Financial Markets, Instruments, and Participants

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Chapter 6

• Financial Markets, Instruments, and Participants

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Definitions

• This chapter is largely definitional
• Try to classify markets
• We look at the Financial system and define
  various types of markets. Then we look at what
  trades in these markets
• Remember markets are interrelated.

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Markets, markets, and more markets

• Many ways to break-down and examine the
  financial system
• classification is often less important as there
  is no true separation--all are connected.
• NOT MUTALLY-EXCLUSIVE!
• A market can fit many definitions at once

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Money Markets

• Short-term securities
• Less than one year maturity
• examples commercial paper, T-Bills, negotiable
  CDs

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Capital Markets

• Market in which longer term (more than one year)
  financial assets trade
• examples stock markets, bond markets

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Financial Product markets

• Can also break financial markets down by product
• example stock market, bond market

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Who is selling?

• Another way of classifying markets is by who is
  the seller
• If the seller is a DSU (that is the product is
  being sold for the first time) then the market is
  a primary market.
• If the seller is anyone else (other investor etc)
  it is a secondary market
• Think used car market

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Importance of secondary market

• Transaction costs are very important
• the more efficient a financial system is the
  better off the entire economy will be
• Investors will require a lower return which in
  turn will allow more investment by DSUs

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See Spot now

• Spot markets are markets whose transactions occur
  immediately
• Future markets are those where the transaction
  may be agreed upon now, but does not actually
  take place until sometime in the future

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Derivative markets

• Price is a function of another asset
• example options, swaps, etc

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Financial Market Securities

• Across all markets many new products
• Why so many types of securities? Demand and
  supply issues
• not an exhaustive list

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Money Market Financial Instruments

• T-Bills, Commercial paper, Negotiable CDs,
  bankers acceptances, repurchase agreements, Fed
  Funds, Eurodollars
• All have short duration and most have high face
  values.
• Generally individuals purchase only through a
  money market fund

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Pricing T-Bills

• Sold at a discount
• Approximate Price face - (discount yieldPar)/4
• for 90 day divide by 4

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Other Money Market Securities

• Bankers acceptances-frequently used in
  international trade. Banks agrees to guarantee
  payment of a customer
• Repurchase agreement repo temporary sale and
  buyback agreement
• Fed Funds-Loans between Fed reserve banks

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Eurodollars

• US dollar denominated
• Originally held in Europe, now more generic

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Capital Markets

• Stocks
• Bonds
• corporate
• Federal government
• agency
• municipal
• Mortgages

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Participants

• Dealer
• Broker
• market maker dealer who links buyers and sellers
• specialist on NYSE

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Types of Markets

• Exchange (ex. NYSE) vs. over the counter market
  (ex. Nasdaq)
• Exchange central location, tend to be auction
  market
• OTC no location, dealer markets

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NYSE VS NASDAQ

• Both are stock markets
• NYSE history
• Traditionally NYSE is goal
• Differences
• Which is better?

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Market making

• To understand NYSE vs NASDAQ must investigate the
  markets more fully
• Market maker dealer who links buyers and sellers
  and takes positions in the asset
• Broker links buyers and sellers
• Specialists are market makers on NYSE

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Specialist System

• One person responsible for the orderly trading in
  a stock
• Location and crowds
• Bid price
• Ask
• Bid-ask spread
• where do profits come from?-transactions

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Bid-ask spread (cont)

• Measure of liquidity
• Spread is a function of many things
• liquidity
• volume
• information
• inventory
• other factors

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Spillover effects

• Obviously a move in one market will effect prices
  in other markets.
• This is true be it international vs. domestic or
  money market vs. capital market etc.