Financial Markets
Term 6, 2011
Professor Venky Panchapagesan
Faculty Block B-208
venky.panchapagesan@iimb.ernet.in
080-26993349
Financial Markets
Course Syllabus
Course Description
This course examines the theory and practice behind the organization of world’s major
financial markets. Students will learn about key economic principles that drive wellfunctioning financial markets along with practical, institutional details necessary to
navigate them. The course covers equity, debt, currency and commodity markets as well
as some exotic markets such as credit default swaps, and traces their evolution within and
outside India. Given that markets fail periodically, students will also study why they do
so by examining some modern systemic and endemic market crises. A key feature of this
course is the discussion of current news events at the start of each class, with students
sometimes leading them, that is intended to reinforce concepts we learn through real
world applications. Also as a capstone project, students will critically evaluate a current
market-related issue from the perspective of different stakeholders, including that of
regulators, and learn to make decisions based on sound economic intuition and good
institutional knowledge.
This course is for students who want to understand how financial markets work in the
real world. It is designed to supplement the already learnt theoretical foundation in
finance to better prepare them for life after graduation, whether they want to interact with
markets passively as an investor, or actively as a trader, investment manager, or as a
regulator. At the end of the course, students will leave with a keen appreciation of
market mechanics, including dissecting the motivations of different players, evaluating
policies and understanding their impact on financial markets and investor behaviour.
About Me
I am a Finance Ph.D. (from the University of Southern California) with almost 20 years
of experience, both in academia as well as in Wall Street. Before joining IIM-B, I was
with the world’s largest hedge fund, Bridgewater Associates (www.bwater.com),
overseeing their global currency trading and building out their trading analytic and data
infrastructure. Prior to that, I worked with Goldman Sachs overseeing trading research
for their quantitative hedge funds (www2.goldmansachs.com/gsam). My academic
experience includes a seven year stint as a finance professor at the Olin School of
Business at Washington University in St. Louis (a top 20 business school) and visiting
academic positions at NASDAQ and NYSE. I am also certified in India as a Chartered
Accountant and a Cost Accountant and hold a PGDM from IIM (Calcutta).
Course Materials
There is no single source that covers most of what we will learn in this course.
Therefore, I do not prescribe a required textbook though I do think a few (listed below)
cover certain parts very well and I have recommended them as optional texts. My lecture
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Financial Markets
notes are meant to only highlight important concepts that we would elaborate and discuss
in class. So please do not use them as substitutes for showing up and participating in
class.
The following two books are optional for this course. They are available at several
online outlets such as flipkart.com and are priced reasonably around 400 to 500 rupees
each.
Title: Trading and Exchanges
Author: Larry Harris (ex-SEC Chief Economist)
(Oxford University Press, ISBN: 0-19-514470-8)
Title: India’s Financial Markets, An Insider’s Guide to How the Markets Work
Authors: Ajay Shah, Susan Thomas and Michael Gorham
(Elsevier, ISBN: 978-0-12-374251-3)
While the former book describes, in simple language, the mechanics of why and how
people trade and is written by one of the well-known world experts on market structure,
the latter book is more of a description of the evolution of India’s financial markets and
where they are today. These books are an excellent resource for keen students of
financial markets and would help you well beyond graduation.
In addition, I will post or distribute a few readings from time to time that will supplement
our understanding of the material covered in class lectures.
Course Structure
The course is broadly structured into five modules.
In the first module, we will refresh our foundational knowledge of Economics and
Finance, and to a lesser extent Statistics. This is important so that we can build upon this
foundation for a deeper exploration of financial markets in the ensuing lectures.
The second module will present a framework to understand the role of a market and to
evaluate its ability to satisfy the needs of its stakeholders. In particular, we will examine
the economic principles behind market organizations, the role of different market
intermediaries and their incentives, frictions caused by misalignment of these incentives,
and the choices in market design for overcoming these frictions. The framework allows
us to evaluate not only the current state of a financial market but also the trajectory in
which it is evolving.
Using the framework developed in the second module, we will study the major financial
markets – equity, debt, currency and commodity markets – in the third module. We will
highlight important issues in these markets and how they are dealt with, both in the
Indian as well as in the international context. We will also examine specialized markets
such as the CDS market and examine some of the challenges faced by them in this
module.
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Financial Markets
In the fourth module, we will examine different types of market breakdowns using real
world examples. We will use our framework to understand their origins and also explore
regulatory as well as other solutions to address them.
In the fifth and final module, students will take up a timely and important market-related
issue and examine it from the perspective of different stake holders such as the regulator,
market governing body such as the exchange, large and small investors etc. The
objective of this exercise is to use our framework to understand everyday issues related to
markets and be able to present intelligent ways, backed by sound economic intuition, to
address them.
Grading
Students will get their basic letter grade (plain grades such as A, B, and so on) through a
mixture of written and oral evaluations. There will be two short quizzes and a mid-term
examination that together will constitute 70 percent of the grading. The remaining 30
percent will be based on end-of-the-term project where students will examine a marketrelated issue (to be chosen from several alternatives that I will provide early in the term)
from different perspectives working in groups.
In other words, the basic final grade will be determined as follows:
2 short quizzes
20%
Mid-term examination
50%
Group project
30%
Basic grading will be relative and is based on the student’s normalized performance
across his peers. A student can supplement this basic grade with high quality in-class
participation and can earn a’+’ version of his basic grade. For example, a student who
has earned the basic grade B can convert it to B+ through in-class participation. Without
class participation, the student’s grade will remain as B.
In addition, students can opt to lead real world discussions at the beginning of each
lecture that would provide them with “bonus” points. I will post topics for discussion in
advance and students can select one among them for class discussion. They need to
prepare and provide the class with general background as well as be able to tie the
discussion to what we are learning in class. Each “good” discussion (I will provide
details on what constitutes “good” in class) can get 5 points which can be used to
substitute for poor performance in other assessments such as the mid-term examination.
Class and Exam Schedule
See tentative schedule below.
Guest Lectures
I may arrange guest lectures by industry leaders/practitioners throughout the term based
on their availability. The primary objective is to expose you to practitioners’ perspectives
and supplement our classroom learning with their practical insight.
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Financial Markets
Tentative Schedule
Module
1
1
2
Lecture No.
1
2-3
4-5
Theme
Introduction
Foundation Refresher
Framework to Study Financial
Markets
Content Details
Recommended Readings
Introduction
Student/Teacher introduction
Mutual Expectations
Project discussion
Current events
Foundational knowledge refresher
Economics
(Zero-sum game, Game theory, Externalities,
Principal/Agent problem, Moral hazard, Adverse selection,
Utility maximization etc.),
Finance
(NPV, Equity as an option, Capital structure and MM
theorems, Real vs. Nominal flows, Portfolio theory, Bond
math, Term structure, Purchasing power parity, Traditional
vs. Behavioral Finance etc.)
Probability, Statistics and Basic Mathematics
Market structure framework
Market goals/objectives  Likely beneficiaries (direct and
indirect beneficiaries)  Economic principles at play 
Choice of organization  Standardization of instruments
 Valuation of instruments  Risks  Regulation and
enforcement  Imperfections and distortions in practice
Dependencies on other frameworks such as legal and
accounting framework
Role of financial innovation
4
1. Ch. 8 and 9 (Larry
Harris, Trading and
Exchanges)
Financial Markets
QUIZ 1
Equity market framework
- Apply our framework to understand equity markets
- Evolution of International and Indian equity
markets along the framework
3
6-7
Equity Markets
Key aspects of equity markets
- Primary and secondary markets
- Primary and secondary participants
- Instruments, e.g., Cash, Futures, Options and other
derivatives
- Decision to go public – principles and process
- Role of private information
- Market design (order-driven and quote-driven
market)
- Role and incentives of intermediaries such as
analysts, investment bankers and market makers
- Price discovery and liquidity
- Trading and microstructure
- Regulation
Indian vs. International experience
Current events (issues/possible solutions)
5
1. Lecture notes on
framework
2. Ch. 3 and 4 (Ajay
Shah et al., India’s
Financial Markets)
3. Ch. 6 and 13 (Larry
Harris, Trading and
Exchanges)
Financial Markets
Debt market framework
- Apply our framework to understand debt markets
- Evolution of International and Indian debt markets
along the framework
3
8-9
Debt Markets
Key aspects of debt markets
- Sovereign and corporate debt (credit differences)
- Short-term vs. long-term debt (maturity
differences)
- Inflation-linked bonds
- Role of public information (macro-economic
announcements)
- Market design and evolution (e.g. prevalence of
auctions, more structuring, on-the-run and off-therun issues)
- Risks - interest rate, default etc.
- Role and incentives of intermediaries such as credit
rating agencies
- Price discovery and liquidity
- Trading and microstructure
- Regulation
Indian vs. International experience
Current events (issues/possible solutions)
6
1. Lecture notes on
framework
2. Articles to be posted
before lecture
Financial Markets
Currency market framework
- Apply our framework to understand currency
markets
- Evolution of International and Indian currency
markets along the framework
3
10-11
Currency Markets
Key aspects of currency markets
- Major determinants - trade and capital flows,
interest rates
- Link between short-term interest rates and currency
rates - carry trading
- Triangulation concept in currencies
- Exchange rate regimes and their implications to
markets (Floating vs. Fixed rates, Pegging)
1. Lecture notes on
- Central bank intervention, currency wars, currency
framework
devaluations
2. Articles to be posted
- Market design (Forward and spot markets,
before lecture
deliverables vs. non-deliverables, on-shore vs. offshore market)
- Role and incentives of intermediaries such as Forex
dealers and brokers
- Price discovery and liquidity
- Trading and market microstructure
- Currency trading as a byproduct of other asset
classes trading
- Regulation
Indian vs. International experience
Current events (issues/possible solutions)
12
Assessment
MID-TERM EXAM
7
Financial Markets
Commodity market framework
- Apply our framework to understand commodity
markets
- Evolution of International and Indian commodity
markets along the framework
3
13-14
Commodity Markets
Key aspects of commodity markets
- Major determinants – weather, production, storage
and economic activity
- Role of commodity markets in hedging
Unique aspects such as settlement through delivery
and standardization of contracts
- Role of geography in development of commodity
markets
- Role and incentives of intermediaries such as
brokers, dealers and analysts
- Types of commodity markets (agriculture, metals
etc.)
- Risks
- Market design (spot vs. forward markets, futures,
options, swaps)
- Forward price curves – contango and
backwardation
- Price discovery and liquidity
- Trading and microstructure
- Regulation
Indian vs. International experience
Current events (issues/possible solutions)
8
1. Lecture notes on
framework
2. Articles to be posted
before lecture
Financial Markets
Specialized market framework
- Apply our framework to understand some
specialized markets
Key aspects of some specialized markets
- Real estate market
- Electricity and power markets
- Credit default swaps market
- Pollution markets
3
15-16
Specialized Markets
-
Market design
Role and incentives of intermediaries
Price discovery and liquidity
Trading and microstructure
Regulation
1. Lecture notes on
framework
2. Articles to be posted
before lecture
Indian vs. International experience
Current events (issues/possible solutions)
QUIZ 2
4
5
Framework to study market breakdowns
Real world examples across different markets
Examination of root causes
Regulatory and non-regulatory responses to prevent such
breakdowns in the future
17
Market Breakdowns
18
Guest Lecture
Guest lecture
19-20
Presentations
Project presentations
9
1. Ch. 28 (Larry Harris,
Trading and
Exchanges)
2. Articles to be posted
before lecture