reporting financialAccuracy in reporting financial

datadata

ReputationReputation

StrengthStrength


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Delisting

Stock exchange can delist companies

for a number of reasons including :-

Merger with another company Solvency problems

Name change company asked to be

removed

Failure to comply with exchange rules


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Desirable Characteristics

of a stock market contd Availability of information

Market efficiency

Prices react quickly to new

information

Small price fluctuations Narrow price spread


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Financing the exchangeFinancing the exchange

Transaction fees paid by members forTransaction fees paid by members for

each order executedeach order executed

Fees paid by

firms when their sec

uritiesFees paid by

firms when their sec

uritiesare originally listedare originally listed

Annual fees by firmsAnnual fees by firms

Entrance fees from new membersEntrance fees from new members

sale of historic trading and marketsale of historic trading and market

informationinformation


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Major challenges for theMajor challenges for the

ExchangesExchanges

Cross border trading

Issuers and investors are

expanding their horizons beyondtheir home markets

Investors becoming much more

demanding

Regulatory improvementRegulatory improvement


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Regulatory improvementRegulatory improvement

Transparency and CorporateTransparency and Corporate

GovernanceGovernance

Corporate

Governance

Protection to

minority

Shareholders

Disclosure

Enhancemarket

confidence

Strong

industry

regulator


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Some important pointsSome important points

Academic HonestyAcademic Honesty

Individual Work Only, Allows for GroupIndividual Work Only, Allows for Group

Discussion of Concepts and ProblemsDiscussion of Concepts and Problems

Do Not Copy WorkDo Not Copy Work

Reference Any SourceReference Any Source

When Confused Ask InstructorWhen Confused Ask Instructor

Topic 1 Introduction to Financial markets

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Transcript of Topic 1 Introduction to Financial markets