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Chapter 1 Market Organization and Structure

Chapter 1 Market Organization and Structure. Presenter Venue Date. What Are the Main Functions of the Financial System?. How Are Rates of Return Determined?. Equilibrium interest rate. How Are Markets Classified?. How Are Assets Classified?. How Are Securities Classified?.

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Chapter 1 Market Organization and Structure

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  1. Chapter 1Market Organization and Structure Presenter Venue Date

  2. What Are the Main Functions of the Financial System?

  3. How Are Rates of Return Determined? Equilibrium interest rate

  4. How Are Markets Classified?

  5. How Are Assets Classified?

  6. How Are Securities Classified?

  7. How Are Contracts Classified?

  8. Pooled Investments Pooled Investments Mutual Funds Trusts Depositories Hedge Funds Limited Partnership Interests Depository Receipts Shares Units Investors

  9. Hedging with Forward Contracts Farmer needs to sell wheat to the miller at a future date. Miller needs to buy wheat from the farmer at a future date to sell to bakers. Risk: the price of wheat increases. The miller is currently short wheat in the spot market (needs to buy it in the future). The miller hedges the spot market position by buying wheat forward. • Risk: the price of wheat decreases. • The farmer is currently long wheat in the spot market (needs to sell it in the future). • The farmer hedges the spot market position by selling wheat forward.

  10. Futures versus Forward Contracts

  11. Swap Contracts

  12. Options

  13. What Are the Major Types of Financial Intermediaries?

  14. Exchanges versus Alternate Trading Systems (ATS)

  15. Depository Institutions

  16. How Do Investors Influence a Bank’s Investment Decisions? Bank’s Balance Sheet Loans Deposits Other investments Other funding sources Who or what receives investor funding? Investors are the primary source of bank funding.

  17. Example of Securitization Mortgage Bank Balance Sheet Mortgages Mortgage-backed securities Lend money to homeowners Buy securities Make payments Receive payments Mortgages are pooled and securities issued are claims on that pool. Interest and principal payments “pass-through” to investors. Homeowners Investors

  18. Insurance Companies INTERMEDIATION

  19. Credit Default Swaps (CDS) Prior to maturity or default Premium Protection buyer Protection seller Protection against default In the event of default Deliverable obligation (physical settlement) or nothing (cash settlement) Protection seller Protection buyer Par (physical settlement) or par less recovery value (cash settlement)

  20. Dealers versus Arbitrageurs

  21. What Positions Can I Take in an Asset?

  22. Option Positions and Their Underlying Risk Exposures

  23. Terminology for Levered Positions

  24. EXAMPLE 1-19 Computing Total Return to a Leveraged Stock Purchase A buyer buys stock on margin and holds the position for exactly one year, during which time the stock pays a dividend. For simplicity, assume that the interest on the loan and the dividend are both paid at the end of the year. Purchase price $20/share Sale price $15/share Shares purchased 1,000 Leverage ratio 2.5 Call money rate 5% Dividend $0.10/share Commission $0.01/share 1. What is the total return on this investment? 2. Why is the loss greater than the 25 percent decrease in the market price?

  25. EXAMPLE 1-20 Margin Call Price A trader buys stock on margin posting 40 percent of the initial stock price of $20 as equity. The maintenance margin requirement for the position is 25 percent. Below what price will a margin call occur?

  26. Compare and Contrast Execution, Validity, and Clearing Instructions

  27. Compare and Contrast Market Orders with Limit Orders

  28. Limit Order Book: “26 Bid, Offered at 28”

  29. Validity Instructions

  30. Stop Orders (Stop-Loss Orders) STOP ORDER: Sell at $30

  31. Primary and Secondary Markets

  32. How Do Secondary Markets Support Primary Markets? Primary markets Cost of Capital Secondary markets

  33. Execution Mechanisms

  34. Order-Driven Markets

  35. What Are the Characteristics of Well-Functioning Financial System?

  36. What Are the Objectives of Market Regulation?

  37. Summary • Main functions of the financial system • Classifications of assets and markets • Financial intermediaries • Long and short positions • Leveraged positions • Execution, validity, and clearing instructions • Market and limit orders • Primary and secondary markets • Quote-driven, order-driven, and brokered markets • Characteristics of a well-functioning market • Objectives of market regulation

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