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GCM Mod 1

This document provides an introduction to global capital markets, including: 1. It defines financial assets and differentiates between debt and equity claims. 2. It discusses the valuation of financial assets, noting that value is based on the present value of expected cash flows discounted by a rate. 3. It outlines several properties of financial assets including liquidity, term to maturity, and cash flow predictability.

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Chinmayee Choudhury
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53 views

GCM Mod 1

This document provides an introduction to global capital markets, including: 1. It defines financial assets and differentiates between debt and equity claims. 2. It discusses the valuation of financial assets, noting that value is based on the present value of expected cash flows discounted by a rate. 3. It outlines several properties of financial assets including liquidity, term to maturity, and cash flow predictability.

Uploaded by

Chinmayee Choudhury
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Global Capital Markets (Module 1)

Chapter 1
Introduction
Financial Assets
Asset: any possession that has value in an exchange
– Tangible asset: The value depends on
particular physical properties
– Intangible assets: Represent legal claims to
some future benefit

Debt versus Equity Claims


– Debt instrument: Fixed amount claim
– Equity claim: Residual Claim

Value of a Financial Asset


Valuation
The process of determining the fair value or price of a
financial asset
Fundamental principle of valuation
The value of any financial asset is the present value of
the cash flow expected
The Value of a Financial Asset
– Estimating the cash flow
– Discount Rate
Three reasons why cash flow of debt instruments is
not known:
1
• The issuer might default
• Call/Put
• Floating Rate

The Role of Financial Assets


• Transfer Funds
• Spread and transfer risk

Properties of Financial Assets

1. Moneyness
2. Divisibility and denomination
3. Reversibility (bid/ask) (thick/thin)
4. Term to maturity
5. liquidity (Money easily)
6. Convertibility (Another asset)
7. Currency
8. Cash flow and return predictability
9. Complexity
10. Tax status

Financial market
2
• The Role of Financial Markets
– Search costs
– Information costs
Why do investors go to secondary market?
1. Meet liquidity needs
2. Information

• Classification of Financial Markets


– Maturity of the claims
• Money market - a financial market for
short-term financial assets (< 1 year)
• Capital market - the financial market for
longer maturity financial assets (> 1 year)
• Classification of Financial Markets
– Whether the financial claims are newly
issued
• Primary market - the market for newly
issued financial assets
• Secondary market - the market, where
after a certain period of time, the financial
asset is bought and sold among
investors

Why is the link between company and secondary


market?

3
• Globalization of Financial Markets
– The integration of financial markets throughout
the world into an international financial market
• Factors influencing Globalization
1. Technology
2. Liberalization
3. Integration

• Globalization of Financial Markets


– Emerging markets
• Participation in the financial markets of
developing economies
• Characteristics of emerging markets:
– Have economies that are in transition but
have started implementing political,
economic, and financial markets reforms in
order to participate in global capital market
– May expose investors to significant price
volatility attributable to political risk and the
unstable value of their currency
– Have a short period over which their financial
markets have operated

Players
• Governments
– Federal government
– Government-sponsored enterprises
4
Housing
 The eleven Federal Home Loan Banks (FHLBanks)
(1932)
 Federal National Mortgage Association (Fannie
Mae) (1938)
 Federal Home Loan Mortgage Corporation (Freddie
Mac) (1970)
Veteran
 National Veteran Business Development
Corporation (1999)
Farming
 Federal Farm Credit Banks (FCBanks) (1916)
 Federal Agricultural Mortgage Corporation (Farmer
Mac) (1987)
Education
 SLM Corporation (Sallie Mae) (1972-1995)

– State governments
– Local governments
• Nonfinancial Corporations
– Microsoft
– Unilever
• Depository Institutions
– Commercial banks
– Savings and loan associations (Thrifts)
– Savings banks

5
– Credit unions
• Insurance Companies
Life Insurance
Property and Casualty Insurance
• Asset Management Firms
– Pension Funds
– Exchange-traded funds
– Hedge funds
– Private equity Funds
– Venture Capital Funds
– Angel Funds
– Sovereign wealth Funds
– Real estate investment trusts
– Structured finance operating companies
• Investment Banks
– Independent/stand alone
– May be a subsidiary of
• Commercial banks
• Insurance companies
• Nonprofit Organizations
• Commercial enterprises
• Not-for-profit organizations
• Foundations: Single person
• endowments
• Foreign Investors
– Individuals

6
– Nonfinancial businesses
– Financial entities
– Supranational institutions
Role of Financial Intermediaries
• Transform financial assets and re-constitute them
into different types of assets.
• Exchange financial assets on behalf of customers.
• Exchange financial assets for their own account.
• Assist in the creation of financial assets.
• Provide investment advice to other market
participants.
• Manage the portfolios of other market participants.
• Maturity Intermediation
• Risk Reduction Intermediation
• Denomination Intermediation
• Information Intermediation
• Reducing the Costs of Contracting
• Providing a Payment Mechanism
Overview of Asset/Liability Management for
Financial Institutions
• Type I Liabilities (Amount and Timing of cash outlay
known)
– FDs, Bonds
• Type II Liabilities (Amount known and Timing of
cash outlay unknown)
– Life Insurance Policy

7
• Type III Liabilities (Amount unknown and Timing of
cash outlay known)
– Certificates of Deposits (CD’s)
• Type IV Liabilities (Amount and Timing of cash
outlay unknown)
- Shares
Regulation of Financial markets
• Justification for Regulation
– efficient manner and at the lowest possible
– financial crises that have occurred at
various times
• Forms of Federal Government Regulation of
Financial Market
– Disclosure Regulation
– Financial Activity Regulation
– Financial Institution Regulation
– Foreign Participant Regulation
Financial Innovation (Financial Engineering)
• Market-broadening instruments: Smaller contract
size in derivatives, Higher interest-bearing current
accounts
• Risk-management instruments: Forwards,
Futures, Options
• Arbitraging instruments and processes: Carry
Trade
• Price-risk-transferring innovations: Futures
• Credit-risk-transferring instruments: Credit
Derivatives

8
• Liquidity-generating innovations: Factoring
• Credit-generating instruments: Overdraft, Credit
Lines
• Equity-generating instruments: Follow On
Offerings, Rights Issue, Bonus Issue

Motivation for Financial Innovation


– Increased volatility of interest rates, inflation,
equity prices, and exchange rates
– Advances in technologies
– Greater sophistication and educational
training
– Financial intermediary competition
– Incentives to get around existing regulation
and tax laws
– Changing global patterns of financial wealth

Securitization and Financial Innovation


Illiquid assets are made liquid

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