final report

Financial Institutions & Market
FIN 353 –Spring 2021
Snow Han
SFSU

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Contents
Financial Systems
=institutions & markets
Financial Markets
money market, capital market, bond market, stock market, derivative market…etc.
Financial Institutions
e.g.: Banks, central banks, mutual funds, hedge funds
Pension fund, insurance… …etc.
Also about financial crisis, regulations…etc.

What it is about?
Stock Exchange
Banks

What it is about?
Dow Jones Index closes above 20,000

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What it is about?
Financial Crisis – Bankruptcy
Bail outs

FORBES 400 RICHEST PEOPLE

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Lecture 1 – INTRODUCTION
Why we need finance?
Why we need to understand financial market & institutions?
Both financial Market and Institutions facilitate things （financial system）
Allocate Resources (limited resources – optimization)

It is the structure that people do things, it is one of the fundamental pillars of the society
Allocate resources
– incentivize people to do thing
To sponsoring business to realize things
To manage risk /diversified vs. systematic

Andrew Carneige 1989 – Gospel of Wealth
It is in the details that things happen
About institutions, about securities, securities market, about regulations, and about financial crisis
Try my upmost effort to include a world perspective, G20

Capitalism
Big multinational institutions – dispersed all over the world – financial arrangement

Forbes 400 richest people – no celebrity. No athletes, no nobel prize winner, one book writer- bill gates
Oprah winfrey , steven spielsburg
Forbes highest paid celebrity
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What is Financial Market?
Financial Markets are markets where people trade
What to trade? – financial instruments

Thus, financial markets are markets in which funds are transferred from people who have an excess of available funds to people who have a shortage
How this happens?
Through trading financial instruments

Market is where people trade products on a large scale

is much more broad and general than trading and making money
Example1: borrowing and establish a lemonade stand for $1000
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Financial Instruments – I
Aka. Securities
(Bond, Stocks, Foreign currency, derivatives, ETF, hedge fund…etc.)
Securities are claims on the issuer/borrower’s future income or assets

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Flow of Funds Through the Financial System

Question !
Who participate in Financial Market?

MUTUAL BENEFICIAL

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Flow of Funds Through the Financial System

Question !
Who participate in Financial Market?

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Financial Instruments – II
Aka. Securities (Bond, Stocks, Foreign currency, derivatives…etc.)
Securities are claims on the issuer/borrower’s future income or assets
Why investor want to buy these securities?

What about funds (hedge fund, mutual fund, pension fund, ETFs…etc.)?
A portfolio of securities

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Direct Financing vs. Indirect Financing

Direct : Borrowers and Lenders meet directly to exchange securities, no involvement of any type of intermediaries.

Indirect : Lenders provide funds to financial intermediaries (e.g.: banks) and intermediaries independently pass these funds onto borrowers

Examples?
Are hedge fund /pension fund/ mutual fund Indirect or direct finance?

What about our lemonade stand example? Does it belong to direct vs. indirect financing?
What about the house loan – indirect financing, the borrower and the lender don’t know each other. Car loan

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Why Financial Market is Important?
Channeling funds from savers (lenders) to spenders (borrowers)
– mutual beneficial
– affects personal wealth, business firms
– efficient allocation of capital (money)
– promote economic growth

This is important. For example, if you save $1,000, but there are no financial markets, then you can earn no return on this – might as well put the money under your mattress.
However, if a carpenter could use that money to buy a new saw (increasing her productivity), then she is willing to pay you some interest for the use of the funds.

Financial markets are critical for producing an efficient allocation of capital, allowing funds to move from people who lack productive investment opportunities to people who have them

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Classification of Financial Markets
By nature of claim/type of securities.
Debt market; Equity market; Derivatives; foreign exchange…etc.
By seasoning of claim.
Primary market; Secondary market
By organizational structure
Exchange market; Over-the-counter market
By maturity of claim.
Money market; Capital market
By immediate delivery or future delivery
Cash or spot market; Derivative market

https://www.youtube.com/watch?v=G_IK0Q1FCnk

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Debt
Periodic payment at fixed frequency
Fixed amount of payment
Fixed maturity
Debt contract –* indenture
Principle at maturity or sold before maturity
No voting rights

Capital gain/loss when sold
Government could issue bonds
Priority claimant

Equity
Some pay dividends, but not for sure, and no specified frequency
Dividends amount is not fixed
Infinite maturity
Can only be sold and resold
Ownership claim
Voting rights

Capital gain/loss when sold
Government could not issue stocks
Residual Claimant

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Debt vs. Equity
Debt Markets (bond markets)
Short-Term (maturity < 1 year) Long-Term (maturity > 10 year)
Intermediate term (maturity in-between)
Could be bond or mortgage (tradable)
Represented $38.2 trillion at the end of 2012.
Equity Markets (stock markets)
Could be common stocks, preferred stocks
infinite maturity (retire vs. repurchase)
Total value of all U.S. equity was $18.7 trillion at the end of 2012.

Debt markets, allow people (household, corporations, government to borrow money) .
It is a type of contract arrangement, which specify the issuer (borrower of money) get some initial amount of money , and the holder subsequently receive a fixed amount of payment in the future over a specified time period.
Many types of market interest rates: mortgage rates, car loan rates, credit card rates, etc.
They are different, but they tend to move together.

Company sell stocks to raise money
Equity entitles the holder of the securities a share of borrower’s future cash flow/income/profit
Some pay periodic payment, not necessarily
Even if they pay, they don’t specify frequency, or amount

Differences between debt market and equity market
Debt market is substantially larger than the equity market

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Bond & Stock Market
Both bond market and stock market belong to direct financing
Stock market is much smaller than bond market (18.7 trillion vs. 38.2 trillion)
But the stock market receives the most attention from the media.

WHY?
It capture the upside potential, and involve more individual investors
Bond market – Very infrequent trades; participants are mostly institutions

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Different Types of Interest Rate

Government Securities
Government can’t issue ownership claim ( in other words, stocks)
Government only issue debts

For the federal government – DEPARTMENT OF THE TREASURY: Treasuries
Short term: T-bills
Long terms: T-notes and T-bonds
For the state/local government – Municipal Bond
For government sponsored entities (GSEs) – Agency Bond

Bureau of Engraving and Printing (BEP)
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Corporate Securities
Ways for corporate to raise money from FINANCIAL MARKET (DIRECT FINANCING)
Issue Bonds (Debt Claim, the majority is long-term)
or commercial papers (short term debt)
Or alternatively, Issue Stocks (Equity claim)
BALANCE SHEET : issue bonds – liability; issue stocks – equity
Both are source of company’s capital and are used to purchase assets and maintain operation:
A= L+E
*What about indirect financing that corporates can take advantage of?

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Corporate Securities
1. Public issuance – Public Offering
Initial public offering (IPO) – could refer to stock issuances, as well as bond issuances
Register with SEC (Securities and Exchanges Commission)
Larger than 1.5 million and maturities > 270 days
SEOs (seasonal equity offering) – just stocks

2. Private Placement
Instead of selling the securities to the public, the company can sell it to only several parties (e.g.: parent companies, wealthy friends…etc.) rather than the public
E.g.: 144a bonds, reg D shares

https://www.statista.com/statistics/226152/largest-ipos-in-the-united-states-by-issue-volume/

GM 2010 – 20.1 billion
Visa – 18 billion in 2008
Agricultural Bank of China Ltd in 2010, when the lender raised $22.1 billion.
Facebook – 16 billion in 2012
Alibaba – initial public offering now ranks as the world’s biggest at $25 billion in 2014

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Primary vs. Secondary Market
Primary Market
New security issues sold to initial buyers
By corporates or government agency ultimately using the money
Typically involves an investment bank (underwriter) who underwrites the offering
Money received by the offering company = offer price * # shares offered
Secondary Market
Securities previously issued are bought and sold (so secondhand)
Examples include the NYSE, AMEX, and Nasdaq
Involves both brokers and dealers who help facilitate trading of these securities

What about venture capital?

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Primary

Initial issue of security

Raise funds for Borrower

Usually trade over-the-counter (OTC) – allocation of shares

Secondary

Transfer of titles of existing securities
No New Funds are raised for Issuers
Could be organized as exchanges, (e.g.: Amex, NYSE), or alternatively as over-the-counter (OTC) markets (e.g.: NASDAQ)

Why we need secondary market?
Two important function:
a. Provides Liquidity for Seller
b. Determines the price

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Exchanges vs. OTC Markets

Exchanges
Trades conducted in centralized locations (e.g., New York Stock Exchange, (NYSE, AMEX…etc.)
Standardized price and quote – broker/dealer needed
Regulatory Control
Relative high transaction costs (such as fees, and commissions)
Over-the-Counter Markets
investors at different locations buy and sell (e.g.: NASDAQ)
More price competition – market makers, less fee
Higher Risk (Fraudulent firms), less transaction costs
Best example: market for Treasury Securities

The NYSE is an auction-based market where traders meet on the floor of the exchange, using person-to-person, telephone orders or electronic orders.
The Nasdaq, on the other hand, is strictly an electronic exchange. The NASDAQ is a global electronic marketplace for buying and selling securities, as well as the benchmark index for U.S. technology stocks. NASDAQ was created by the National Association of Securities Dealers to enable investors to trade securities on a computerized, speedy and transparent system, and commenced operations on February 8, 1971. By Barry Norman, Investors Trading Academy.

Broker: scottrade, TD Ameritrade etrade, optionshouse Charles schwab, fidelity
No inventory
Their profit come from their collected fees, and commissions

Dealers: Financial companies
The buy and sell stocks for their own account
Market maker
They are the counter part of your trade

https://www.youtube.com/watch?v=G_IK0Q1FCnk

Open bell : https://www.youtube.com/watch?v=wNzJSEZvcSE

Closing bell :https://www.youtube.com/watch?v=DqMV4PH1JFg

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Broker vs. Dealer
Both brokers and dealers matches desired buyers and sellers for a security

Broker: Scottrade, TD Ameritrade etrade, optionshouse Charles schwab, fidelity
No inventory
Their profit come from their collected fees, and commissions

Dealers: Financial companies
The buy and sell stocks for their own account
Market maker
They are the counter part of your trade

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NYSE trading floor

Brokers
ann1num

TOP dealers in 2016 by Revenue

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Exchange
Visible Marketplace

All Members Trade with exchanges

Accounts with exchanges (specialist)
less risk

Relatively costly

More oversight / regulation
OTC
Wired Network of Dealers, No Central, Physical Location

All Securities Traded directly with the counterpart

Risky trading with fraudulent firms

Larger amount

Less oversight / regulation – customized contract basis

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Money vs. Capital Market
We can also classify markets by the maturity of the securities:
Money Market:
Short-Term debt (maturity < 1 year) e.g.: treasury bills, federal funds, commercial papers, repos Capital Market: Long-Term debt (maturity > 1 year)
e.g.: commercial and consumer loans, corporate bonds, agency bonds…etc.
& equities (infinite maturity)

Principal Money Market Instruments

Principal Capital Market Instruments

Globalization of Financial Markets
Foreign exchange market
is where international currencies trade and exchange rates are determined.
Although most people know little about this market, it has a daily volume nearing $3 trillion!
However in recent years, USD keep weakening

1/10 of bond market, and 1/5 of stock market
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USD exchange rate Index

How Exchange Rate Affect us?
When the dollar (USD) strengthens,
USD becomes more expensive compared with other currencies
Thus, domestic goods become more expensive, reducing foreign purchase (exports)
Foreign currencies and goods become cheaper compared with USD increasing domestic purchase of foreign goods (Imports)

What about when USD weakens?
Other currencies become more expensive compared with USD
Thus, foreign goods become more expensive, reducing imports. Domestic goods become cheaper, increasing exports.

Major 6 currencies
USD, Euro, British Pound(GBP), CAD, Australian Dollars(AUD), and Japanese Yen (JPY), *Swiss Franc
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Global Perspective:
Relative Decline of U.S. Capital Markets
The U.S. has lost its dominance in many industries:
automobiles and consumer electronics, etc.
A similar trend appears at work for U.S. financial markets, as London and Hong Kong compete. Indeed, many U.S. firms use these markets over the U.S.
Why?
9-11 made U.S. regulations tighter
Greater risk of lawsuit in the U.S. – means higher cost of listing
Sarbanes-Oxley has increased the cost of being a U.S.-listed public company (legal and financial costs)

Globalization of Financial Markets
Foreign Bonds
Sold in foreign country, and denominated in that country’s currency
Foreign Stocks (via Overseas IPOs)
Stocks sold in foreign country, and denominated in that country’s currency
Eurobond (Now larger than U.S. corporate bond market)
Sold in foreign country, but denominated with different currency
Eurocurrencies
Foreign currencies deposited in banks outside the home country

Now more than 80% of new issued bonds are eurobonds
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Foreign Index

Russell 2000 and Russell 3000
Maintained by FTSE in London stock exchange. S&P 500 is the most popular with regard to big-cap mutual fund, while the Russell 2000 is the most popular with sml and mid-cap mutual fund.
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Review
Why financial system is important?
Different types of financial markets
bond vs. stock
primary vs. secondary
exchanges vs. OTC market
money vs. capital
Foreign markets and foreign exchange market
Important trend in global financial market

Flow of Funds Through the Financial System