Derivatives Markets (Prashant)

8/11/2019 Derivatives Markets (Prashant)

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facilitating trading among independent parties.

Swap: A derivative in which two counterparties agree to exchange one stream of

cash flows against another stream. These streams are called the legs of the swap.

Capital Markets

Capital markets are perhaps the most widely followed markets. Both the stock and

bond markets are closely followed and their daily movements are analyzed as

proxies for the general economic condition of the world markets. As a result, the

institutions operating in capital markets - stock exchanges, commercial banks and

all types of corporations, including nonbank institutions such as insurance

companies and mortgage banks - are carefully scrutinized.

The institutions operating in the capital markets access them toraise capital for

long-term purposes,such as for a merger or acquisition, to expand a line of

business or enter into a new business, or for other capital projects. Entities that are

raising money for these long-term purposes come to one or more capital markets.

In the bond market, companies may issue debt in the form of corporate bonds,

while both local and federal governments may issue debt in the form of government

bonds. Similarly, companies may decide to raise money by issuing equity on thestock market. Government entities are typically not publicly held and, therefore, do

not usually issue equity. Companies and government entities that issue equity or

debt are considered the sellers in these markets.

The buyers, or the investors, buy the stocks or bonds of the sellers and trade them.

If the seller, or issuer, is placing the securities on the market for the first time, then

the market is known as theprimary market.Conversely, if the securities have

already been issued and are now being traded among buyers, this is done on

thesecondary market.Sellers make money off the sale in the primary market, not

in the secondary market, although they do have a stake in the outcome (pricing) of

their securities in the secondary market.

The buyers of securities in the capital market tend to use funds that are targeted

for longer-term investment. Capital markets are risky markets and are not usually
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used to invest short-term funds. Many investors access the capital markets to save

for retirement or education, as long as the investors have long time horizons, which

usually means they are young and are risk takers.

Money Market

The money market is often accessed alongside the capital markets. While investors

are willing to take on more risk and have patience to invest in capital markets,

money markets are a good place to "park" funds that are needed in a shorter time

period - usually one year or less. The financial instruments used in capital markets

include stocks and bonds, but the instruments used in the money markets include

deposits, collateral loans, acceptances and bills of exchange. Institutions operating

in money markets are central banks, commercial banks and acceptance houses,

among others.

Money markets provide a variety of functions for either individual, corporate or

government entities. Liquidity is often the main purpose for accessing money

markets. When short-term debt is issued, it is often for the purpose of covering

operating expenses or working capital for a company or government and not for

capital improvements or large scale projects. Companies may want to invest funds

overnight and look to the money market to accomplish this, or they may need to

cover payroll and look to the money market to help. The money market plays a key

role in ensuring companies and governments maintain theappropriate level of

liquidityon a daily basis, without falling short and needing a more expensive loan

or without holding excess funds and missing the opportunity of gaining interest on

funds.

Investors, on the other hand, use the money markets to invest funds in a safe

manner. Unlike capital markets, money markets are considered low risk; risk-

adverse investors are willing to access them with the anticipation that liquidity is

readily available. Older individuals living on a fixed income often use the moneymarkets because of the safety associated with these types of investments.

The Bottom Line

There are bothdifferences and similarities between capital and money markets.

From the issuer or seller's standpoint, both markets provide a necessary business

function: maintaining adequate levels of funding. The goal for which sellers access
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each market varies depending on their liquidity needs and time horizon. Similarly,

investors or buyers have unique reasons for going to each market: Capital markets

offer higher-risk investments, while money markets offer safer assets; money

market returns are often low but steady, while capital markets offer higher returns.

The magnitude of capital market returns is often a direct correlation to the level of

risk, however that is not always the case.

Although markets are deemed efficient in the long run, short-term inefficiencies

allow investors to capitalize on anomalies and reap higher rewards that may be out

of proportion to the level of risk. Those anomalies are exactly what investors in

capital markets try to uncover. Although money markets are considered safe, they

have occasionally experienced negative returns. Inadvertent risk, although unusual,

highlights the risks inherent in investing - whether long or short term, moneymarkets or capital markets.

Commodity.Commodities are bulk goods and raw materials, such as grains, metals, livestock,oil, cotton, coffee, sugar, and cocoa, that are used to produce consumer products.

The term also describes financial products, such as currency or stock and bond indexes.

Commodities are bought and sold on the cash market, and they are traded on the futuresexchanges in the form of futures contracts.

Commodity prices are driven by supply and demand. When a commodity is plentiful -- tomatoesin August, for example -- prices are comparatively low. When a commodity is scarce because ofa bad crop or because it is out of season, the price will generally be higher.

You can buy options on many commodity futures contracts to participate in the market for lessthan it might cost you to buy the underlying futures contracts. You can also invest throughcommodity funds

Definition of 'Equity Financing'

The process of raising capital through the sale of shares in an enterprise. Equity

financing essentially refers to the sale of an ownership interest to raise funds for

business purposes. Equity financing spans a wide range of activities in scale and

scope, from a few thousand dollars raised by an entrepreneur from friends and

family, to giant initial public offerings (IPOs) running into the billions by household

names such as Google and Facebook. While the term is generally associated with

financings by public companies listed on an exchange, it includes financings by


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private companies as well. Equity financing is distinct from debt financing, which

refers to funds borrowed by a business.

Definition of 'Shares'

A unit of ownership interest in a corporation or financial asset. While owning shares

in a business does not mean that the shareholder has direct control over the

business's day-to-day operations, being a shareholder does entitle the possessor to

an equal distribution in any profits, if any are declared in the form of dividends. The

two main types of shares are common shares and preferred shares.

Definition of 'Debenture'

A type of debt instrument that is not secured by physical assets or collateral.

Debentures are backed only by the general creditworthiness and reputation of theissuer. Both corporations and governments frequently issue this type of bond in

order to secure capital. Like other types of bonds, debentures are documented in an

indenture.

Definition of 'Bond'

A debt investment in which an investor loans money to an entity (corporate or

governmental) that borrows the funds for a defined period of time at a fixed

interest rate. Bonds are used by companies, municipalities, states and U.S. and

foreign governments to finance a variety of projects and activities.

Bonds are commonly referred to as fixed-income securities and are one of the three

main asset classes, along with stocks and cash equivalents.

Definition of 'Derivative'

A security whose price is dependent upon or derived from one or more underlyingassets. The derivative itself is merely a contract between two or more parties. Its

value is determined by fluctuations in the underlying asset. The most common

underlying assets include stocks, bonds, commodities, currencies, interest rates and

market indexes. Most derivatives are characterized by high leverage.


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Definition of 'Bull Market'

A financial market of a group of securities in which prices are rising or are expected

to rise. The term "bull market" is most often used to refer to the stock market, but

can be applied to anything that is traded, such as bonds, currencies and

commodities.

Bull market:-

bull market is when the market appears to be in a long-term climb. Bull marketstend to develop when the economy is strong, the unemployment rate is low, andinflation is under control. The emotional and psychological state of investors alsoaffects the market. For example, if investors have faith that the upward trend instock prices will continue, they are likely to buy more stocks. If there are morebuyers interested in buying shares at a given price than there are sellers who arewilling to part with their shares at that price, stock prices will continue to rise.

Bear Market

A bear market describes a market that appears to be in a long-term decline. Bearmarkets tend to develop when the economy enters a recession, unemployment ishigh, and inflation is rising. Investors lose faith in the market as a whole, which inturn decreases the demand for stocks. Keep in mind that a sustained bear market issomething that you should expect to occur from time to time, and that, in the past,the stock market has risen more than it has declined.

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Derivatives Markets (Prashant)