Understanding Financial Markets: Primary vs. Secondary, Money vs. Capital, & Derivatives, Appunti di Economia E Tecnica Dei Mercati Finanziari

Scarica Understanding Financial Markets: Primary vs. Secondary, Money vs. Capital, & Derivatives e più Appunti in PDF di Economia E Tecnica Dei Mercati Finanziari solo su Docsity! INTRO Why study financial markets? Markets and institutions (intermediaries) are the primary channels to allocate capital in our society. Proper capital allocation leads to economic growth and individual and social wealth. There are two different views of Financial Systems (FSs) Structural View: System of financial instruments, intermediaries, markets and supervisors and regulators. The traditional functional View: Allocation of savings, Payment instruments and system, Transmission of monetary policy impulses. According to Merton the functions of FS are mainly stable through time while the FS’s structure evolves. The main driving forces are: ▪ Exogenous: regulation, technology, customers, globalization, etc.; ▪ Endogenous: competition, financial innovation, etc. Changes in FS’s structure influence the effectiveness and efficiency of functions performed by FS. WHAT ARE FIN MARKETS Financial Markets are structures through which funds flow. They can be distinguished among two major dimensions: Primary VS Secondary markets and Money VS Capital markets. Markets can be restricted to particular categories of traders or open to the public and in particular to end-investors. Another distinction is between wholesale and retail markets. Markets can be distinguished with regard to the mode of trading: markets quote driven, markets order driven, hybrid markets. Financial markets can be distinguished along two major dimensions: Primary vs. Secondary markets and Money vs. Capital markets. PRIMARY MARKETS Are markets in which users of funds (e.g., corporations and governments) raise funds by issuing financial instruments such as stocks and bonds. The fund users have new projects or expanded production needs, but do not have sufficient internally generated funds to support these needs. Thus the fund users issue securities in the external primary markets to raise additional funds. New issues of financial instruments are sold to the initial suppliers of funds (households) in exchange for money that the issuer needs. (A needs money, A issues financial instruments, B buys them, A receives money immediately, B has a bond or a stock that will mature). Most primary market transactions in Usa are arranged through financial institutions called investment banks that act as intermediaries between issuing corp. and investors. By issuing primary market securities with the help of an investment bank, the funds user saves the risk and cost of creating a market for its securities on its own. The investment bank provides the security issuer with advice on the securities issues (such as offer price and number of securities) and attracts the initial public purchasers. Rather than a Public Offering (an offer of sale to the investing public at large) a primary market sale can take the form of a private placement. With Private Placement the user of funds seeks to find an institutional buyer to purchase the whole issue. Privately placed securities have been among the most illiquid assets. Primary market fin. Instruments include issues of equity by firms initially going public (allowing their equity or shares to be publicly traded on stock markets for the first time). This first time issues are called (IPOs) initial public offering. Other example of primary markets is government bond auctions, placements of private issuers (seasoned stocks/ IPOs). SECONDARY MARKETS Are markets where financial instruments are traded (rebought/ resold) among investors. Once financial instruments such as stocks are issued in primary markets, they are then traded in secondary markets. Buyers of secondary markets are economic agents (consumers, businesses and governments) with excess funds while sellers are economic agents in need of funds. It is a centralized marketplace where economic agents know they can transact quickly and efficiently. These markets give the opportunity to save time and costs of seeking buyers or sellers on their own. Usually the transactions in this market go through a security broker that acts as an intermediary (the initial issuer of the instrument is not involved in this transfer). Secondary markets exist also for financial instruments backed by mortgages and other assets. Secondary markets offer benefits to both investors (supplier of funds) and issuing corporations (users of funds). They offer buyers and sellers liquidity (=the ability to turn an asset into cash quickly) as well as info about prices or the value of their investment. Some examples of secondary markets are: NYSE, Nasdaq and the Italian Stock Exchange. The secondary market does not provide new resources to deficit units, but it is critical to 1. Ensure liquidity to investors 2. Permit assessment of the securities issued in the continuous (and therefore to make possible the activities of institutional and private investors). MONEY MARKETS markets that trade debt securities with maturities of one year or less (e.g. US, and Italian treasury bills). In this context economic agents with short-term excess supplies of funds can REQUIREMENTS FOR MARKET EFFICIENCY -Width: order volumes -Thickness: thick price distribution -Elasticity: reactivity of orders for limited price variations -The design / modification of organizational and operational characteristics of financial markets is aimed to improve the efficiency conditions and pricing (price discovery) TYPES OF BROKERAGE SERVICES Brokers who work exclusively for third parties by facilitating the search for trade partners and making it possible to cross between supply and demand. They can offer information services. Dealers who operate on their own account and perform the function of making liquid the market of particular financial assets, ensuring the continuity of trades. They hold their own portfolio of financial assets they use to respond promptly to the trading needs expressed by other operators. expressing the purchase price (bid) and selling prices (ask). Market makers are operators acting on their own account and who are committed to make public pricing conditions at which they are willing to negotiate: quoting prices at which they wish to purchase (bid) and sell (ask) minimum lots of financial assets. They are committed to "make a market". PROVISION OF INVESTMENT SERVICES Under Security Market Law (art. 1) "Investment services and activities" we mean the following tasks when pertaining to financial instruments: 1. proprietary trading 2. execution of orders on behalf of clients 3. underwriting and / or placement on a firm commitment or with residual commitment to issuers 3.2 placement without firm or residual commitment to issuers d) portfolio management 4. reception and transmission of orders 5. advice on investments 6. management of (Multilateral Trading Facilities) MTFs: self-regulated financial trading venue. These are alternatives to the traditional stock exchanges where a market is made in securities, typically using electronic systems FINANCIAL INSTITUTION FIs perform the essential function of channeling funds from those with surplus funds (suppliers of funds) to those with shortages of funds (users of funds). FIs are authorized and supervised agents Depository institutions: commercial banks, savings associations, savings banks and credit unions Non Depository: • Contractual: insurance companies, pension funds • Non-contractual:securities firms, investment banks and mutual funds Why there’s a need for FIs? First, once they have lent money in exchange for financial claims, suppliers of funds need to monitor continuously the use of their funds. They must be sure that the user of funds neither steals the funds outright nor wastes the funds on projects that have low or negative returns, since this would lower the chances of being repaid. MONITORING IS COSTLY (time, expense, effort to collect all necessary info). Second, is the liquidity cost, given the choice between holding cash and long-term securities, fund suppliers may well choose to hold cash for liquidity reasons, especially if they plan to use their savings to finance consumption expenditures in the near future and financial markets are not very developed, or deep, in terms of the number of active buyers and sellers in the market. Third, fund suppliers face a price risk (risk that an asset’s sale price will be lower than its purchase price) upon the sale of securities. Because of (1) monitoring costs, (2) liquidity costs, and (3) price risk, the average investor in a world without FIs would likely view direct investment in financial claims and markets as an unattractive proposition and prefer to hold cash. As a result the financial system has developed an alternative and indirect way for investors to channel funds to users of funds. This is the INDIRECT TRASNFER of funds to ultimate users of funds via FIs. WHY DO FIS EXIST? Economies of scale on transaction costs • Search costs • Screening costs • Costs to produce financial contracts • Monitoring costs Provision of liquidity services Risk sharing provision • Asset transformation • Portfolio diversification Asymmetric information • Screening and monitoring aimed to minimize informational asymmetries Risks Incurred By FIs Financial Institutions face many types of risk. Specifically, FI hold some assets that are potentially subject to default or credit risk. FINANCIAL RISKS: 1. Credit 2. Assets subject to Default or Credit risk. 3. Foreign exchange risk and country or sovereign risk. 4. Interest rate risk because FIs actively trade these assets and liabilities rather than hold them for longer-term investments. 5. Market or Asset price risk (price and volatility) 6. Off-Balance Sheet risk because FIs hold contingent assets and liabilities off the balance sheet. 7. Liquidity risk 8. Bank Insolvency OPERATIONAL RISKS: 1. Technology 2. Human errors and frauds 3. Legal and compliance 4. Reputation 5. Natural disasters Credit risk is the risk that the promised cash flows from loans and securities held by FIs may not be paid in full FIs make loans or buy bonds backed by a small percentage of capital Thus, banks, thrifts, and insurance companies can be significantly hurt by even minor amounts of loan losses