Market Organization & Structure
1. Functions of a financial system
Helping people achieve porpose in using financial system
Saving
Borrowing
Raising capital equity
Managing risks
Spot market trading
Information moticated trading
Determining rates of return
Capital allocation efficiency
Financial systems allocate funds to the most productive
Law of supply & demand : money now vs money in the future.
2. Assets & Contracts
Classification of markets
Spot market vs futures markets & options markets
Primary markets vs Secodary markets
Money Markets vs Capital markets
Traditional investment markets vs alternative investment markets.
Securities
Fixed income
Equities
Pooled investements
Currencies
Contracts
Forward contracts : An agreement to trade an Underlying in the future at a price agreed upon today.
Futures contracts : Standardized future contracts {Clearinghouse, initial margin, maintenance margin}
Swaps : An agreement to exchange payments of periodic cashflows that depend on future asset prices or interest rates
Commodity swap : Payments depend of future prices of a commodity
Currency swap : Payments are denominated in deifferent currencies
Equity swap : Payments depend on the return of a stock/index
Options : Allows the holder to Buy : Call option or Sell : Put option an underlying at a Strike price, at {European-style} or before {American-style} a date in the future.
Other contracts : Are mainly insurance contracts, Ex : Credit Default Swaps
Commodities : Trade in the spot market and forward/futures markets
Real Assets : Tangible properties, Ex : real estate, airplanes, machinery...etc.
3. Financial Intermediaries : Facilitate transactions among buyers & sellers
Brokers, Exchanges & Alternative Trading Systems
Brokers : Agents who fill orders for their clients
Block Brokers : Provide brokererage services for large clients
Investment Banks : They help corporate clients arrange transactions {Securities offerings, Mergers & Acquisitions}
Exchanges : Provide a market where traders can meet to arrange their trades
Alternative Trading Systems (ATS) : Trading venues that function like Exchanges but without a regulatory authority. Many of them are classifies as Dark Pools because they do not display information about trades
Dealers : Fill their clients orders by trading with them
Securitizers : Securitization is the process of buying assets, placing them in a pool, and then selling securities that represent ownership of the pool, through a Special Purpose Vehicle (SPV)
Depository Institutions & Other Financial Corporations : Institutions that raise money from depositiors and lend it to borrowers
Insurance Companies : Help people & companies Offset risks that concern them
Arbitrageurs
Settlement & Custodial Services
4. Positions : The quantity of an asset that an entity Owns or Owes
Short Positions : Selling an asset you do not Own, or Writting and Selling a Contract
Long Positions : Owning an asset {Stocks, Bonds, Contracts...etc. }. Benefit from an Appreciation in the prices
Leveraged Positions : Buying securities by borrowing some of the purchase price.
5. Orders : Provide instructions on What instrument to trade, How much to trade and whether to buy or sell.
Execution instrustions : How to fill the order
Margin requirement : The minimum fraction of the purchase price that must be the trader's equity.
Margin Call : Request for additional equity when the securities price fall.
Call money rate : Interest rate on margin loan
Margin loan : Borrowed money to purchase securities
Limit Order : Instruction to obtain the best price but not accept a price lower or higher (depending on the position buyer or seller) than a specified limit
Market Order : Instruction to obtain the best price immediately available
All-or-nothing orders : Can only trade if their entire sizes are traded
Exposure instructions : Indicate whether, how and perhaps to whom instructions should be exposed
Hidden orders : exposed only to the broker or exchange that receive them
Iceberg order : Display size is less than real size of order, and the additional size is hidden from public and can be filled only if a suitable larger order arrives.
Validity Instructions : When the order may be filled
Good Till Canceled Order
Fill or Kill Order
Day Order
Good on Close Order
Stop Order : An order in which a stop price condition is specified
Stop-loss Order : A combination of a stop and limit order
Clearing Instructions : How to arrange the final settlement of the trade
6. Primary Security Markets
Public Offerings
Private Placements & Other Primary Market Transactions
An Underwritten Offering : In which the investment bank buys whatever left of shares it couldn't sell.
Book Building : Process of lining up the subscribers who will buy the security.
N.B : In large public offerings, a syndicate of investment banks and dealers help the Lead Underwriter build the book.
Best Effort Offering : In which the investment bank act only as a broker
Shelf Registration : [Also called SEC Rule 415] Corporations sell their securities directly to the secondary market and not in a single transaction, but in multiple transactions overtime.
Rights Offerings : The corporation distributes rights to the existing shareholders to buy the stock at a fixed price, usually lower than the market price.
Private Placements : Corporations sell securities directly to a smaal group of qualified investors, usually with the assistance of an investment bank - Only in OTC Markets
7. Secondary Markets & Contrat Market Structures
Execution mechanisms
Trading Sessions : Markets are organized as :
Call Markets : Trades can be arranged only when the market is called at a particular place & time
Continuous markets : Trades can be arranged anytime the market is open
Quote-driven markets : Customers trade with dealers
Order driven markets : An order matching system is run by an exchange, a broker, or an ATS
Brokered markets : Brokers arrange trades between their customers
Order Matching Rules :
Trade pricing rules :
Price Priority : Highest priced buy orders & lowest priced sell orders go first.
Time precedence rule : Use time to rank orders at the same price
Uniform pricing rule :
Discriminatory pricing rule : The limit price of the standing order determines the trading price
Derivative pricing rule : Trades occur at the midpoint of the best bid and ask quotes published by the exchange at which the security primarily trades.
8. Well functioning financial systems : They allow traders to solve financing & risk management problems.
Characteristics
Operationally Efficient Markets : Low costs of arraging trades
Informationally Efficient markets
Complete Markets : Assets or contracts needed to solve these problems are available to trade
Prices reflect the fundamental value of securities
Allows participants to estimate fundamental values of securities
9. Market Regulation :
Objectives :
Promote fairness
Set mutually beneficial standards
Control agency problems
Preventing excessively risky investments
Control Fraude
Ensure that long terme liabilities are funded
Competitive-bid : Mechanism for choosing the syndicate that takes the IPO process. (Used especially for State-Owned Companies)