Global Financial Market. Private Financial Intermediaries (FIs) Private FIs: profit-seeking firms whose assets are predominantly financial. Financial

Global Financial Market

Private Financial Intermediaries (FIs)

• Private FIs: profit-seeking firms whose assets are predominantly financial.

• Financial Intermediaries (FIs) are the professionals that guide us through our risk shifting and cash flow timing transactions in financial markets.

Broker/Dealer Operations• Broker:

FI that brings together buyers and sellers without acting as a principle in the transaction.

• Dealer: FI that makes a market in a financial security, thereby participating as a principal in the financial transaction.

• Market Maker or Specialists: Dealers that make a market in one or more number of securities and who maintain a “fair and orderly” market by dealing personally in the market.

Other Operations of Private FIs

• Underwriting: the process whereby the FI brings to market a newly issued financial security.

• Asset Transformation: the FI’s creation of new financial securities by selling financial securities that are different from the financial securities it buys.

• Securitization: the packaging of non-traded financial securities into a newly created tradable financial security.

The Structure of Financial Markets

• Two settings: 1. Formal Financial Exchanges 2. Over-the-counter (OTC) Markets• Financial Exchanges are formalized Trading

Institutions. Only members have the right to trade in Fin. Exchanges. Each Financial Exchange has detailed and explicit rules governing the conduct of the trade of securities.

Examples:NYSE: New York Stock ExchangeCBOT: Chicago Board of TradeCME: Chicago Mercantile ExchangeLIFFE: London International Financial Futures ExchangeLSE: London Stock Exchange

The Structure of Financial Markets (cont.)

• Over The Counter (OTC) covers all other financial market transactions. In an OTC trade buyer or seller are free to negotiate all contractual details. Modern OTC markets rely on telephone and computer screens to link buyers and sellers with market dealers. Dealers quote both bid and ask prices to prospective buyers and sellers.

• Examples: NASDAQ, FX Market

NASDAQ: National Association of Securities Trader Automated QuotationFX Market: Foreign Exchange Inter-bank Market

The Structure of Financial Markets (cont.)

• Drivers of Liquidity: Manual vs. Automated trading systems

Example 1: Trade in German Govt. Bond futures moved from LIFFE derivatives market to Swiss-German derivatives exchange EUREXExample 2: Flight from BBB to AA bonds in 1998 after Russian Default

• Liquidity can also be created through the removal of credit (counterparty) risk. In the money market use of “Sale and Repurchase of Agreement’ or REPO is such an example.

• Repo is a short-term contract when one party agrees to sell a security to another party (the lender) and then repurchase subsequently at a higher price.

Clearing & Settlement Service

• Process: Each party (say A&B) keeps cash in a Bank Account, known as Clearing Bank) and keeps his/her own securities in “securities accounts”. To settle a trade, the securities are taking out of party A’s account and deposited into party B’s account, while the cash is taking out of party B’s account and deposited into party A’s account.

• Oldest method – messengers sent for confirmation (up to 50’s).

Clearing & Settlement Service (cont.)

• Depository Trust Company (DTC) in 60’s.• All parties have securities accounts with DTC and DTC

keeps records of all transfers.• Other than the recording a trade, a trade confirmation is

also required. In last 30 years, all clearing houses are consolidated as:

• For equity trades: National Security Clearing Corporation (NSCC)

• For all Fixed Income: Fixed Income Clearing Corporation (FICC)

• Both NSCC and FICC, as well as DTC are subsidiaries of Depository Trust & Clearing Corporation (DTCC).

• Today most trades are handled in an automated fashion from organization to settlement (called Straight through Processing, STP).


• Regulations: • There are two types of regulation in securities market,

one by legislation (through US government) and the other is self governing. After Great Depression and 1929 market crash, the Security Act helped to create SEC or Security Exchange Commission and Commodity Futures Trading Commission (CFTC in 1972) which are government agencies.

• Non-government agencies/ self regulatory organizations:

National Association of Security Dealers (NASC)National Futures Association (NFA)Bond Markets Association ( BMA)

• Regulation and Compliance:• Whether self regulated or regulated by government,

compliance is an important issue in every firm.


Type of PFI

1. Buy-side companies:Professional Asset Management Companies (invest

client’s money): Blackrock, PIMCO, BGI, Deutsche Asset Mgmt

Mutual Fund Co.2. Flagship Sell-side companies are: Goldman Sachs Morgan Stanley Lehman Bros Bear Sterns3. Mutual Fund or Asset management companies. Fidelity Vanguard


Commercial Bank and Investment Bank

• 1930’s Glass Steagal Act d separated the Commercial Banking activity and Investment Banking activity. In 1990’s it changed and

• Citibank bought Salomon Brothers• Chase bought JP Morgan• UBS• HSBC• Deutsche Bank• Credit Swiss


Money is made in Private Financial Intermediaries• Investment Banking fees• Asset Management fees• Brokerage fees• Market making revenues• Proprietary trading revenues• Hedge Funds make money from asset management and

proprietary trading• Dealers make money from Market making revenues and

Proprietary trading revenues• Brokers make money from Brokerage fees.

Global Financial Markets• 1700’s: London, Amsterdam, Paris, Antwerp• Mid-1800’s: London, Amsterdam, Paris and New York• Mid-1900’s: mainly New York• 1990: London is back with New York, Tokyo• 1990’s: PIMCO, BAI – west coast Florida, California

USA Europe Asia AustraliaNew York London Tokyo SydneyChicago Paris Singapore

Frankfort Hong Kong+California Amsterdam Shanghai+Florida Bombay

Global Financial Markets (cont.)

• Investment Banking Underwriting Bringing new securities

to market Advising on Mergers &

Acquisitions

• Retail Brokerage – buy/sell securities for clients Maintain accounts for individual

investments• Prime Brokerage – buy & sell to other brokers/ dealers• Asset Management – buy side activity• Equities / Fixed Income / Securities – Trading


• Trading groups are organized by type of customers.• Hedge Funds, Banks, Asset Managers, Corporations• Trading group include a Trader, Trading Assistants, Interns +

some Quants And Technology people for support.• Trade Solicitation vs. Pricing securities vs. Closing Trade• Trading Books and manage p&L of the trading Desk• Bank Office or operations - reconciliation/clearing

- netting - settling trades

• Traders are supported by research group 1. Understand the existing Pricing Model2. Develop programs that traders could run on their

computers• All have Market Data Platforms (Bloomberg or Reuters)• Recent trend is Quantitative Risk Management


• Other Market Players1. Portfolio Managers data mining task2. Hedge Funds Use models and take risks (smaller operations) typically hires – quant traders

• Quant traders need expertise in Excel modeling but knowledge of quantitative modeling and the knowledge of particular products are necessary.

• Desk Quants creates and maintains quantitative models that are used in day to day trading activity. Desk Quants are an intermediary between trader and technology units.

• Sales and Market Research• They provide research support to the sales people. Broader

analysis of economic / political / and issues driving market.


Positions of hiring:

• Analysts vs. Associates

• VP vs. Directors

• Managing director

Sell Side Financial Intermediaries: Participants in Secondary Markets

Dealer Dealer Dealer

Inter BrokerDealer

ExchangesNYSE

ExchangesNASDAQ

ExchangesFCN

Broker Broker Broker

I N V E S T O R S

TOP MANAGEMENT

Legal / Compliance

Revenue / Producing

Technology Risk Management

Investment Banking

Asset Management

Retail / Prime Brokarage

Equity

Fixed Income

Organization Structure of a Sell Side Financial Intermediaries:

Foreign Exchange

Rates Credit Risk Management

Mortgages

Munis

Treasuries Int. Rate Derivatives

Swaps Structured Products

Market Participants:Firms Government Agencies Other FIs

General Motors

US Treasury FNMA World Banks

Goldman Sachs Lehman Bros. Citi Group

I

N V E S T O R S

Global Financial Markets

Size of Different Global Financial Markets

(Source: RPM Handbook)

Table 1. Key Statistics for the Principle Global Equity Market

2002 Market Cap (End Yr) $ Trillion

Average Daily Turnover

$ Billion

Average Transaction Value

$ Thousand

NYSE 9.0 40.9 19

NASDAQ 2.0 28.8 12

London Stock Exchange

1.8 15.9 105

Euronext 1.5 7.8 31

Tokyo 2.1 6.4 n/a

Deutsche Borse 0.7 4.8 17

Other N. America 0.6 6.3

Other Europe 2.1 10.1

Emerging Markets 3.0 13.1

Total 22.8 134.0

Table 2. Stock of International and Domestic Market Debt, Sept. 2003 (US$ Trillion)

All Maturities Remaining Maturities < 12M

Domestic Internat’l Total Domestic Internat’l Total

Government 18.1 1.1 19.2 4.1 0.1 4.2

Financial Institutions 15.5 7.8 23.2 4.0 1.4 5.4

Corporate Sector 4.9 1.4 6.3 0.6 0.2 0.8

Total 38.5 10.2 48.7 8.7 1.7 10.4

Table 3. Market Capitalization of Bonds Listed on Principal Exchanges (US $ Trillion)

Luxembourg London Osaka NYSE Italy

Domestic Public Sector

0.0 0.0 3.6 1.1 1.1

Domestic Private Sector

0.1 0.1 0.1 0.2 0.1

Foreign 4.8 0.6 0.0 0.1 0.0

Total 4.9 0.7 3.7 1.4 1.2

Table 4. Daily Foreign Exchange Turnover April 2001 (US$ Billion)

Different Foreign Exchange Markets

Turnover Volume (US$ Billion)

Spot 387

Forward 131

Foreign Exchange Swap 656

Total 1173

Table 5. Major OTC Derivatives June 2003

Notional Amounts

(US$ Trillion)

Gross Market Values

(US$ Billion)

Interest Rate Swaps 94.6 1126

Interest Rate Options 16.9 434

Forward Rate Agreements 10.3 20

Currency Forwards and

Currency Swaps

12.3 476

Currency Swaps 5.2 419

Currency Options 4.6 101

Equity Derivatives 2.8 260

Commodity Derivatives 1.0 110

Other Including Credit

Derivatives

22.0 1083

Total 169.7 4029

Table 6. Principal Exchanges for Equity Derivatives

Notes: EUREX was formed joining DTB and SOFEX Euornext is a combination of Dutch and Paris exchanges

DTB: Deutsche TerminBorse

SOFEX: Swiss Options and Financial Futures Exchanges

Millions of Contracts Traded 2002

Individual Stock Equity Index

Options Futures Options Futures

AMEX 150.7 32.7

BOVESPA (Sao Paolo Stock Exchange)

89.7 1.1

Chicago Board Options Exchange

173.2 94.4

Chicago Mercantile Exchange

5.4 212.2

International Securities Exchange

152.3

EUREX 143.3 0.1 90.3 120.4

Euronext 323.6 7.6 108.3 51.9

Pacific SE 72.7 12.7

Philadelphia SE/BOT 84.9 3.6

World-Wide 1300.0 57.1 420.2 531.3

Table 7. Principal Exchanges for Fixed Income DerivativesMillions of Contracts Traded 2002

Government Debt Interest Rate


Chicago Board Options Exchange (CBOT)

54.7 205.6 7.7

Chicago Mercantile Exchange (CME)

105.6 202.5

EUREX 31.6 415.0

Euronext 8.1 42.7 149.2

Korean Futures Exchange 12.8

Sydney Futures Exchange 1.6 21.7

Singapore Exchange 21.7

BM & P 2.5 48.6

World-Wide 89.1 677.5 151.2 532.5

Table 8. Principal Exchanges for Currency and Commodity Derivatives

Millions of Contracts Traded 2002

Currency Commodity


Chicago Board Options Exchange (CBOT)

12.6 54.1

Chicago Mercantile Exchange (CME)

2.2 22.1 0.8 6.8

New York Mercantile Exchange

26.4 107.3

London Metal Exchange 2.3 56.3

Zhenzhou Commodity Exchange

14.6

Tel Aviv SE 12.0

BM & P 2.0 16.1

World-Wide 16.7 41.1 47.8 265.2

Brokers

Dealers

UnderwritersInvestment bankers

Mutual funds Pension funds

Banks

Insurance comp

Non-intermediatedTransactions(direct financing)

Funds SurplusUnits

Funds DeficitUnits

Transparent FIs

Opaque FIs

Financial Securities

FinancialSecurities



FinancialSecurities


Shares


DepositsLoans

PoliciesFinancial Securities

IOUs IOUs

Figure 2.1 Private Financial Intermediaries (FIs)

Documents

Global Financial Market. Private Financial Intermediaries (FIs) Private FIs: profit-seeking firms whose assets are predominantly financial. Financial