Brokers Awareness program
Dr. Mounther Barakat
Securities and Commodities Authority
1-1
‫برنامج توعية الوسطاء‬
‫د‪ .‬منذر بركات العمري‬
‫هيئة االوراق المالية والسلع‬
‫‪1-2‬‬
Introduction
‫مقدمة‬
It has been noticed that traders and entry
level brokers may be
1- from backgrounds other than finance,
or
2- little finance background, or
3- of finance background that needs to
be refreshed
If you are none of the above, this is
not for you
1-3
What is this program about?
‫ماذا يحوي برنامج توعية الوسطاء؟‬
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Introduction to the field of finance
Financial risk and return
Demand on financial assets
Structure of interest rates
Financial markets efficiency
Economic policies and the role of the central bank
Capital, money, commodity, derivatives, mortgage, foreign
exchange markets
Organization of markets and its operations
Introduction to financial analysis
Conflict of interest and financial crises
Financial institutions: Investment companies, securities firms,
banks, insurance companies, finance companies, pensions, ...
1-4
What is Finance?
‫تعريف صناعة وعلم التمويل‬


Finance deals with: efficient allocation
of resources by using pricing systems
that are based on the riskness of
assets.
Three areas of finance:



Financial markets and Institutions –
Intermediation
Corporate finance
Investments
1-5
Definitions from Finance perspective
‫تعريفات هامة‬
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Asset
Real asset Vs. Financial asset
Primary asset Vs. Secondary asset
Intermediary Vs. broker Vs. dealer
Market
Financial market
Balance sheet
Income statement
Statement of cash flow
Cash Vs. profit
Surplus Vs. Deficit Units
1-6
The financial System
‫النظام المالي‬

Types of financial Systems

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Religious
Socialism
Capitalism
Mixed
The financial system in the UAE is the free
market system with considerations specific to
the UAE (e.g. Islamic and Arab culture, …)
1-7
The financial system
‫مكونات النظام المالي‬

Participants
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The financial sector
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Governments
Businesses
Individuals
Foreigners
Financial markets
Financial institutions
Money and Interest rates
1-8
The Financial System
‫النظام المالي‬
Financial System
I/M
Fin. Sec.
Participants
- Interest rates
- Financial Markets
- Government.
- Money Supply
- Financial Institutions
- Businesses
- Individuals
- Foreigners
1-9
The Financial Sector
‫القطاع المالي‬
Financial Sector
Financial Markets
Long Term
Short Term
Equity
Money
Debt
FOREX
Financial Institutions
Depositories
Non-depositories
Banks
Investment Companies
Credits Unions
Securities firms
Contractual
financing
1-10
Interest Rates and Money Supply
‫أسعار الفائدة والكتلة النقدية‬
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Interest is the rent of money
Equal to the real growth rate of GDP plus the expected
inflation rate plus a premium to compensate for the
riskness of the company being analyzed.
Money supply is the amount of liquidity that is being
allowed by the UAE central bank. The company being
analyzed benefits if the amount of liquidity is near the
healthy level.
Both interest rates and money supply have a great
effect on the performance and value of the company
and need to be taken into consideration in any financial
analysis.
1-11
Function of Financial Markets and Institutions
‫وظيفة األسواق والمؤسسات المالية‬

Allows transfers of funds from person or
business without investment opportunities
(i.e., “Lender-Savers”) to one who has them
(i.e., “Borrower-Spenders”)
‫تحويل االموال ممن يملكونها الى من يحتاجونها‬


Improves economic efficiency
‫زيادة الفاعلية االقتصادية‬
1-12
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Segments of Financial Markets
1.
2.
Direct Finance
•
Borrowers borrow directly from lenders in financial
markets by selling financial instruments which are
claims on the borrower’s future income or assets
‫• التمويل المباشر‬
Indirect Finance
•
Borrowers borrow indirectly from lenders via financial
intermediaries (established to source both loanable
funds and loan opportunities) by issuing financial
instruments which are claims on the borrower’s future
income or assets
‫• التمويل غير المباشر‬
1-13
Importance of Financial
Markets
‫اهمية االسواق المالية‬
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
Financial markets are critical for producing an
efficient allocation of capital, which contributes to
higher production and efficiency for the overall
economy, as well as economic security for the
citizenry as a whole
‫توزيع المصادر بفاعلية وإنتاجية عالية وأمان‬
Financial markets also improve the lot of individual
participants by providing investment returns to
lender-savers and profit and/or use opportunities to
borrower-spenders
‫زيادة معدل العائد والربحية للجميع‬
1-14
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Function of Financial Markets
‫رسم توضيحي لفكرة انتقال االموال‬
Flow of Funds Through the Financial System
1-15
Classifications of Financial Markets
‫تصنيف األسواق حسب اإلصدار‬
1.
Primary Market ‫السوق األولية‬

2.
New security issues sold to initial buyers
Secondary Market ‫السوق الثانوية‬

Securities previously issued are bought
and sold
1-16
Classifications of Financial Markets
‫تصنيف األسواق حسب التنظيم‬
3.
4.
Exchanges )‫االسواق المنظمة (البورصات‬

Trades conducted in central locations
(e.g., ADSM, DFM, ….)
Over-the-Counter Markets ‫االسواق الغير منظمة‬

Dealers at different locations buy and sell
1-17
Classifications of Financial Markets
‫تصنيف األسواق حسب االستحقاق‬
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Long term (Capital Markets)
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Debt
Equity
Short term (Money Markets)
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Foreign Exchange
Money markets
1-18
Classifications of Financial Markets
‫تصنيف األسواق المالية حسب نوعية األصول‬
1.
Debt Markets ‫أسواق الدين‬
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2.
Short-Term (maturity < 1 year) Money
Market
Long-Term (maturity > 1 year) Capital
Market
Equity Markets ‫أسواق الملكية‬
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Common Stock
1-19
Characteristics of Debt Markets Instruments
‫أدوات الدين‬
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Debt instruments ‫صفات ادوات الدين‬
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Buyers of debt instruments are suppliers (of
capital) to the firm, not owners of the firm
Debt instruments have a finite life or maturity date
Advantage is that the debt instrument is a
contractual promise to pay with legal rights to
enforce repayment
Disadvantage is that return/profit is fixed or
limited
1-20
Characteristics of Equity Markets Instruments
‫أدوات الملكية‬

Equity instruments (common stock is most
prevalent equity instrument) ‫صفات ادوات الملكية‬

Buyers of common stock are owners of the firm
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Common stock has no finite life or maturity date
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Advantage of common stock is potential high
income since return is not fixed or limited
Disadvantage is that debt payments must be
made before equity payments can be made
1-21
Characteristics of Financial Markets
‫أسواق الدين‬
Debt Markets ‫صفات اسواق الدين‬
1.
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Although less well-known by the average
person, debt markets are much larger in total
dollars than equity markets, due to greater
number of participant classes (households,
businesses, government, and foreigners) and
size of individual participants (businesses, and
government)
This is not the case in the UAE; debt market is
mostly bank loans and informal or off balance
sheet lending.
1-22
Characteristics of Financial Markets
‫أسواق الملكية‬
Equity Markets ‫صفات اسواق الملكية‬
2.
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Although newly founded and lacks the needed
environment to function properly, it proved to
have played its role in establishing the elements
of the sovereignty of the country and in
promoting economic development.
To the contrary of most economies including that
of the US the equity market in UAE is larger than
the debt market, due to the fact that the bond
markets are small and illiquid.
1-23
Function of Financial Intermediaries
‫دور الوساطة المالية‬

Financial Intermediaries ‫الوسطاء الماليين‬
1.
2.
3.
Engage in process of indirect finance
More important source of finance than
securities markets
Needed because of transactions costs
and asymmetric information
1-24
Function of Financial Intermediaries
‫دور الوساطة المالية‬
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Transactions Costs ‫تكاليف التحويالت‬
1.
2.
Financial intermediaries make profits by
reducing transactions costs
Reduce transactions costs by developing
expertise and taking advantage of
economies of scale and scope.
1-25
Function of Financial Intermediaries
‫دور الوساطة المالية‬
•
A financial intermediary’s low transaction costs
mean that it can provide its customers with
liquidity services, services that make it
easier for customers to conduct transactions
‫توفير السيولة دون الحاجة الى انهاء المشروع االنتاجي‬
1.
2.
Banks provide depositors with checking
accounts that enable them to pay their bills
easily
Depositors can earn interest on checking and
savings accounts and yet still convert them into
goods and services whenever necessary without
having to discontinue and liquidate investments
1-26
Function of Financial Intermediaries
‫دور الوساطة المالية‬

Another benefit made possible by the FI’s low
transaction costs is that they can help reduce
the exposure of investors to risk, through a
process known as risk sharing
‫ ادارة المخاطر‬
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FIs create and sell assets with lesser risk to one
party in order to buy assets with greater risk from
another party (e.g. banks)
This process is referred to as asset
transformation, because in a sense risky assets
are turned into safer assets for investors
1-27
Function of Financial Intermediaries
‫دور الوساطة المالية‬

Adverse Selection ‫االمتناع عن االستثمار‬
1.
2.
Before transaction occurs
Potential borrowers most likely to
produce adverse outcome are ones most
likely to seek loan and be selected –
brokers and financial analysts can
prevent that by studying the credit
worthiness of the borrowers
1-28
Function of Financial Intermediaries
‫دور الوساطة المالية‬

Moral Hazard ‫المخاطرة بأموال الغير‬
1.
2.
After transaction occurs
Hazard that borrower has incentives to
engage in undesirable (immoral)
activities making it more likely that won't
pay loan back
1-29
Function of Financial Intermediaries
‫دور الوساطة المالية‬

Financial intermediaries reduce adverse
selection and moral hazard problems,
enabling them to make profits. How
they do this is covered in many of the
topics to come.
‫المؤسسات المالية تقلل من هذه المخاطر‬
1-30
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Financial Institutions
‫انواع المؤسسات المالية‬
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Depository Institutions (Banks) ‫المؤسسات اإليداعية‬
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Commercial banks
Savings & Loan Associations (S&Ls)
Mutual Savings Banks
Credit Unions
Contractual Savings Institutions ‫المؤسسات التعاقدية‬
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Life insurance companies
Property & casualty insurance companies
Pension funds
1-31
Financial Institutions
‫انواع المؤسسات المالية‬
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Investment Intermediaries ‫المؤسسات االستثمارية‬
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Finance companies
Mutual funds
Money market mutual funds
1-32
Financial Institutions
‫انواع المؤسسات المالية‬
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Commercial banks ‫البنوك التجارية‬
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Raise funds primarily by issuing checkable,
savings, and time deposits which are used to
make commercial, consumer and mortgage loans
Collectively, these banks comprise the largest
financial intermediary and have the most
diversified asset portfolios
Around 1 trillion DHS in total assets in the UAE
1-33
Financial Institutions
‫انواع المؤسسات المالية‬
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S&Ls, Mutual Savings Banks and Credit Unions
‫المؤسسات االدخارية ومؤسسات االقراض الغير ربحية‬
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Raise funds primarily by issuing savings, time, and checkable
deposits which are most often used to make mortgage and
consumer loans, with commercial loans also becoming more
prevalent at S&Ls and Mutual Savings Banks
Mutual savings banks and credit unions issue deposits as
shares and are owned collectively by their depositors, most
of which at credit unions belong to a particular group, e.g., a
company’s workers
1-34
Financial Institutions
‫انواع المؤسسات المالية‬

All CSIs acquire funds from clients at periodic
intervals on a contractual basis and have
fairly predictable future payout requirements.

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Life Insurance Companies ‫شركات تأمين الحياة‬
receive funds from policy premiums, can invest in
less liquid corporate securities and mortgages,
since actual benefit pay outs are close to those
predicted by actuarial analysis
Fire and Casualty Insurance Companies ‫شركات تأمين االصابة‬
receive funds from policy premiums, must invest
most in liquid government and corporate
securities, since loss events are harder to predict
1-35
Financial Institutions
‫انواع المؤسسات المالية‬

All CSIs acquire funds from clients at periodic
intervals on a contractual basis and have
fairly predictable future payout requirements.

Pension and Government Retirement Funds
‫صناديق التقاعد‬
hosted by corporations and state and local
governments acquire funds through employee and
employer payroll contributions, invest in corporate
securities, and provide retirement income via
annuities
1-36
Financial Institutions
‫انواع المؤسسات المالية‬

Finance Companies ‫شركات التمويل‬
sell commercial paper (a short-term debt
instrument) and issue bonds and stocks to raise
funds to lend to consumers to buy durable
goods, and to small businesses for operations

Mutual Funds ‫صناديق االستثمار‬
acquire funds by selling shares to individual
investors and use the proceeds to purchase
large, diversified portfolios of stocks and bonds –
we will have a training course on these some
time this summer
1-37
Financial Institutions
‫انواع المؤسسات المالية‬

Money Market Mutual Funds
‫صناديق االستثمار باألدوات قصيرة االمد‬
acquire funds by selling checkable deposit-like
shares to individual investors and use the
proceeds to purchase highly liquid and safe
short-term money market instruments
Hedge Funds, ETFs and others
1-38
Regulation of Financial
Markets

Reasons for Regulation ‫اسباب التشريع المالي‬
1.
Increase Information to Investors
2.
Protect investors and their investments
3.
4.
Ensure the Soundness of Financial
Intermediaries
Improve Monetary Control
1-39
Regulation Reason:
Increase Investor Information
‫زيادة توفر المعلومات‬
•
•
Asymmetric information in financial markets means
that investors may be subject to adverse selection
and moral hazard problems that may hinder the
efficient operation of financial markets and may also
keep investors away from financial markets
The Securities and Commodities Authority (SCA)
requires corporations issuing securities to disclose
certain information about their sales, assets, and
earnings to the public and restricts trading by the
largest stockholders (known as insiders) in the
corporation.
1-40
Regulation Reason:
Increase Investor Information
‫زيادة توفر المعلومات‬
•
Such government regulation can reduce adverse
selection and moral hazard problems in financial
markets and increase their efficiency by increasing
the amount of information available to investors
1-41
Regulation Reason: Ensure
Soundness of Financial
Intermediaries ‫ُر ْشد الوسطاء‬

Because providers of funds to financial
intermediaries may not be able to assess
whether the institutions holding their funds
are sound or not, if they have doubts about
the overall health of financial intermediaries,
they may want to pull their funds out of both
sound and unsound institutions, with the
possible outcome of a financial panic that
produces large losses for the public and
causes serious damage to the economy
1-42
Regulation Reason: Ensure
Soundness of Financial
Intermediaries ‫ُر ْشد الوسطاء‬

To protect the public and the economy from
financial panics, six types of regulations are
needed:

Restrictions on Entry - soundness

Disclosure – transparency

Restrictions on Assets and Activities – no dummies

Deposit Insurance – peace of mind

Limits on Competition – no price wars

Restrictions on Interest Rates – no usury
1-43
Regulation: Restriction on
Entry ‫موانع الدخول‬

Restrictions on Entry



Very tight regulations as to who is allowed to set
up a financial intermediary
Individuals or groups that want to establish a
financial intermediary, such as a bank or an
insurance company, must obtain a charter from
the government
Only if they are upstanding citizens with
impeccable credentials and a large amount of
initial funds will they be given a charter.
1-44
Regulation: Disclosure ‫االفصاح‬


Disclosure Requirements
There are stringent reporting requirements
for financial intermediaries



Their bookkeeping must follow certain strict
principles,
Their books are subject to periodic inspection,
They must make certain information available to
the public.
1-45
Regulation: Restriction on Assets
and Activities ‫تحديد النشاطات‬


There are restrictions on what financial
intermediaries are allowed to do and what
assets they can hold
Before you put your funds into a bank or
some other such institution, you would want
to know that your funds are safe and that the
bank or other financial intermediary will be
able to meet its obligations to you
1-46
Regulation: Restriction on Assets
and Activities ‫تحديد النشاطات‬


One way of doing this is to restrict the
financial intermediary from engaging in
certain risky activities
Another way is to restrict financial
intermediaries from holding certain risky
assets, or at least from holding a greater
quantity of these risky assets than is
prudent
1-47
Regulation: Deposit Insurance
‫التأمين‬

The government can insure people
providing funds to a financial
intermediary from any financial loss if
the financial intermediary should fail
1-48
Regulation: Past Limits
on Competition ‫حدود للتنافس‬


Although the evidence that unbridled
competition among financial intermediaries
promotes failures that will harm the public is
extremely weak, the government needs to
impose many restrictive regulations
The purpose is to prevent financial
intermediaries from competing to the point
where the integrity of the financial system is
compromised.
1-49
Regulation: Past Restrictions
on Interest Rates ‫حدود ألسعار الفائدة‬


Competition must also be inhibited by
regulations that impose restrictions on
interest rates that can be paid on
deposits
These regulations need to be instituted
because of the widespread belief that
unrestricted interest-rate competition
help encourage bank failures
1-50
Regulation Reason: Improve
Monetary Control ‫التحكم بالكتلة النقدية‬



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 central bank
Reserve requirements help the central bank exercise
more precise control over the money supply – well,
much can be detailed about the UAE monetary policy.
1-51
The cost of money
‫تكلفة رأس المال‬


The price, or cost, of debt capital is the
interest rate.
The price, or cost, of equity capital is the
required return. The required return
investors expect is composed of
compensation in the form of dividends and
capital gains.
1-52
What four factors affect the cost of money?
‫العوامل التي تؤثر في تكلفة رأس المال‬



Time preferences for consumption (sacrifice)
Expected inflation (loss in purchasing power)
Risk (worry)
1-53
“Nominal” vs. “Real” rates
‫العائد االسمي والحقيقي‬
k
= represents any nominal rate
k* = represents the “real” risk-free rate of
interest, if there was no inflation.
Typically ranges from 1% to 4% per
year.
kRF = represents the rate of interest on
Treasury securities.
1-54
Determinants of interest rates
)‫محددات سعر الفائدة (العائد‬
k = k* + IP + DRP + LP + MRP
k
=
k* =
IP =
DRP =
LP =
MRP =
required return on a debt security
real risk-free rate of interest
inflation premium
default risk premium
liquidity premium
maturity risk premium
1-55
Premiums added to k* for different types of debt
‫مقارنة عالوات المخاطر المختلفة‬
IP
S-T Treasury

L-T Treasury

S-T Corporate

L-T Corporate

MRP DRP
LP






1-56
Yield curve and the term structure of interest rates
‫منحنى العائد وعالقة الفائدة باالستحقاق‬


Term structure –
relationship between
interest rates (or yields)
and maturities.
The yield curve is a
graph of the term
structure.
1-57
Hypothetical yield curve
‫منحنى عائد افتراضي‬
Interest
Rate (%)
15

Maturity risk premium

10
Inflation premium
5
An upward sloping
yield curve.
Upward slope due to
an increase in
expected inflation and
increasing maturity
risk premium.
Real risk-free rate
0
1
10
Years to
20 Maturity
1-58
The Yield Curve
‫منحنى العائد‬


Corporate yield curves are higher than that
of Treasury securities, though not
necessarily parallel to the Treasury curve.
The spread between corporate and Treasury
yield curves widens as the corporate bond
rating decreases.
1-59
The Yield Curve
‫منحنى العائد‬
Interest
Rate (%)
15
BB-Rated
10
AAA-Rated
5
Treasury
6.0% Yield Curve
5.9%
5.2%
Years to
0
Maturity
0
1
5
10
15
20
1-60