COMM 300: Financial markets

From BluWiki

Terminology

• Bill vs. note vs. bond
• Bill matures under one year
• Notes mature in 2-7 years
• Bond matures in over 7 years

• Bulls vs. bears
  • Bulls think market is strong
  • Bears think market will fall

• Longs mean you're betting stocks will go up.
• Shorts mean you're betting the stocks will go down.
  • You sell stock on the open market, then buy it back for less

The financial playground

• Markets (are the different areas on the playground)
• Institutions (are the kids playing)
• Instruments (are the toys in the playground)

Financial markets

Functions of the financial markets

• Provide capital to those who can use it best
• Transfer ownership and risk
• Provide price information
• Facilitate payment
• Provide liquidity

Overview of financial markets

Capital markets

• Markets that take more than one year to mature
• Can be broken down into:
  • Debt
  • Bank debt
    • Bonds
  • Equity markets
    • Private equity markets
      • Angel investing, Venture capital investing, private equity (late, lower risk, investors)
    • Public equity markets < WHAT YOU'RE MOST FAMILAR WITH
      • This is the stock market, listed

Money market instruments

• Negotiable instruments that can be bought & sold
• Treasury bills
• CDs
• Bankers acceptances
• Fed funds
  • Overnight loans between banks
• Repos

• Foreign Exchange market
  • Largest market in the world
  • Currency trading

Derivatives

• Value based on another asset
• Forwards, futures, options, swaps, GNMAs
• Typically used to increase return or decrease risk

Sources of money

Banks

• Companies will invest and raise money from banks
• Projects raise money through banks (e.g. World Bank)

Debt markets

• Companies will invest and raise money through bonds (coporate and government)
• Governments will invest and raise money through bonds
• Projects (e.g. Power plants in Brazil) raise money through medium & long-term bonds

Equity markets

• Institutions invest in common stock
• Companies raise money through stock

Financial Institutions

Depository Institutions

• Include commercial banks and others (such as S&Ls, Mutual savings banks, and Credit unions)
• Commercial banks are like the "deparment stores" of the financial institutions
  • They want to be everyone to everybody

Commercial banks

• Deposits
• Loans
  • Commercial
  • Consumer
  • Mortgage
• Trust services
• Financial planning

Balance sheets

Note they are reversed! Loans are assets, and deposits (from customers) are liabilities.

Nondepository institutions

• Investment banks
• Others
  • Insurance companies
  • Mutual funds
  • Hedge funds
  • Mortgage banks
  • etc.

Investment Banks

• Initially specialized in one thing: taking companies public
• Now they:
  • Securities issuance
    • Security creation
    • Initial public offerings
  • Mergers & acquisitions
  • Private equity
  • Trading - if they're so good at doing the above, they should employ their info, this is what trading is.
  • Research

Other finanacial institutions

• Insurance companies
  • Allow people to hedge risk
• Mutual and pension funds
• Brokerage firms
  • Etrade, etc.
• Mortgage banks
  • DOES NOT HOLD MORTGAGE. Just acts as a go-between between investor and
• Finance companies

Hedge funds

• Like a mutual fund, an investment company
• Less regulated than mutual funds
• Higher risk, higher return
  • Very risky
• "A compensation scheme masquerading as an asset class"
  • This is because they charge VERY high fees

The toys on the playground

Common stock

• Ownership interest

Preffered stock

Cumulative provision < LOOK THIS UP

Diverative securities

• Forwards contracts
  • A price today for a security in the future
  • Pros: you can establish a price now for a delivery in the future
  • Cons: You can dump it quickly

• Futures contracts
  • Forwards contracts that are exchanged on a standardized market

• Option
  • The right, but not the obligation to buy or sell
    • A specified asset for a specified price within a specified period of time.
  • Options are more risky than