Key Points To note on Financial Markets

- the history of Financial Markets and Insurance; Market Regulation; Money Markets; Bond
Markets and Trading
- understanding of financial markets, analysis of market events and ability to perform
valuations of financial instruments
- High Frequency Trading and the Dodd-Frank Act

- OTC market is a virtual market directly between the buyers and the sellers. The trades in OTC
markets are not centrally cleared but after the financial crisis of 2007 some regulations were
introduced to have some contracts cleared through central counterparty (CCP) which is exactly
similar to an exchange clearing house. 

- Banks, other large financial institutions, fund managers, and 

- corporations are the main participants in OTC derivatives markets. In OTC markets the
trades/contracts are non-standardized.

In exchange, we have the concept of central clearing house and all the trades pass through clearing
house which reduces the default risk in the trade. The contracts are standardized as per rules and
regulations of the exchange.

Pg 32 John Hull option futures and other derivatives 10th edition. details explanation on clearing houses, 
CCP and bilateral clearing. Also check the faculty reply.

Get broader understanding of financial markets…..

Functions of Financial Markets

Financial markets create an open and regulated system for companies to
acquire large amounts of capital.7 This is done through the stock and bond
markets. Markets also allow these businesses to offset risk. They do this with
commodities, foreign exchange futures contracts, and other derivatives.

Since the markets are public, they provide an open and transparent way to set
prices on everything traded. They reflect all available knowledge about
everything traded. This reduces the cost of obtaining information because it's
already incorporated into the price.

The sheer size of the financial markets provides liquidity. In other words,
sellers can unload assets whenever they need to raise cash. The size also
reduces the cost of doing business. Companies don't have to go far to find a
buyer or someone willing to sell.
Key points to note from Enron Downfall

1. Deregulation of the energy markets allowed companies to place bets on

future prices
QE & Interest Rates

There is a negative relation between QE and interest rates. To execute quantitative easing,
central banks increase the supply of money by buying government bonds and other
securities. Increase in the supply of money lowers the interest rates.

For relative performance risk, you need to take the interest rate of another asset with the
same risk level and the same maturity. No need to multiply with the probability.

Regulation

Any regulation by the Government of any country is known as government regulation while
regulations by non-governmental organizations (NGOs) are known as non-governmental
regulations. IFRS and ISO are examples of non-governmental regulations.

Direct regulations will be directed towards any sector/industry like mining industry, oil and
gas sector etc. Indirect regulation is not directed towards any sector but has indirect impact
of any sector.

Domestic regulation is the regulation by any country while international regulation is

applicable to a number of countries like Basel III regulation is an international regulation.

Central Banks

 the central banks issues a monetary policy to control inflation and adjust the inflation rates.
Central banks can increase or decrease the money supply to adjust various economic
indicators.

Every country is independent and can the decide about the money supply and the value of its
currency. By changing the value of its currency, the import/export is also adjusted and there
is no international regulatory body to ask the country to change its money supply or the
value of the currency. Take the example of China whose currency is undervalued by more
than 10% which helps in its exports. The US and the European countries are asking China to
adjust the value of its currency for a long time. 

Fixed income & Bond income

Bonds are also called fixed income securities while bond income is the future cash flows of
any bond.

Market Crash
In a market crash, the money is wiped out or goes in the air as no one get benefitted from it.
It s hard to say about the panicked sellers as sometimes it seems a good decision to sell,
sometimes not. But essentially the trades involved in short selling are benefitted when there
is a market crash as they can buy at a much lower price to earn profit.

Demonetization

Demonetization is done for various reasons like trade purpose, to control hyperinflation or
to combat corruption and crime . The Indian government did demonetization with a goal to
combat India's thriving underground economy, fight tax evasion and to eliminate the black
money.

Debt Instrument

Any debt instrument with some additional features (like callable bond) are still known as
fixed income instruments although they can have different cash flows. You are right to say
that their volatility measures are different and we have many types of debt instruments in
the market with these kinds of features and they are still a part of fixed income or debt
instrument.

Devaluation

The devaluation of currency or increase in interest rates is not a single factors for the
financial crisis to happen e.g. 2007-2008 financial crisis began years earlier with
cheap credit and lax lending standards that fueled a housing bubble.

The interest rates usually rise during the recession. At the start of a recession, there
is an increase in demand for liquidity. Businesses rely on credit to cover their
operations in the face of falling sales and consumers run up credit cards or other
sources of credit to make up for the loss of income. There's a decrease in supply at
the same time, as banks curtail lending. W

hen demand increases and supply decreases, prices rise sharply. So the normal
expectation would be for interest rates to rise as the recession begins.

Higher interest rates in a country increase the value of that country's currency
relative to nations offering lower interest rates. Higher interest rates offer lenders in
an economy a higher return relative to other countries which increases the value of
currency. The higher interest rates attract foreign capital and cause the exchange
rate to rise. When this happens, its exchange rate improves. I don't think this
situation will lead to financial crisis.

Speculation

The speculators are one of the big participants in the derivative markets. I hope you are
talking about interest (attraction) and not the interest rate. don't think interest can be any
variable in deciding the price of any derivative instrument.

In derivative holding is also not possible as the transaction has to be completed at maturity
and not before it. So, holding of underlying assets is not a concern at the time of finalizing a
contract plus we have the concept of short selling also.  If we talk about compulsory
delivery, then some other issues arise in the trading e.g. storage cost. If we look at future
contracts, more than 99% are cash settled and delivery of asset is very rare.

The price determination is a complex thing for the speculators. Various speculator may
conceive the price in a different way. For example the price of any asset asset is $30. One
speculator might see it a good price to buy it while another speculator might see a price to
sell it. I agree with yo and a number of variables are needed for price determination but it is
always difficult to say whether it is a correct price or not.

Regulation of Investment Products

You are right and normally description of risk is provided for any investment product of the
institution. Beta (Risk) of the investment is provided to the investor who are interested in the
investment along with qualitative description.

Mark-to-Market

Mark to market (MTM) is a method of measuring the fair value of assets and liabilities on
market basis rather than book value. It provides a realistic evaluation of a company's current
financial situation based on current market conditions.

A financial marks traders' accounts to their market values daily by settling the gains and
losses (In a margin balance account) that result due to changes in the value of the security
and can take a long or short position. If at the end of any day, the futures contract entered
into goes down in value, the long margin account will be decreased and the short margin
account increased to reflect the change in value of the derivative and it needs to be settled
daily. The daily mark to market settlements will continue until the expiration date of the
futures contract or until the investor closes out his position. 

Interest Rates

If the interest rates increase, the prices of bonds falls and vice versa. There is a negative
relation between bond prices and the interest rates. 
If interest rates increase, the bond prices will decrease because the investor will find the
bonds unattractive and its demand decreases. The news bonds will be issued at the high
interest rates and the prices of old bonds decreases as they will be paying less interest
rates.

Negotiable CD

Negotiable CDs are tradable in the secondary market. Anyone having CDs can go to the bank
at the time of maturity and receives the money by presenting it.
The borrower (bank) remains the same and no new negotiable CD is formed and the terms
written on CD remains the same.

It is correct to say that negotiable CDs are comparatively more liquid than non-negotiable
CDs as they can be traded in the secondary markets. For non-negotiable CDs you can
withdraw your money early from the bank but some penalty will be imposed

Bonds

a measure of the sensitivity of the price of a bond or other debt instrument to a change in
interest rates. One type of duration is called Macaulay duration which estimates how many
years it will take for an investor to be repaid the bond’s price by its total coupon
payments/cash flows. These are same terms and can be used interchangeably.

Earnings per Share

Earnings per share (EPS) is calculated by dividing the company's profit by the outstanding
shares of its common stock. EPS indicates how much money a company makes for each
share of its stock.

The price-to-earnings ratio (P/E ratio) measures its current share price relative to its per-
share earnings (EPS). P/E ratios are used by investors  to determine the relative value of a
company's shares in a relative comparison. EPS is used to calculate P/E ratio.

Definition:
An investment fund is a supply of capital belonging to numerous investors used to
collectively purchase securities while each investor retains ownership and control of his own
shares. 

Question 1:
Will it be correct if I say " the sole purpose of a Capital Investment Fund is to create a
portfolio of securities (equities and bonds) for investors and giving them expert advice on
investment options. Operational cash flow is then raised by charging a premium for services
rendered. Thus, concept of debt-to-equity ratio may not apply to its financial position".

Question 2: 
Will it be correct if I say " A capital markets investment fund can raise operational cash flow
through equity financing or debt financing. Thus, its financial position can also depend on its
debt-to-equity-ratio".

A bond is an IOU guarantees holder face of bond payment when it matures  Interests

Issuers -> Governments, Corporations (firms looking to expand) simply to raise finance they
issue a bond
Gvt highly unlikely to go bankrupt (Name of Bond, Coupon -> interest rate over a duration,
Maturity -> time when bond is paid back, market price)

Yield = Coupon/market price * 100

Derivatives Valuation

Current asset price = S0 = $20

next price if  there is upward movement = Su = $22
next price if there is downward movement = Sd = $18

U = Su /S0 = 22/20 = 1.1

d = Sd /S0 = 18/20 = 0.9

Thus, Su = S0U 

Hedging & Speculation

If you speculate that the prices of any shares will increase, you will buy it and this is called
speculation.

If you need any asset any future and you enter in a future contract of that asset to lock your
position it is called hedging.

The main difference lies in the objectives. The objective of the speculation is to earn profit
while the objective of the hedging is to lock your position against adverse price movement.

Forward & Future Contracts

Long is party to buy

Short party to sell

Spot price -> cost of carry

Forward contracts are unregulated - OTC - credit risk  Direct contracts – non standard
contracts and unregulated

Futures

In futures there Hedging, open interest, settlements and margin – terms in future
Put – Call

Call
Arbitrage & Non Arbitrage
Two different securities should have same price otherwise arbitrage exists
Beta & Alpha

Beta  measures the expected move in a stock relative to movements in the overall
market and it is a measure of a stock's volatility in relation to the overall market. The
beta of the market is always taken as 1 and individual stocks are ranked according
to how much they deviate from the market. Stocks having beta more than 1.0 are
considered more riskier and stocks having beta of less than 1.0 are considered as
less riskier.

Alpha shows how well/badly a stock has performed in comparison to a benchmark

index and it indicates how volatile a stock's price has been in comparison to the
market as a whole. Alpha is represented by a number (It can be positive or negative)
and an alpha of 1.0 means the investment outperformed its benchmark index by 1%.
An alpha of -1.0 means the investment underperformed its benchmark index by 1%.
If the alpha is zero, its return matched the benchmark.