Global Financial Market by OznN8nG9


									Global Financial Market

     Gautam Goswami
    Fordham University
 Private Financial Intermediaries
• 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
 Other Operations of Private FIs
• Underwriting: the process whereby the FI
  brings to market a newly issued financial
• Asset Transformation: the FI’s creation of new
  financial securities by selling financial securities
  that are different from the financial securities it
• Securitization: the packaging of non-traded
  financial securities into a newly created tradable
  financial security.
      The Structure of Financial
• 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

  NYSE: New York Stock Exchange
  CBOT: Chicago Board of Trade
  CME: Chicago Mercantile Exchange
  LIFFE: London International Financial Futures
  LSE: 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 Quotation
  FX Market: Foreign Exchange Inter-bank Market
      The Structure of Financial
           Markets (cont.)
• Drivers of Liquidity: Manual vs. Automated trading
       Example 1: Trade in German Govt. Bond futures
       moved from LIFFE derivatives market to Swiss-
       German derivatives exchange EUREX
       Example 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
• 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
• For all Fixed Income: Fixed Income Clearing Corporation
• 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).
  Clearing & Settlement Service
• 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
      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.
Clearing & Settlement Service
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 Sterns
3. Mutual Fund or Asset management companies.
  Clearing & Settlement Service
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
• Deutsche Bank
• Credit Swiss
  Clearing & Settlement Service
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           Australia
New York       London         Tokyo           Sydney
Chicago        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 &

• Retail Brokerage – buy/sell securities for clients
                      Maintain accounts for individual
• Prime Brokerage – buy & sell to other brokers/ dealers
• Asset Management – buy side activity
• Equities / Fixed Income / Securities – Trading
 Global Financial Markets (cont.)
• 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 Model
       2. Develop programs that traders could run on their
• All have Market Data Platforms (Bloomberg or Reuters)
• Recent trend is Quantitative Risk Management
 Global Financial Markets (cont.)
• Other Market Players
  1. Portfolio Managers  data mining task
  2. 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

• 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.
 Global Financial Markets (cont.)

Positions of hiring:

• Analysts vs. Associates
• VP vs. Directors
• Managing director
Sell Side Financial Intermediaries:
Participants in Secondary Markets

    Dealer           Dealer            Dealer

             Inter            Dealer      Broker
    Exchanges            Exchanges          Exchanges
      NYSE               NASDAQ               FCN

                Broker         Broker         Broker

I        N       V       E       S      T      O        R   S
   Organization Structure of a Sell Side Financial Intermediaries:

            Legal /           Revenue /      Technology           Risk
            Compliance        Producing                        Management


            Retail / Prime                   Fixed Income

  Foreign             Rates                 Credit            Risk
 Exchange                                                     Management

Mortgages            Treasuries                  Int. Rate

            Munis                   Swaps                       Structured
                      Market Participants:
Firms             Government                    Agencies                Other FIs

  General         US Treasury                  FNMA                     World Banks

        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)   Average Daily   Average Transaction
                           $ Trillion         Turnover      Value
                                              $ Billion     $ Thousand

NYSE                          9.0               40.9                19
NASDAQ                        2.0               28.8                12
London Stock                  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 <
                         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           0.0          0.0       3.6        1.1             1.1

Domestic           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 Turnover Volume (US$ Billion)
Spot                                           387

Forward                                        131

Foreign Exchange Swap                          656

Total                                         1173
                 Table 5. Major OTC Derivatives June 2003

                          Notional Amounts      Gross Market Values
                          (US$ Trillion)        (US$ Billion)
Interest Rate Swaps                 94.6                    1126

Interest Rate Options               16.9                    434

Forward Rate Agreements             10.3                     20

Currency Forwards and               12.3                    476
Currency Swaps
Currency Swaps                       5.2                    419

Currency Options                     4.6                    101

Equity Derivatives                   2.8                    260

Commodity Derivatives                1.0                    110

Other Including Credit              22.0                    1083
Total                               169.7                   4029
             Table 6. Principal Exchanges for Equity Derivatives
Millions of Contracts Traded   Individual Stock             Equity Index
                               Options            Futures   Options        Futures
AMEX                               150.7                         32.7
BOVESPA (Sao Paolo                 89.7                           1.1
Stock Exchange)
Chicago Board Options              173.2                         94.4
Chicago Mercantile                                                5.4         212.2
International Securities           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
   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
           Table 7. Principal Exchanges for Fixed Income Derivatives
Millions of Contracts Traded   Government Debt           Interest Rate
                               Options     Futures       Options         Futures
Chicago Board Options             54.7           205.6                       7.7
Exchange (CBOT)
Chicago Mercantile Exchange                                  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   Currency              Commodity
                               Options    Futures    Options     Futures

Chicago Board Options                                    12.6       54.1
Exchange (CBOT)
Chicago Mercantile                 2.2        22.1        0.8       6.8
Exchange (CME)

New York Mercantile                                      26.4      107.3
London Metal Exchange                                     2.3       56.3

Zhenzhou Commodity                                                  14.6
Tel Aviv SE                        12.0

BM & P                             2.0        16.1

World-Wide                         16.7       41.1       47.8      265.2
Figure 2.1   Private Financial Intermediaries (FIs)

                      Financial                              Financial
                      Securities                             Securities

                                          Dealers           Financial
                      Securities                            Securities
                                                                                  Transparent FIs
                        Financial    Investment bankers     Financial
                        Securities                          Securities    Funds Deficit
        Funds Surplus                                        Financial    Units
            Units                                            Securities
                         Shares       Mutual funds
                                      Pension funds
                                                                                   Opaque FIs
                      Policies                               Securities
                                     Insurance comp

                      IOUs                                  IOUs
                                       (direct financing)

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