FINANCIAL MARKETS &
INSTRUMENTS:
THE INVESTMENT
INDUSTRY
1
VIDEO: 9 LIFE LESSONS
Copyright © 2019 - Novia One Group™
2
THE FINANCIAL SYSTEM
It is an organised and
regulated structure
where exchange of funds
take place between the
lenders and borrowers.
It brings together
Financial participants,
markets , products and
services.
Copyright © 2019 - Novia One Group
3
MAIN FUNCTIONS OF A FINANCIAL
SYSTEM
USE
BORROW
Save for future use
Borrow money for current use
RAISE
Raise capital
MANAGE
Manage risks
EXCHANGE Exchange assets for immediate and future deliveries
TRADE ON Trade on information
Copyright © 2019 - Novia One Group™
4
STRUCTURE OF THE INVESTMENT INDUSTRY
Direct Finance
Financial markets:
Money markets: < 1 year
Capital markets: > 1 year
Capital Suppliers:
Savers, Lenders &
Investors, Asset
Managers, Pension
Funds, SWF,
Capital users:
Issuers & borrowers
Financial Intermediaries &
Market Infrastructure:
Banks, Insurance companies,
stock exchanges, Custodians
other credit institutions
Copyright © 2019 - Novia One Group™
Investment
industry refers
primarily to
direct finance
5
Reduces search costs for providers and users of
capital
BENEFITS OF THE
INVESTMENT
INDUSTRY
Helps capital flow to its highest valued uses
Efficient resource allocation
Provides information about investment values
Creates securities to meet needs of savers and
borrowers
Provides liquidity
6
PARTICIPANTS
Include those who need to raise funds and those who need to invest funds.
Investment bank:
Initial public offering (IPO)
Sell-side analysts
Issuer:
Firm that needs to
raise funds
Primary market
Secondary market:
Trading of previously
issued securities
▪ Stock exchanges
▪ Brokers, dealers
▪ Auditors
▪ Clearing/settlement agents
▪ Custodians
7
ROLE OF INVESTMENT
BANKS
• Investment banking is a specific division of
banking related to the creation of capital for
other companies, governments and other
entities.
• They offer a range of services from financial
advisory, underwriting, trading, research,
raising capital, issuance of shares and bonds,
to advisory on mergers and acquisitions. They
are usually involved where large amount of
money moving happens.
Copyright © 2019 - Novia One Group
8
FUNCTIONS
OF
INVESTMENT
BANKS
Copyright © 2019 - Novia One Group
9
FORCES THAT AFFECT THE EVOLUTION OF
INVESTMENT INDUSTRY
Competition: among firms in terms of prices, services and
product innovation
Digitisation: Fintech reduces transaction costs, time to
market and customer experience
Globalization: investors seeking investments in other
countries
Regulation: protects investors and financial disclosure
Copyright © 2019 - Novia One Group™
10
BUSINESS APPLIED LEARNING EVIDENCE
WORKBOOK ACTIVITY 1
Complete the Multiple-Choice Questions
1-10
Copyright © 2019 - Novia One Group™
11
TYPES OF INVESTORS
INSTITUTIONAL
INDIVIDUALS
Institutional investors are organisations
that invest to meet stated goal
• Examples: Pension funds, Insurance
co’s, asset managers
High net worth: May employ asset
managers
• Retail: Typically invest through banks,
insurance companies, unit trusts
12
INVESTMENT INDUSTRY
SERVICES
Copyright © 2019 - Novia One Group™
13
SELLSIDE VS. BUYSIDE
Sellside
Buyside
• Firms are typically investment banks,
brokers, and dealers that provide
investment products and services.
• Participants are typically investors and
investment managers that purchase
investment products and services and
manage their own money or money of
clients.
FRONT, MIDDLE & BACK OFFICE
THE FRONT OFFICE OF A SELLSIDE FIRM CONSISTS OF
CLIENT FACING ACTIVITIES THAT PROVIDE DIRECT
REVENUE GENERATION.
THE MIDDLE OFFICE INCLUDES THE CORE ACTIVITIES
OF THE FIRM, SUCH AS RISK MANAGEMENT,
INFORMATION TECHNOLOGY, CORPORATE FINANCE,
PORTFOLIO MANAGEMENT, AND RESEARCH.
Copyright © 2020 - Novia One Group
THE BACK OFFICE HOUSES THE ADMINISTRATIVE AND
SUPPORT FUNCTIONS NECESSARY TO RUN THE FIRM,
SUCH AS ACCOUNTING, HUMAN RESOURCES,
PAYROLL, AND OPERATIONS. ALSO RESPONSIBLE FOR
SETTLEMENT OF TRADES
15
BUSINESS APPLIED LEARNING EVIDENCE
WORKBOOK ACTIVITY 2
1.
2.
List and describe any three (3) types of investors:
Discuss in your group:
What is meant by intermediation and why has it become so important in today’s
financial systems.
3.
4.
5.
6.
7.
Write, in your own words, a summary of the conclusion reached as a group:
Give an example of a financial intermediary and describe their role:
List and describe any three (3) roles that your organisation plays in the
financial system:
Provide two (2) actual examples of major players in each of the following
categories:
What is the difference between a broker and a dealer?
Give an example of a business unit in your organisation that falls in each of
the following categories:
Copyright © 2019 - Novia One Group™
16
WHAT ARE FINANCIAL OR SECURITIES
MARKETS
▪ The places where buyers and sellers can trade securities are known as financial
markets.
▪ Financial market facilitates flow of funds from savers to spenders.
Savers
Spenders
• those who have excess funds available to invest. They are also referred to
as lenders or investors. Savers provide funds/capital to spenders.
• Individuals (households)
• Companies
• Governments who lend funds when their current tax receipts > current
spending needs.
• those who need funds. They are also referred to as borrowers.
• Individuals (households)
• Companies (firms)
• Governments: Governments borrow funds when their current tax receipts
< current spending needs.
17
Copyright © 2019 - Novia One Group™
18
PURPOSE OF FINANCIAL
MARKETS
▪ Price setting
▪ Asset valuation
▪ Arbitrage
▪ Raising capital
▪ Commercial transactions
▪ Investing
▪ Risk management
Copyright © 2019 - Novia One Group
19
Capital Markets
Primary Markets
Primary
beneficiary is the
issuer
Objective is to
raise money
Includes new
securities such as
Initial Public
Offering
Secondary Markets
Primary
beneficiary is the
investor /
shareholder
Copyright
Copyright
© 2019
© -2019
Novia
- Novia
One Group
One Group
Objective is
capital
appreciation
Includes the
trading of
securities already
offered to the
marketplace.
20
VIDEO: FINANCIAL MARKETS
Copyright © 2019 - Novia One Group™
21
Copyright © 2019 - Novia One Group
22
VIDEO: PRIMARY MARKETS :
WHAT IS AN IPO
Copyright © 2019 - Novia One Group™
23
SECONDARY MARKET TRADING
Liquid secondary markets reduce the costs of raising capital because investors
value the ability to sell their securities quickly to raise cash.
Secondary markets require a trading venue—either physical or electronic—
where trading among investors can take place.
Most secondary market trading globally is now done via electronic trading
systems, instead of open outcry.
Copyright © 2019 - Novia One Group
24
▪ Brokers act as agents of the investors and facilitate trading between
buyers and sellers by bringing willing buyers and sellers together, by
negotiating prices, and by executing their orders.
BROKERS
▪ Brokers provide liquidity in the market and help to reduce
transaction costs.
Copyright © 2019- Novia One Group
25
▪ Act as principals and facilitate trading by standing ready
and willing to buy a financial asset for their own account
(known as proprietary trading).
DEALERS
▪ “Make markets in securities” by acting as buyers for
investors willing to sell and as sellers for investors willing
to buy.
▪ Provide liquidity in the market and help to reduce
transaction costs.
Copyright © 2019 - Novia One Group
PRIMARY
DEALERS
DEALERS
▪ Primary dealers are dealers with which central
banks trade when conducting monetary policy.
▪ Central banks sell bonds to primary dealers to
decrease the money supply.
▪ The primary dealers then sell the bonds to
their clients.
▪ Central banks buy bonds from primary dealers
to increase the money supply, the primary
dealers buy bonds from their clients and sell
them back to the central banks.
Copyright © 2019 - Novia One Group
EXCHANGES:
▪ Exchanges represent organized and regulated financial
markets that assist, regulate and control business of buying,
selling and dealing in securities e.g. JSE, ZAR-X, NYSE, NASDAQ.
▪ Match buyers with sellers: At its core, an exchange is simply a
place where people who want to buy securities and people
who want to sell securities can quickly and easily find one
another.
▪ Make sure trades are completed: Once buyers and sellers
agree on a trade, the exchange takes the details of the trade
and sends them to be “cleared,” or finalized, at a
clearinghouse.
28
VIDEO: WHAT IS A STOCK
EXCHANGE
Copyright © 2019 - Novia One Group™
29
TRADING
VENUES VS EXCHANGE
Exchanges are the most common type of trading venue, but alternative trading venues,
which have their own rules, have gained in popularity.
The two main distinctions between exchanges and alternative trading venues are that
exchanges typically have regulatory authority and more trade transparency than
alternative trading venues.
Copyright © 2020 - Novia One Group
30
▪Make a list of the stock exchanges in South Africa?
Copyright © 2019 - Novia One Group
31
NEW FINANCIAL MARKETS PLAYERS
Copyright © 2020 - Novia One Group
32
ZAR-X
▪ T+0 (Realtime) settlement in South Africa. Trading is done on a
prefunded basis for buyers and seller’s shareholding is pre cleared
prior to conclusion of the transaction.
▪ Custody of securities will be at a Central Securities Depository (CSD) in
an Segregated Depository Account (SDA) as contemplated in the
Financial Markets Act of 2012 (FMA) with a Central Securities
Depository Participant (CSDP) facilitating clearing.
▪ No high frequency trading, derivatives or short selling will be allowed.
ZAR X have deliberately structured our fees in such a manner that we
wish to encourage investing rather than trading.
Copyright © 2020 - Novia One Group
33
TRADING
Quote driven markets
Investors trade with dealers at the prices
quoted by the dealers.
Order driven
Markets arrange trades using rules to
match buy orders with sell orders.
Brokered markets
Which are usually markets for assets that
are unique, brokers arrange trades among
their clients.
Copyright © 2020 - Novia One Group
34
POSITIONS
A position
Quantity of an asset or security that a person or
institution owns or owes.
Long Positions
Investors have long positions when they own
assets or securities. Long positions benefit when
prices rise.
Short Positions
Positions that benefit when prices fall are short
positions, which involve borrowing assets, selling
them, and repurchasing them later to return to
their owner.
Copyright © 2019 - Novia One Group
35
SHORT
SELLING
VIDEO: WHAT IS SHORT
SELLING
Copyright © 2019 - Novia One Group™
37
LEVERAGE / MARGIN
/ GEARING
When investors borrow
some of the purchase price
to buy securities, they are
said to buy securities on
margin and leverage their
positions.
Leveraged positions expose
investors to more risk and
higher potential gains and
losses than otherwise
identical debt free
positions.
38
ORDERS
Orders are
instructions to
trade.
They always
specify:
what security
to trade
whether to
buy or sell
how much
should be
bought or sold.
39
ORDERS
Execution
instructions
Exposure
instructions
Time in force
how to fill an order
whether, how, and
by whom an order
should be seen;
When an order can
be filled
40
ORDERS
Market orders
• to obtain the best price immediately available when filling the order. They
generally execute immediately but can be filled at disadvantageous prices.
Limit order
• specifies a limit price—a ceiling price for a buy order and a floor price for a
sell order. They generally execute at better prices, but they may not execute
if the limit price on a buy order is too low or if the limit price on a sell order is
too high.
Stop orders
• Specify stop prices; the order is filled when a trade occurs at or above the
stop price for a buy order and at or below the stop price for a sell order.
Traders often use stop orders to stop losses on their long positions.
Copyright © 2020 - Novia One Group
41
VIDEO: WHAT ARE DARK POOLS
42
CLEARING AND SETTLEMENT
Intermediaries help traders clear and settle orders that have been filled.
The most important clearing activity is confirmation, which is performed by clearing
houses.
Settlement follows confirmation; at settlement, the seller must deliver the security to
the clearing house and the buyer must deliver cash.
Copyright © 2019 - Novia One Group
43
TRADING COST
The costs associated with trading are called transaction costs and include
two components: explicit costs and implicit costs.
Brokerage commissions are the lowest explicit trading cost.
Implicit trading costs result from bid–ask spreads, price impact, and
opportunity costs.
Traders usually choose order submission strategies that minimise
transaction costs.
Copyright © 2019 - Novia One Group
44
DAY TRADING
▪ Day trading is the act of buying and
selling a stock within the same day. Also
known as intraday trading.
▪ The trading system where you have to
square-off your trade on the same day.
Squaring off the trade means that you
have to do the buy and sell or sell and
buy transaction on the same day before
the market close.
▪ Day traders seek to make profits by
leveraging large amounts of capital to
take advantage of small price movements
in highly liquid stocks or indexes.
45
ALGORITHMIC TRADING
▪ Algorithmic trading (automated
trading, black-box trading, or
simply algo-trading) is the process
of using computers programmed
to follow a defined set of
instructions for placing a trade in
order to generate profits at a
speed and frequency that is
impossible for a human trader.
▪ It can be high-frequency, but it can
also be low frequency, trading at
the daily or even weekly
timeframe based on a set of predefined rules
Copyright © 2019 - Novia One Group
46
HIGH FREQUENCY
TRADING
▪ High-frequency trading (HFT) is a program trading
platform that uses powerful computers to transact a
large number of orders at very fast speeds. It uses
complex algorithms to analyze multiple markets and
execute orders based on market conditions.
▪ Ultra-low latency direct market access is a set of
technologies used as part of modern trading
strategies, where speed of execution is critical. Direct
market access (DMA), often combined with
algorithmic trading is a means of executing trading
flow on a selected venue by bypassing the brokers'
discretionary methods.
▪ Co-location (JSE Solution)
47
SUSPENDED SHARES
▪ Suspension of Shares means the company is still
listed on the JSE but the Shares cannot be traded until
further notice. This is because a company has not met
one of the listing requirements. The information is
made public via a SENS announcement.
48
STRATE & JSE
49
CLEARING
AND
SETTLEMENT
Listed bonds
Money market
(except Treasury
bills)
Treasury bills
Listed shares
Foreign exchange
Copyright © 2019 - Novia One Group
T+3
T+0
T+3
T+3
(JSE)
T+2
50
▪ The primary aim of the T+3 project is to shorten
the settlement cycle for equities from 5 to 3 days.
T+3
▪ Prior to the crisis, many markets had already
settled on T3 since 1995. The JSE’s settlement
cycle is notably out of step with global precedent
(including emerging markets).
▪ The FSCA has mandated the JSE to move to T3
settlement cycle – T3 is now a licensing
requirement.
WHY IS A SHORTER SETTLEMENT
CYCLE RELEVANT?
Exposure: ‘Client-side transactions between buy-side and brokers represent significant
uncollateralised, unguaranteed exposure.
The amount of this market risk depends on time and volatility and thus increases with
longer settlement cycles’
Capital CSDPs are starting to hold capital for exposures. Longer cycles mean more capital.
Systemic Risk Systemic risk increases when the magnitude of outstanding transactions
increases (risk is based on number of outstanding transactions and the concentration)
Copyright © 2019 - Novia One Group
52
WHAT WERE THE BENEFITS OF
REDUCING THE JSE’S SETTLEMENT CYCLE?
Align to global best practice – comply with the FSCA mandate
Harmonisation across international markets
Increased liquidity – faster reinvestment of assets that are released from
the settlement process quicker
Margin will be called earlier in the cycle
Reducing the number of
outstanding unsettled trades will:
reduce settlement exposure / credit risk
reduce systemic risk
improve efficiencies by causing participants to adapt and
modify behaviours
Copyright © 2019 - Novia One Group
53
Copyright © 2019 - Novia One Group
54
BUSINESS APPLIED LEARNING EVIDENCE
WORKBOOK ACTIVITY 4
1.
2.
3.
4.
5.
6.
7.
8.
9.
Describe the activities that take place in the following markets:
Give an example for each of the following securities listed in South Africa:
Give an example of each of the market types listed below:
List five (5) stock exchanges (locally and internationally) representing the
secondary market:
Briefly explain the conditions under which the long- and short positions will
make profits by completing the table.
Explain what the orders listed below are instructing a broker to do:
Give one (1) disadvantage for each of the orders listed below:
Link the descriptions with their appropriate term by drawing a line to each:
What is the biggest benefit of having more than one stock exchange in a
market?
Copyright © 2019 - Novia One Group™
55
55
WHAT ARE INVESTMENT VEHICLES?
Assets offered by the investment industry to help investors move money from
the present to the future, with the hope of increasing the value of their money.
These assets include
Securities: shares, bonds, warrants
Real Assets: gold, real estate
Many investment vehicles are entities that own other investment vehicles such
as an equity mutual fund (unit trust fund) which owns shares.
Copyright © 2019 - Novia One Group™
56
DIRECT INVESTMENTS
INDIRECT INVESTMENTS
INVESTMENTS IN SECURITIES ISSUED BY
COMPANIES AND GOVERNMENTS.
SHARES IN UNIT TRUSTS /
FUNDS AND EXCHANGE TRADED FUNDS
REAL ASSETS
SUCH AS PRECIOUS METALS, ART, OR TIMBER.
INTERESTS IN HEDGE FUNDS
ASSET
BACKED SECURITIES, SUCH AS MORTGAGE
BACKED SECURITIES
INTERESTS IN PENSION FUNDS
Copyright © 2019 - Novia One Group™
57
COMPARISON OF DIRECT AND INDIRECT INVESTMENTS
Indirect (Pooled Vehicles)
Direct Investments
▪ Access to professional
management
▪ Minimum investment
requirement
▪ Shared ownership of large assets
e.g. a building
▪ Reduction in risk through
diversification
▪ Low trading costs compared to
underlying assets
▪ Are able to make their
investment decision and
therefore exercise control over
the selection of securities in
their portfolio
▪ Can time when to buy or sell
securities to minimise tax
liabilities
▪ Can obtain high quality advice at
a lower cost
Copyright © 2019 - Novia One Group™
58
TYPES OF INDICES
Total Return Index:
Includes both the return
from price changes and
dividend income.
Price Index:
Includes only the return
from price changes.
Copyright © 2019 - Novia One Group™
59
INDEX FUNDS
Full
replication
strategy
Sampling
replication
Fund managers
invest in every
security in the
benchmark index
Fund managers might invest
in only a representative
sample of the index
securities.
Some of these funds could
also be referred to as smart
beta funds.
Copyright © 2019 - Novia One Group™
60
VIDEO: SMART BETA
Copyright © 2019 - Novia One Group™
61
TYPES OF POOLED INVESTMENTS
Hedge Funds
Unit Trusts
Exchange traded
funds (ETFs)
• Are private investment pools that investment managers organise
and manage.
• As a group, they pursue diverse strategies.
• Investors hold a participatory interest in the funds and not the
underlying shares in the fund.
• Pooled investments
• Low cost
• Passively managed funds
Copyright © 2019 - Novia One Group™
62
VIDEO: WHAT IS AN ETF?
Copyright © 2019 - Novia One Group™
63
MAIN DIFFERENCES
The other main differences between the various types of
pooled investments are relate to:
Risks
management
accountability
Depends on
the
underlying
assets
Less
important for
passive funds,
more for
active funds.
management fees
Cost charged
to the fund
trading costs
Passive lower
than active
implication of
cash
distributions
Capital vs
interest
Copyright © 2019 - Novia One Group™
64
HEDGE FUND CHARACTERISTICS
The defining characteristics of hedge funds include:
Now
available to
both retail
and qualified
investors
Regulated by
CISCA
Use leverage,
short selling
& derivatives
Pension
funds can
invest up to
10% of their
assets into
hedge funds
Copyright © 2019 - Novia One Group™
65
FUND OF FUNDS
Funds of funds are
investment
vehicles that invest
in other funds.
Fund of funds
managers seek to
add value by
selecting managers
who will
outperform their
peers rather than
by selecting
securities that will
outperform other
securities.
Fees can be high
because investors
implicitly pay two
levels of fees.
Copyright © 2019 - Novia One Group™
66
INVESTMENT CONTROL PROBLEMS
Not all managers act in the best interest of their clients and
sometimes there are problems relating to:
▪ Investment losses from poor research e.g. buying a stock on the
investment advice of a friend without conducting research and due
diligence
▪ Missed opportunities
▪ Self serving advice
▪ Outright fraud
Copyright © 2019 - Novia One Group™
67
INVESTMENT CONTROL PROBLEMS
Churning
Trading the portfolio to often in order to benefit from
commission
Favouring
clients /
themselves
Investment managers may favour themselves or their
preferred clients over other clients when allocating trades
that have been, or are expected to be, profitable. For
instance, a manager might offer shares in an initial public
offering that is expected to do well only to preferred clients.
Copyright © 2019 - Novia One Group™
68
BUSINESS APPLIED LEARNING EVIDENCE
WORKBOOK ACTIVITY 3
1.
2.
3.
4.
5.
6.
List three (3) types of indices and give an actual example of the use
of each type:
List two (2) advantages investors in pooled investment vehicles have:
List two (2) advantages that indirect investment has over direct
investment:
List four (4) different unit trusts and briefly describe each (use the
given example to guide your answer)
List two (2) examples of exchange traded funds:
What, in your opinion is the general sentiment of investors towards
hedge funds?
Copyright © 2019 - Novia One Group™
69