Lecture002 IBF

7/28/2019 Lecture002 IBF

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Jamil Ahmed

Assistant Professor


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Financial System

Financial System channels funds from savors(lenders/saving surplus units) to users (borrowers/savingdeficit units).

Therefore, a Financial System comprises of some

intermediaries and financial markets who bridge gapebetween the surplus units and deficits units.

The system actually provides a meeting point or focal pointfor who have recourses to spare and who need them.

The intermediaries in turn are composed of institutionsclassified under three categories i.e. Deposit Institutions,Investment Institutions and Contractual Institutions.


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Flow of Funds


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Components of Financial System

Individuals, businesses, national governments,

govt. agencies, local/state governments who

form financial market.

Financial Intermediaries.

Regulators i.e. SBP/SECP & other participants

like security exchanges.


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Financial Markets

Financial markets provide a forum in which

suppliers of funds and demanders of funds can

transact business directly.

Its a market where financial assets are

traded/exchanged.


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Real Assets / Financial Assets

Real Assets: Assets owned by an entityhaving physical shape or are tangible in

nature i.e. Land, building, equipment etc.

Financial Assets: They are intangible assetsrepresenting claim against the future cash

flows.

Both assets are linked as to acquire the realassets a firm has to issue financial assets.


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The Role of Financial Assets

They help in transfer of funds from those

have the surplus to the ones who are in

deficit.

They redistribute the risk associated with cash

flow generated by tangible assets among

those seeking and those providing the assets.


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Role of Financial Markets

Determine the price or required rate of return

of an asset.

Provide liquidity i.e. ability to convert anasset to cash.

Reduces the transaction cost, which consists

of search costs and information costs. Payment Mechanism


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Classification of Financial Markets

- Primary Vs Secondary Markets

Primary Markets

A financial market dealing with financial claims that

are newly issued, is called the primary market.

These markets distribute the newly issued securitiesto investors.

Market Participants:

Corporations & governments as issuers.

Various investors i.e. which include individuals, all

categories of businesses and governments.

Investment bankers who act as agents for issuers.


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The fee earned by underwriter is difference between the pricepaid to the issuer and security re-offered to the investors, termedas Gross Spread or Underwriter Discount.

However, when underwriter only facilitates issue using itsexpertise, the arrangement is referred as best Effort.

The New issue of securities issued through Primary Markets arereferred to as IPOs Initial Public Offerings.

Due to risk intaking whole issue, usually a number ofinvestment banker undertake an IPOs issue, called a Syndicate.The spread in this case is divided among syndicate members.

Primary MarketsProcess of issuing the new Securities (Cont) :


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The IPOs may also be issued by followingprocesses:

Bought dealsAuction Process

Preemptive Rights offering

Private Placements: The distribution of sharesto a limited number of institutional investors.

Primary MarketsProcess of issuing the new Securities (Cont) :


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Secondary Markets

The financial Market where already issued

financial assets are traded.

Key feature is that the issuer of the security

does not benefit from and does not play any

role in this market i.e. issuer does not get

funds from buyers of his securities.

Existing issue change hands.


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Secondary Market

Functions of Secondary Markets

Provides information about the value of a financialassets and in turn a firm issuing the securities. Howinvestors value both.

Non Corporate companies analyze the prices of theirbonds and the rate of interest investors expect anddemand.

They provide the investors/financial assets liquidity.Reduces the cost of transactions.


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Secondary Markets

What constitutes Secondary Markets:

Stock Exchange

Stock Indices:

Market Value Weighted Index: measures the total

value of all the outstanding stock issued by thevarious companies in the index.

Float Adjusted Index: the value of the index

reflects the value available in the public markets.

Price Weighted Index: index is calculated using astock price instead of the company value.

OTC Markets: Represents group of traders

dispersed in a geographical area and linked to an

stock exchange.


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Debt Vs Equity Market:

Debt Market: is a financial market where all sorts ofdebt instruments or financial assets characterized asdebt are traded.

Examples of debt instruments includes T-Bills, notes, bonds

and CDs. Participants: Institutional Investors, Govt.s, Traders,

Individuals.

Equity Market: is financial market where equity

instruments or financial assets representing equity aretraded.

Participants: Institutional Investors, traders and individuals,Govt.s etc.


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Money Vs Capital MarketMoney Market: A financial Market where Short

Term Debt securities are traded e.g. bankersacceptance, commercial papers, repos,negotiable certificates of deposits, Treasury billsof maturity of one year or less.

Capital Market: is the market of financial assets,where issuers can raise long term funds and suchassets are traded e.g. stocks and bonds.


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Broker Markets and Dealer Markets

Broker markets consists of national and regional

securities exchanges, which are organizations that

provide a marketplace in which firms can raise funds

the sale of new securities and purchasers can resell

securities

Dealer markets consist of both the Nasdaq market

and and the over-the-counter (OTC) market, where

the (unlisted) shares of smaller firm are sold and

traded.


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The key difference between broker and dealermarkets is a technical point dealing with the waytrades are executed.

When a trade occurs in a broker market, buyers andsellers are brought together and the trade takes placeon the floor of the exchange.

In contrast, buyers and sellers are never actuallybrought together in a dealer transactions areexecuted by securities dealers that make markets incertain securities.

Broker Markets and Dealer

Markets (continued)


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The New York Stock Exchange (NYSE) is the most

famous of all broker markets and accounts for about

60% of the value of shares traded in the U.S. stock

markets. Trading is conducted through an auction process

where specialists make a market in selected

securities.

As compensation for executing orders, specialists

make money on the spread (bid priceask price).


(cont.)


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The over-the-counter (OTC) market is anintangible market for securities transactions.

Unlike organized exchanges, the OTC is both a

primary market and a secondary market.

The OTC is a computer-based market wheredealers make a market in selected securities and arelinked to buyers and sellers through the NASDAQ

System.

Dealers also make money on the spread.


(cont.)


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International Capital Markets (cont.)

Finally, the international equity market

allows corporations to sell blocks of shares to

investors in a number of different countries

simultaneously.

This market enables corporations to raise far

larger amounts of capital than they could raise

in any single national market.


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Money Market Instruments Following are commonly used money market

instruments:

Treasury Bills

Federal Funds

Repurchase Agreements

Negotiable Certificates of Deposit

Commercial Papers

Bankers Acceptance

Eurodollars


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Capital Market Instruments

Following are commonly used money market

instruments:

T Bonds

Corporate Bonds

Municipal Bonds

Stocks

Lecture002 IBF

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