Global Financial Market
Private Financial Intermediaries
(FIs)
• 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
market.
Other Operations of Private FIs
• Underwriting: the process whereby the FI
brings to market a newly issued financial
security.
• Asset Transformation: the FI’s creation of new
financial securities by selling financial securities
that are different from the financial securities it
buys.
• Securitization: the packaging of non-traded
financial securities into a newly created tradable
financial security.
The Structure of Financial
Markets
• 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
securities.
Examples:
NYSE: New York Stock Exchange
CBOT: Chicago Board of Trade
CME: Chicago Mercantile Exchange
LIFFE: London International Financial Futures
Exchange
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
systems
Example 1: Trade in German Govt. Bond futures
moved from LIFFE derivatives market to SwissGerman 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
(cont.)
• 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
(NSCC)
• For all Fixed Income: Fixed Income Clearing Corporation
(FICC)
• 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
(cont.)
• 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
organizations:
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
(cont.)
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.
Fidelity
Vanguard
Clearing & Settlement Service
(cont.)
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
• UBS
• HSBC
• Deutsche Bank
• Credit Swiss
Clearing & Settlement Service
(cont.)
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
New York
Chicago
+California
+Florida
Europe
London
Paris
Frankfort
Amsterdam
Asia
Tokyo
Singapore
Hong Kong
Shanghai
Bombay
Australia
Sydney
Global Financial Markets (cont.)
• Investment Banking  Underwriting
 Bringing new securities
to market
 Advising on Mergers &
Acquisitions
• Retail Brokerage – buy/sell securities for clients
Maintain accounts for individual
investments
• 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
computers
• 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
necessary.
• 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
Inter
Dealer
Dealer
Broker
Exchanges
NYSE
Exchanges
NASDAQ
Broker
I
N
V
Exchanges
FCN
Broker
E
S
Broker
T
O
R
S
Organization Structure of a Sell Side Financial Intermediaries:
TOP
MANAGEMENT
Legal /
Compliance
Revenue /
Producing
Technology
Risk
Management
Investment
Banking
Equity
Asset
Management
Fixed Income
Retail / Prime
Brokarage
Foreign
Exchange
Rates
Mortgages
Credit
Treasuries
Munis
Risk
Management
Int. Rate
Derivatives
Swaps
Structured
Products
Market Participants:
Firms
Government
General
Motors
Agencies
US Treasury
Goldman
Sachs
I
FNMA
World Banks
Lehman Bros.
N
V
Other FIs
E
S
Citi Group
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)
$ Trillion
Average Daily
Turnover
$ Billion
Average Transaction
Value
$ Thousand
NYSE
9.0
40.9
19
NASDAQ
2.0
28.8
12
London Stock
Exchange
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 <
12M
Domestic
Internat’l
Total
Domestic
Internat’l
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
Total
Table 3. Market Capitalization of Bonds Listed on Principal
Exchanges (US $ Trillion)
Luxembourg
London
Osaka
NYSE
Italy
Domestic
Public
Sector
0.0
0.0
3.6
1.1
1.1
Domestic
Private
Sector
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)
Markets
Spot
387
Forward
131
Foreign Exchange Swap
656
Total
1173
Table 5. Major OTC Derivatives June 2003
Notional Amounts
(US$ Trillion)
Gross Market Values
(US$ Billion)
Interest Rate Swaps
94.6
1126
Interest Rate Options
16.9
434
Forward Rate Agreements
10.3
20
Currency Forwards and
Currency Swaps
12.3
476
Currency Swaps
5.2
419
Currency Options
4.6
101
Equity Derivatives
2.8
260
Commodity Derivatives
1.0
110
Other Including Credit
Derivatives
22.0
1083
Total
169.7
4029
Table 6. Principal Exchanges for Equity Derivatives
Millions of Contracts Traded
2002
Individual Stock
Options
Equity Index
Futures
Options
AMEX
150.7
32.7
BOVESPA (Sao Paolo
Stock Exchange)
89.7
1.1
Chicago Board Options
Exchange
173.2
94.4
Chicago Mercantile
Exchange
Futures
5.4
212.2
International Securities
Exchange
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
2002
Chicago Board Options
Exchange (CBOT)
Government Debt
Interest Rate
Options
Options
54.7
Futures
205.6
Chicago Mercantile Exchange
(CME)
EUREX
31.6
8.1
Korean Futures Exchange
12.8
1.6
7.7
105.6
202.5
42.7
149.2
415.0
Euronext
Sydney Futures Exchange
21.7
Singapore Exchange
21.7
BM & P
World-Wide
Futures
89.1
677.5
2.5
48.6
151.2
532.5
Table 8. Principal Exchanges for Currency and Commodity Derivatives
Millions of Contracts Traded
2002
Currency
Options
Commodity
Futures
Chicago Board Options
Exchange (CBOT)
Options
Futures
12.6
54.1
0.8
6.8
New York Mercantile
Exchange
26.4
107.3
London Metal Exchange
2.3
56.3
Chicago Mercantile
Exchange (CME)
2.2
22.1
Zhenzhou Commodity
Exchange
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)
Brokers
Financial
Securities
Financial
Securities
Financial
Securities
Funds Surplus
Units
Shares
Deposits
Financial
Securities
Dealers
Underwriters
Investment bankers
Mutual funds
Pension funds
Financial
Securities
Financial
Securities
Financial
Securities
Banks
Financial
Securities
Insurance comp
IOUs
Non-intermediated
Transactions
(direct financing)
Funds Deficit
Units
Opaque FIs
Loans
Policies
Transparent FIs
IOUs