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44 Market Organization and Structure (Intermediaries of Financial Market…
44 Market Organization and Structure
main functions of the financial system
Fullfill different entities' requirements
Saving
Borrowing
Raising equity
Managing Risks
Exchanging assets
Information-Motivated Trading
Determine interest rates
Interest rates are justified according to
the total supply of savings and the total demand of borrowings
.
the required rates of return for securities vary by their risk characteristics, terms, and liquidity
Capital allocation efficiency
This would result in an allocation to capital to its most valuable uses.
Classification of Assets
Financial assets
Security
Fixed income securities & Equity securites
Pooled investment vehicles
Public vs. private
Public securities
trade in liquid markets in which sellers can easily find buyers for their securities
Private securities
are not traded in public markets which are often illiquid and not subject to regulation
Currency
Issued by national monetary authorities
Derivative contracts
are agreements between two parties that require some action in the future
Real assets
Commodity
Real Assets
Characteristics
Provide income, tax advantage, diversification benifits
Entail substantial management costs
Require substantial due diligence before investing
Intermediaries of Financial Market
Brokers, Dealers and Exchange
Brokers
Block brokers
Investment banks
Exchange
Alternative trading systems (ATS)
Dealers
Primary dealers
Broker-dealers
Securitizers
purchase and repackage assets or mortgages and put them into a pool in order to sell them in shares
Depository Instititutions
Raise funds from depositors and other investors and lend it to borrowers
Insurance Companies
Offsetting risks by creating insurance contracts that provide a payment in the event that some loss occurs.
Arbitrageurs
seek to gain certain return without bearing any risk
Clearinghouses and Custodians
Clearinghouse
act as buyers when customers want to sell assets and as sellers when customers want to buy assets, and thus limit counterparty risk
Custodians
help prevent the loss of securities
Hedgers
use short positions in one asset to hedge an existing risk from a long position in another asset that has returns that are strongly correlated with the returns of the asset shorted.
Classification of markets
Primary vs. Secondary markets
Money vs. Capital markets
Traditional vs. Alternative markets
Organization of the Securities Market
How securities sold through primary market
Sold publicly
Underwritten offering (the most common way)
The investment bank guarantees the sale of the issue at an offering price that is negotiates with the issuer.
Investment bank bears the risk of buying the unsold portion of securities
Best efforts
the investment bank doesn't purchase the whole issue
Indications of interest
Book building
line up subscribers who will buy the security
the investment bank gathers investors who are interested in the issue and willing to buy a portion of them
Sold privately
Private placement
sell securities directly to a small group of qualified investors
Other transaction methods
Shelf registration
type of public offering
Dividend reinvestment plan
reinvest their dividends in newly issued shares of the coporation
Rights offering
rights to buy stock at a fixed price
Competitive bids
Negotiated sales
Secondary capital markets
securities are trade after their initial offerings
supports the primary market by providing
Liquidity
Price discovery
How securities are traded in secondary markets
Order-driven market
Order machting rules
Price priority
Secondary precedence rule
time precedence
Quote-driven market
Dealers make a market in the stock
Brokered markets
Position in an Asset
Long Position
Benefit from an increase in the price
Short Position
Benefit from a decrease in the prices of the assets or contracts sold.
Payment-in-lieu
The received dividends and interests must be paid back to the investor who lent the stock
Short rebate rate
Lenders require that the short seller leave the proceeds of the short sale on deposit with them as collateral for the stock loan.
Lenders invest the collateral in short-term securities, and they rebate the interest to the short sellers at rates.
If a security is hard to borrow, the rebate may be very small or even negative.
Leverage Position
Traders buy securities by borrowing some of the purchase price.
indicates how many larger a position is than the equity that supports it
Margin requirement
Initial margin
Maintenance margin
Margin call
Instructions of Transaction Processes
Execution instructions
specify how to trade
The most common orders
Market orders
buy or sell a security at the best current price
Limit orders
Make the market
Take the market
Behind the market
Far from the market
Instructions concern the volume of the trade
All-or-nothing orders
Instructions concern the visibility of the trade
Hidden orders
Iceberg orders
Validity instructions
specify when the order can be filled
Day orders
Good-till-cancelled orders (GTC)
Immediate or cancel orders
Good-on-close orders
Good-on-open orders
Stop oder
Stop-sell order
Stop-buy
Clearing instructions
specify how to settle the trade