The financial markets are markets, which facilitate the raising of funds or the investment of assets. The financial markets can be divided into different subtypes: •Capital markets consists of: * Stock markets, which facilitates equity investment and buying and selling of shares of stock. *Bond markets, which provides financing through the issue of debt contracts and the buying and selling of bonds and debentures. •Money markets, which provides short term debt financing and investment. •Derivatives markets, which provides instruments for handling of financial risks. •Futures markets, which provide standardized contracts for trading assets at some forward date; see also forward market. •Insurance markets, which facilitates handling of various risks. •Foreign exchange markets
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Role of financial markets
1. 2. 3. 4. 5.
National growth Entrepreneurship growth Industrial growth
1. Transfer of resources
2. Enhancing income
3. Productive usage 4. Capital formation
5. Price determination
6. Sales mechanism 7. Information
Constituents of Indian Financial Market
Financial Market Money Market Primary Market Secondary Market (DFHI) Capital Market Primary Market Secondary Market
International Financial Market & Reasons for Emergence
Financial market that are integrated and operated world wide by using uniform trading practices are known as “Global/ International Financial Market”
1. 2. 3. 4. 5. Deregulation Science and technology Institutionalization Competition Information flow
1. Provide funds to borrowers 2. Provide lender an opportunity to lend and generate income
3. Provide liquidity
Classification of International Market
Internal market – where the capital issues and issuers are domiciled within the boundaries of a particular country.
External market-also known as foreign market, international market, Euro market or offshore market, deals with the issue of securities not domiciled in the country but are also sold and traded throughout the world. Rules of the country where it is issued .
Constitute of Financial Markets
1. Primary market 2. Secondary market 3. Money market 4. Capital market 5. Debt market 6. Eurobond market 7. Equity market 8. Financial services market (ATM, credit card, leasing, stock borrowing)
INTERNATIONAL MONETARY SYSTEM
It is complex set of rules, mechanisms and agreements that determines the behavior of the foreign exchange market.
GOLD AND GOLD BULLION STANDARD
The first modern international monetary system was the gold standard Operating during the late 19th and early 20th cents. The gold standard provided for the free circulation between nations of gold coins of standard specification. Gold was the only standard of value. During the 1920s the gold standard was replaced by the gold bullion standard
THE GOLD EXCHANGE SYSTEM
In the decades following World War II, international trade was conducted according to the gold Exchange standard. Nations fix the value of their currencies not with respect to gold, but to some foreign currency, which is in turn fixed to and redeemable in gold
At the Bretton Woods international conference in 1944, a system of fixed exchange rates was adopted & International Monetary Fund came into picture
Modified version of Gold Standard adopted by US The US treasury would buy and sell gold for foreign currency only to another government agency
Export and import of gold was prohibited
the gold price was fixed at $35 an ounce, and the US government guaranteed that it would control the price at this level FLOATING EXCHANGE RATE After the collapse of the Bretton Woods Agreements, the world observed a period of high risk in financial markets. High government deficits, high inflation and the OPEC oil embargo increased financial price volatility. In this system the gold standard became Obsolete and the values of various currencies were to be determined by the market .
INTERNATIONAL MONETARY FUND
Agreement came into force on December 27, 1945 The organization came into existence in May 1946(29 counteries signed the article of agreement) Established to promote the health of the world economy. Headquartered in Washington, D.C 184 member countries
Promote international monetary cooperation
Facilitate the expansion and balanced growth of international trade Promote exchange stability and maintain orderly exchange arrangements among members.
INTERNATIONAL MONETARY FUND
• International Monetary Fund (IMF) is an international organization that provides
financial assistance and advice to its member countries and it helps to•Working to foster global monetary cooperation, • Secure financial stability • Facilitate international trade • Promote high employment and sustainable economic growth • Reduce poverty
The IMF works for global prosperity by promoting
• The balanced expansion of world trade • Stability of exchange rates • Avoidance of competitive devaluations, and orderly correction of balance of payments problems. • Providing loans to its member states to help alleviate balance of payments problems.
What Does It Do?
The IMF is responsible for the creation and maintenance of the international monetary system, the system by which international payments among countries take place. It thus strives to provide a systematic mechanism for foreign exchange transactions in order to foster investment and promote balanced global economic trade. To achieve these goals the IMF focuses on and advises the macroeconomic policies of a country, which affect its exchange rate and its government's budget, money, and credit management . The IMF will also appraise a country's financial sector, its regulatory policies, as well as structural 15 policies within the macroeconomic that relate to the Continued.. labor market and employment
How Does It Work?
The IMF gets its money from quota subscriptions paid by member states. The size of each quota is determined by how much each government can pay according to the size of its economy. The quota in turn determines the weight each country has within the IMF and hence it's voting rights as well as how much financing it can receive from the IMF. Twenty-five percent of each country's quota is paid in the form of Special Drawing Rights (SDRs), which are a claim on the freely usable currencies of IMF members
What Is an SDR?
The SDR, or special drawing right, is an international reserve asset introduced by the IMF in 1969 (under the First Amendment to its Articles of Agreement) out of concern among IMF members that the current stock, and prospective growth, of international reserves might not be sufficient to support the expansion of world trade. The main reserve assets were gold and U.S. dollars, and members did not want global reserves to depend on gold production, with its inherent uncertainties, and continuing U.S. balance of payments deficits, which would be needed to provide continuing growth in U.S. dollar reserves. The SDR was introduced as a supplementary reserve asset, which the IMF could "allocate" periodically to members when the need arose, and cancel, as necessary.
International Bank for Reconstruction and Development (IBRD)
The International Bank for Reconstruction and Development better known as the World Bank. Came into existence on December 27, 1945. It started its operations on June 25, 1946 The IBRD was established mainly for reconstruction of Europe and Japan after World War II, with an additional mandate to foster economic growth in developing countries in Africa, Asia and Latin America. . The bank focused mainly on large scale infrastructure projects, building highways, airports, and 18 Continued.. powerplants.
Goal of World Bank
The World Bank provides long term loans, grants, and technical assistance, It provides advice and assistance to developing countries on almost every aspect of economic development.
To help developing countries implement their poverty reduction strategies.It also help in different areas like health and education sector To environmental and infrastructure projects, including dams, roads, and national parks.
The IBRD's Affiliated Agencies
The International Finance Corporation (IFC), established in 1956, The International Development Association (IDA), established in 1960,
The Multilateral Investment Guarantee Agency (MIGA), established in 1988 and
The International Centre for Settlement of Investment Disputes (ICSID), established in 1966.
WORLD BANK AND INDIA
World Bank is currently financing 71 development projects in India with a total commitment of around US$14 billion. In addition, over the past five years, nearly US$ 1 billion has been provided to support broad reform programs in the states of Andhra Pradesh, Karnataka and Uttar Pradesh. It helps India to reduce the number of people living in poverty from one half to one-third of the population.
Some Examples Where World Bank Help India
• Tuberculosis is India’s leading cause of adult illness and death from a communicable disease.Under the Government’s National TB Control Program through which more than 10,000 symptomatic patients are examined and more than 500 lives are saved every day. A World Bank-financed project has helped the government achieve these results by establishing the institutions and managerial capability to expand TB control services nation-wide. • Importantly, the project relies on local community awareness and involvement and is currently benefiting from the assistance of 31,000 community volunteers.
Some Cases Where World Bank Help India
• Population growth in India has brought increased demand for water, placing an unsustainable burden on its water supply systems. Several World Bank financed projects are helping communities manage and improve their irrigation systems to increase their crop yields. The projects have enabled several million farmers and their families to increase their incomes and improve their lives.
• Eurocurrency is any currency that is banked outside of its country of origin. • It could be dollars or yen in London, euro in the United States.Eurodollars which accounts for 75% of all Eurocurrencies are dollars banked outside the United States.
Euro Currency Market
• Onshore Currencies – Currencies banked inside of their country of origin are known as Onshore currencies. • Offshore Currencies – Currencies banked outside of their country of origin are known as offshore currencies. • Thus we can say that Eurocurrency Market is an offshore market.
Genesis and growth of the market
Political events pushed growth of eurocurrency markets in :• 1950s: Eastern European holders of dollars reluctant to make deposits in the U.S. • 1957: British banks no longer allowed to lend pounds to finance non-British • 1960s: US banks discouraged from lending to nonUS residents. • 1973-74 & 1979-80: Oil prices rise and OPEC members who have dollars. Don’t want to deposit in U.S. due to regulations
Major Sources of Eurocurrencies
Foreign Government MNC’s Foreign Banks Countries with large balance of payment surplus
Euro Bank Advantage
Eurocurrency lending rates lower than domestic due to: than domestic due to: Lack of reserve requirements Lack of reserve requirements Lack of fees and expenses Lack of fees and expenses Low transaction costs Low transaction costs
Eurocurrency deposit rates higher than domestic due to: than domestic due to: Lower regulatory costs Lower regulatory costs Larger percentage of deposits can be lent lent 28 Need to be higher to attract domestic deposits Continued..
Rate of interest
Domestic lending rates
Eurocurrency lending rates
Eurocurrency deposit rates
Domestic deposit rates
Maturity: Varies from 3-10 years 10 years Interest rates: For governments, corporations, or nonEuro banks the rate is LIBOR+premium for a given period given period Rollover:: At the end of each period (6 mos.) interest is recalculated at the current LIBOR+premium Syndicates: Banks are primary lenders, often form groups and pool Eurocurrencies for lending Fees: Commitment fee paid annually on balance, penalty 31 fee for payments ahead of schedule penalty Continued..
Drawbacks of Eurocurrency Market
• Bank Failure • Foreign Exchange Risk
What is Foreign Exchange Market
Features of Foreign Exchange Market
The foreign exchange market is an over-thecounter market. The foreign exchange market functions round the clock.
Markets and Market Participants
Central Bank Foreign exchange brokers Commercial banks
Traditional users (Importers,Exporters and investors)
Foreign Exchange Transactions
Spot Transaction:This transaction involves the payment and receipt of the foreign exchange with in two business days after the day the transaction is agreed upon. Forward Transaction: This transaction involves an agreement today to buy or sell a specified amount of a foreign currency at a specified future date at a rate agreed upon today.
Exchange Rate Quotations
Direct Quoting – A direct quote gives the home currency price of a certain amount of foreign currency, usually one or 100 units. Indirect Quoting – The value of one unit of home currency is presented in terms of foreign currency. Buying and Selling Rates – Normally there are two rates published one being buying rate and other is selling rate. The buying rate is called Bid rate. The selling rate is known as the Ask rate.
Spot market is a market where the currencies are traded for immediate delivery at a rate existing on the day of transaction.
The delivery takes two working days after the transaction is complete. If a particular market is closed on Saturday and Sunday and if transaction takes place on Thursday, delivery of currency shall take place on Monday.Monday is known as the Value date or the settlement date.
Currency Arbitrage in Spot Market
Currency Arbitrage- When one currency is purchased at a cheaper rate in one market and sold at a higher rate in the other market. ExampleIn New York : $ 1.980 – 10/pound; and
In London: $1.9710- 10/pound
We will buy the dollar in New York and sell it in London making a profit of $ 1.980-1.9710 = $0.009 per pound.
In forward market, contracts are made to buy and sell currencies for future delivery.The fixed price contract is made today for delivery of a certain amount of currency at a specified future date.The specified date is the settlement date.The agreed-upon price is termed the forward rate.
No money actually changes hands today.
Forward-exchange contracts may be used, to hedge a future import payment or export receipt.
A forward contract can be used by the companies for speculation. 39
The purpose of speculator is to reap profits from the changes in the exchange rates.The source of profit to them being the difference between the forward rate and the future spot rate. ExampleA speculator sells US$ 1000 three months forward at the rate of Rs. 40.50/US$.On maturity US$ depreciates to Rs.40, the speculator will get Rs 40500 under the forward contract.He will exchange Rs 40500 at the then future spot rate of Rs40/US$ and will get US$ 1012.50.He will make profit of US$ 12.50
Speculation in Forward Market
Market For Currency Futures
This market came into being in 1972 when the Chicago Mercantile Exchange had set up its monetary market division for trading of currency futures.Other exchanges were established for this purpose in the subsequent period. Some of them are London International Financial Futures Exchange, Singapore International Monetary Exchange and Sydney Futures Exchange.
What is Currency Futures
A Currency Future contact is a standardize agreement with an organized exchange to buy or sell some items, such as a currency or commodity, at a fixed price at a certain date in the future.Currency futures are similar to foreign exchange forwards in that they are contracts for delivery of a certain amount of a foreign currency at some future date and at known price.
Features Of Currency Futures
Transactions through clearing house
Margin Money Marking to the Market
Market For Currency Options
The currency option has a distinctive feature that is not found in a forward or futures contract.It is the buyer of the currency options has the freedom to exercise the option if the agreed upon rate turns in his favour. If the rate does not turn in his favour, he can let the options expire.Thus the exercising of options is the buyers right but not his obligation.For this privilege the buyer has to pay a premium to the option seller.
Types Of Options
There are two types of Options Call option - The buyer of this option agrees to buy the underlying currency. Put option - The buyer of this option agrees to sell the underlying currency.