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AdvanceFinancialInstrumentsand Markets Lec#01

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Fall 2013 ADVANCED FINANCIAL INSTRUMENTS AND MARKETS

LectureNo.01 Financial Institutions and Role of Government


Hammad Hassan Mirza AssistantProfessor(Finance) DepartmentofBusinessAdministration UniversityofSargodha

CourseIntroduction
Simultaneously Philosophical and Practical underpinnings Banking, Insurance, Securities, Derivatives, Financial Crisis Crisis. International Bias but will try best to relate. Course is more theoretical but cannot avoid mathematics/statistics completely. Problem Sets/case studies/Quiz etc.

PropertyofDepartmentofBusinessAdministration, UniversityofSargodha

CourseObjectives
Onsuccessful completion ofthismodule, youare expectedto:
1. 2 2. 3. 4. 5. Gainsomeknowledgeofthemainfunctionsoffinancial marketsandinstitutions Developanunderstandingoftheworkingsofequity capitalmarketsandInstrumentsofRiskManagement Understandthenatureoffinancialinstrumentsandthe reasonsforinnovatingsuchinstruments Beawareoftherelevantempiricalcapitalmarkets research Becomefamiliarwiththekeyresearchmethodsusedin thefinancialmarketsliterature
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HammadHassanMirza(Asst.Prof Finance)Dept.BusAdmn.UOS

AdvanceFinancialInstrumentsand Markets Lec#01

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TeachingMethodology

Lecturefordisseminating keyconcepts Discussiononpracticalissues AssignmentsandPresentations/Projects Quiz/CaseStudies

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Evaluation

Individual ClassPresentations/Projects Regular g ClassPresentations/Participation / p (7 (7%) ) TermPaper/Assignment(8%) ClassQuiz/CaseStudies(5%) MidTermTest(45Minutes) FinalExamination (2hours)

20%

20% 60% 100%

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RecommendedText
1. Fabozzi, Frank J., Franco Modigliani, Frank J. Jones, and Michael G. Ferri. Foundations of Financial Markets and Institutions, 4th ed. Prentice Hall, 2010. FS Mishkin, SG Eakins. Financial Markets and Institutions 5th Edition. Pearson Publications h C. Hull, ll Options, Futures and Other Derivatives, 6th Edition, Prentice John Hall. Frank J. Fabozzi: Bond Market Analysis and Strategies, Prentice Hall. Szymon Borak Wolfgang Karl Hrdle Brenda Lpez Cabrera, Statistics of Financial Markets, Springer Heidelberg Dordrecht London New York Robert Dubil, An Arbitrage Guide to Financial Markets, 2004 , John Wiley & Sons Ltd Relevant Research Articles (Downloadable from www.financecottage.com)
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2. 3. 4. 5. 6. 7.

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HammadHassanMirza(Asst.Prof Finance)Dept.BusAdmn.UOS

AdvanceFinancialInstrumentsand Markets Lec#01

13:49

CourseContents (MidTerm)
Financial Institutions andRoleofGovt. RiskandFinancial crisis TechnologyandInvention inFinance PortfolioDiversification andSupporting Financial Inst. 5. Determinants ofAssetPricesandInterest Rates 6. Organization andStructureofMarkets 7. MarketforGovernment andCorporate Securities 8. MortgageandSecuritized AssetMarkets 9. MarketDerivative Securities PropertyofDepartmentofBusinessAdministration,Universityof
Sargodha 7

1. 2. 3. 4.

CourseContents (FinalTerm)
1. 2. 3. 4. 5. 6. 7. CollateralPresentValueandVocabularyofFinance MechanicsofFutureMarkets Hedging Strategies usingfutures InterestratesandDeterminants ofForwardandFutureprices MechanicsofOptionMarkets Insurance:Thearchetypical RiskManagement Institution Financial InstrumentsandMajorWorldFinancial Crisis

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TodaysSession
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HammadHassanMirza(Asst.Prof Finance)Dept.BusAdmn.UOS

AdvanceFinancialInstrumentsand Markets Lec#01

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Session I

WhyFinance WallStreetCrash1929 JapaneseAssetPriceBubble AsianFinancial Crisis ImportanceofFinancial Markets BasicFinancial Instruments

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WallStreetCrashof1929
The Wall Street Crash of 1929, also known as the Black Tuesday and the Stock Market Crash of 1929, began in late October 1929 and was the most devastating stock market crash in the history of the United States, when taking into consideration the full extent and duration of its fallout. The crash signaled the beginning of the 10year Great Depression that affected all Western industrialized countries and did not end in the United States until the onset of American mobilization for World War II at the end of 1941. 15 million people had unemployment coming to them after the banks crashed.
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Japaneseassetpricebubble1986
The Japanese asset price bubble was an economic bubble in Japan from 1986 to 1991, in which real inflated The bubble bubble's estate and stock prices were greatly inflated. s subsequent collapse lasted for more than a decade with stock prices initially bottoming in 2003, although they would descend even further amidst the global crisis in 2008. The Japanese asset price bubble contributed to what some refer to as the Lost Decade. Some economists, such as Paul Krugman, have argued that Japan fell into a liquidity trap during these years.
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HammadHassanMirza(Asst.Prof Finance)Dept.BusAdmn.UOS

AdvanceFinancialInstrumentsand Markets Lec#01

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AsianFinancialCrisis1997
The Asian financial crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic ld d f l contagion. The h crisis meltdown due to financial started in Thailand with the financial collapse of the Thai baht after the Thai government was forced to float the baht (due to lack of foreign currency to support its fixed exchange rate), cutting its peg to the U.S. dollar, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven.
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USSubprimeMortgage
The U.S. subprime mortgage crisis was a set of events and conditions that led to the late2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages. Several major financial institutions collapsed in September 2008, with significant disruption in the flow of credit to businesses and consumers and the onset of a severe global recession.
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ImportanceofFinancialMarkets
Financial markets, such as bond and stock markets, are crucial in our economy. These markets channel funds from savers to investors, ff thereby promoting economic efficiency. Market activity affects personal wealth, the behavior of business firms, and economy as a whole Debt markets, or bond markets, allow governments, corporations, and individuals to borrow to finance activities.

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HammadHassanMirza(Asst.Prof Finance)Dept.BusAdmn.UOS

AdvanceFinancialInstrumentsand Markets Lec#01

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ImportanceofFinancialMarkets
The stock market is the market where common stock (or just stock), representing ownership in a company, are traded. Companies initially sell stock (in the primary market) to raise money. But after that, the stock is traded among investors (secondary market). The foreign exchange market is where international currencies trade and exchange rates are set. Although most people know little about this market, it has a daily volume around $1 trillion!
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PakistanMarketIndicators 20072013

1. 2. 3. 4. 5.

PKR/USD KSE100Index InterestRate(SBOP) InflationRate PakGovt.BondYeild

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DesignofFinancialMarkets

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AdvanceFinancialInstrumentsand Markets Lec#01

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BasicFinancialInstruments
ItsyourTurn..

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Session II
Introduction
FinancialAssets FinancialMarkets GlobalizationandFinancialMarkets DerivativeMarkets

RoleofFinancial Intermediaries OverviewofAsset/Liability Management forFIs RoleofGovernment

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Introduction
ProductVSFactorMarket Financial MarketandFinancial Assets Financial Assets,Financial Instruments, Securities DebtVSEquityInstruments PricingPrinciplesofFinancial Assets RoleofFinancial Asset
TransferofFundsfromSurplustoDeficitunits Redistributionofunavoidablerisk

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HammadHassanMirza(Asst.Prof Finance)Dept.BusAdmn.UOS

AdvanceFinancialInstrumentsand Markets Lec#01

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FinancialMarkets
RoleofFinancial Markets
PriceDiscoveryProcess OfferingLiquidity ReductionofSearch/InformationCost

ClassificationofFinancial Markets
PrimaryVsSecondary(SeasoningofClaim) MoneyVsCapital(Maturity) DebtVsEquity(NatureofClaim) CashVsDerivative(Delivery/SettlementofClaim) OrganizedVsOTC(Structure)
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GlobalizationofFinancialMarkets
Thefactorsthathaveledtotheintegration of Financial Markets
Deregulation/Liberalization TechnologicalAdvancesformonitoring/executing. IncreasedInstitutionalizationofFinancialMarkets

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FinancialInstitutions
Functionsperformed byFinancial Institutions
FinancialIntermediation Exchangeoffinancialassetsonbehalfofcustomers Exchangeoffinancialassetsontheirownaccount Assistingincreationoffinancialassets Providinginvestmentadvice Managementofportfolios

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HammadHassanMirza(Asst.Prof Finance)Dept.BusAdmn.UOS

AdvanceFinancialInstrumentsand Markets Lec#01

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FinancialIntermediaries

CommercialBanks Savingandloanassociation SavingBanks Insurancecompanies Pensionfunds CaptiveFinanceCompanies??

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RoleofFinancialIntermediaries

DirectandIndirect Investments MaturityIntermediation RiskDiversification CostReduction PaymentMechanism

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AssetLiabilityManagementof FinancialInstitutions
NatureofLiabilities
Theamountandtimingofthecashoutlaysthatmustbe madetosatisfythecontractualtermsoftheobligation issued (LiquidityConcerns) issued.
TYPE OFLIABILITY AMOUNTOFCASH OUTLAY Type I Type II Type III Type IV Known Known Uncertain Uncertain TIMINGOFCASH OUTLAY Known Uncertain Known Uncertain

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HammadHassanMirza(Asst.Prof Finance)Dept.BusAdmn.UOS

AdvanceFinancialInstrumentsand Markets Lec#01

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PrimaryAssetsandLiabilitiesofFIs

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RoleofGovernmentinFinancial Markets
StopMarketFailure?
MainReasonsforRegulation 1. IncreaseInformationtoInvestors
Decreasesadverseselectionandmoralhazardproblems SECforcescorporationstodiscloseinformation Preventsfinancialpanics Chartering,reportingrequirements,restrictionsonassets andactivities,depositinsurance,andanticompetitive measures Reserverequirements

2. EnsuringtheSoundnessofFinancialIntermediaries

3. ImprovingMonetaryControl

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RegulationReason:EnsureSoundness ofFinancialIntermediaries(cont.)
Toprotectthepublicandtheeconomyfromfinancial panics,thegovernment hasimplemented sixtypesof regulations: RestrictionsonEntry Disclosure RestrictionsonAssetsandActivities DepositInsurance LimitsonCompetition RestrictionsonInterestRates
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AdvanceFinancialInstrumentsand Markets Lec#01

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Regulation: RestrictiononEntry
RestrictionsonEntry
Regulatorshavecreated verytightregulations astowho isallowedtosetupafinancial intermediary Individuals orgroupsthatwanttoestablisha financialintermediary, suchasabankoraninsurance company,mustobtainacharter fromthestateorthe federalgovernment Onlyiftheyareupstanding citizenswithimpeccable credentials andalargeamountofinitial fundswillthey begivenacharter.
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Regulation:Disclosure
DisclosureRequirements Therearestringentreportingrequirementsfor financialintermediaries
Theirbookkeeping mustfollowcertain strictprinciples, Theirbooksaresubjecttoperiodic inspection, Theymustmakecertaininformation available to thepublic.

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Regulation:Restrictionon AssetsandActivities
Restrictionsontheactivities andassetsofintermediaries helpstoensuredepositors thattheirfundsaresafeand thatthebankorotherfinancial intermediary willbeableto meetitsobligations. obligations Intermediary arerestricted fromcertain riskyactivities Andfromholding certain riskyassets,oratleastfrom holdingagreater quantity oftheseriskyassetsthanis prudent

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AdvanceFinancialInstrumentsand Markets Lec#01

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Regulation:DepositInsurance
The government can insure people depositors to a financial intermediary from any financial loss if the financial intermediary should fail

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Regulation: LimitsonCompetition
Althoughtheevidence thatunbridled competition amongfinancialintermediaries promotesfailuresthat illharmthepublic p blicis i extremely e tremel weak, eak ithas ha not will stoppedthestateandfederalgovernments from imposingmanyrestrictive regulations Inthepast,bankswerenotallowedtoopenup branchesinotherstates,andinsomestatesbanks wererestricted fromopening additional locations
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Regulation:Restrictions onInterestRates
Competition has also been inhibited by regulations that impose restrictions on interest rates that can be paid on deposits These regulations were instituted because of the widespread belief that unrestricted interestrate competition helped encourage bank failures during the Great Depression Later evidence does not seem to support this view, and restrictions on interest rates have been abolished

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AdvanceFinancialInstrumentsand Markets Lec#01

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RegulationReason: ImproveMonetaryControl
Because banks play a very important role in determining the supply of money (which in turn affects many aspects of the economy), much regulation of these financial intermediaries is intended to improve control over the money supply One such regulation is reserve requirements, which make it obligatory for all depository institutions to keep a certain fraction of their deposits in accounts with the Federal Reserve System (the Fed), the central bank in the United States Reserve requirements help the Fed exercise more precise control over the money supply
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ThankYou!
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HammadHassanMirza(Asst.Prof Finance)Dept.BusAdmn.UOS

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