Financial Market Analysis
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U N I T 4 – I N T E R N A T I O N A L M O N E Y A N D C A P I T A L M A R K E T
Financial Market Analysis ACCT3602
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International Financial Market 2
International financial markets undertake intermediation by transferring purchasing power from lenders and investors to parties who desire to acquire assets that they expect to yield future benefits.
International financial transactions involve exchange of assets between residents of different financial centres across national boundaries.
International financial centres are reservoirs of savings and transfer them to their most efficient use irrespective of where the savings are generated.
International Financial Market 3
Like their domestic counterpart, international financial markets may be divided into money and capital markets.
The major differences: Financial contracts are made between foreign currencies
Any one participant or investment is made outside the national borders.
Liberalization and globalization has resulted in merging domestic financial systems in international financial system.
Foreign exchange markets will constitute an important element of international financial system.
International Financial Market 4
International financial markets help to reduce, and in some instances, solve the inadequacies of domestic financial market. These inadequacies may include: MNCs require large funds – these MNCs may not be able to raise the required funds
in domestic market.
Cost of borrowing – higher interest rates tend to increase the cost of borrowing. Low cost borrowing may be found in international markets.
Investors in developed countries can earn higher income through higher interest obtainable in international markets especially in developing countries.
Risk, return, maturity and liquidity prefer foreign countries.
Thus, there are favorable opportunities to raise funds from international financial markets.
International Capital Market
A capital market is a system that allocates financial resources in the
form of debt and equity according to their most efficient uses.
Its purpose is to provide a mechanism through which those who
wish to borrow or invest money can do so efficiently.
Individuals, companies, governments, mutual funds, and pension
funds participate in capital market.
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Purpose of National Capital Market
National Capital Markets help individuals and institutions borrow
the money that other individuals and institutions want to lend,
usually through debt and equity
Debt: consists of loans which the borrower promises to repay the borrowed
amount (Principal) plus a pre-determined rate of interest.
Equity: part ownership of a company by means of shares wherein the equity
holder participates with other part owners in the company’s financial gains and
losses.
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Purpose of International Capital Market
International Capital Market is a network of individuals, companies, financial
institutions and governments that invest and borrow across national boundaries.
Large international banks play a central role in international capital markets.
They gather the excess cash of investors and savers around the world, and then channel this cash to borrowers across the globe.
Expands the money supply for borrowers
Reduces the cost of money and borrowers
Reduces the risk for lenders
Allows investors to offset gains in some economies with losses in others.
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Forces Expanding the International Capital Market
Three forces are expanding International Capital Markets:
Information Technology
Deregulation (removing restrictions and regulations)
Financial Instruments - A document (such as a check, draft, bond,
share, bill of exchange, futures or options contract) that has a
monetary value or represents a legally enforceable (binding)
agreement between two or more parties regarding a right to payment
of money.
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Securities traded in International Capital Market
International Bond
all bonds sold by issuing companies, governments, or other organizations outside their own countries.
• Types of International Bonds:
• Eurobond - issued outside the country in whose currency it is denominated. For example, a bond issued in Venezuela in U.S. dollars and sold in Britain, France, and Germany is called a Eurobond.
• Foreign bond - sold outside the borrower’s country and denominated in the currency of the country in which it is sold. For example, a yen-denominated bond issued by German carmaker BMW in Japan’s bond market.
• Interest rates are driving growth in the international bond market.
• Borrowers in emerging economies seek to borrow money in developed nations where interest rates are lower, and investors in developed nations seek to buy bonds of companies in emerging economies to earn higher rates of return.
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Securities traded in International Capital Market 10
International Equity
all stocks bought and sold outside the issuer’s home country.
Buyers include banks, mutual funds, pension funds etc.
Four factors lie behind the growth in the international equity market. • Spread of Privatization-As many countries abandoned central planning and socialist-style economics,
the pace of privatization accelerated worldwide. A single privatization often places billions of dollars of new equity on stock markets.
• Emerging markets – some companies seek funding abroad to overcome domestic capital shortages. Economic Growth in Emerging Markets-Continued economic growth in emerging markets is contributing to growth in the international equity market. Companies based in these economies require greater investment as they succeed and grow. The international equity market becomes a major source of funding because only a limited supply of funds is available in these nations.
• Global investment banks facilitate the sale of equity worldwide by bringing together sellers and potential buyers. Increasingly, investment banks are searching for investors outside the national market in which a company is headquartered. In fact, this method of raising funds is becoming more common than listing a company's shares on another country's stock exchange.
• The automation of stock markets (cyber-markets) now allow online global trading activities 24 hours a day.
Securities traded in International Capital Market 11
Eurocurrency Markets
• All the world’s currencies that are banked or deposited outside their countries of origin are referred to as Eurocurrency and traded on the Eurocurrency Market. • For example, a deposit of U.S. dollars (USD) held in a British bank would be
considered eurodollar, as would a deposit of British Pounds (GBP) made in the United States would be considered europound.
• Sources of Eurocurrency deposits include: • governments, commercial banks, international companies, and extremely wealthy
individuals.
• The appeal of the Eurocurrency market is based on its complete absence of regulation and low transaction costs.
• The downside of this market is that there is greater risk due to a lack of government regulation.
International Money Markets 12
International Money Market represents the short and intermediate term borrowing and investment market.
Global firms have access to the international money markets through financial intermediaries (primarily large global banks)
directly through financial markets
Intermediary markets include: Eurocurrency Loan Market (i.e., Euro-Lines of Credit)
Euro-credits Market (i.e., Syndicated Euro-credits)
Direct markets include: Short Term and Medium Term Euro-notes Market
Euro-commercial Paper Market
Types of International Financial Markets 13
Spot and Futures Market
Foreign Exchange Market
Mortgage Market
Commodities Market
Spot Market 14
Spot Market or cash market is a public financial market in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market, in which delivery is due at a later date.
Spot markets can operate wherever the infrastructure exists to conduct the transaction and most instruments exist primarily on the internet. contracts bought and sold on these markets are immediately effective
settlement happens in t+2 working days
i.e., delivery of cash and commodity must be done after two working days of the trade date.
A spot market can be: an organized market;
an over-the-counter (OTC) market
Spot Market 15
Over-the-Counter (OTC)
Over-the-counter (OTC) is a place where buyers and sellers meet to trade bilaterally through consensus.
There is no third-party supervisor of a transaction or a central exchange institution to regulate the trade.
Assets being traded may not be standardized in terms of quantity, price, or other terms.
Prices in OTC markets may not be published, as trades are largely private.
The currency exchange market is the most active and widely known OTC market.
Spot Market 16
Organized Exchanges Buyers and sellers meet to bid and offer financial instruments and commodities available. Trading can be carried out on an electronic trading platform or a trading floor. Electronic
trading platforms have made trading more efficient, where prices are determined instantaneously, given the large number of trades in some exchanges.
Exchanges deal in several financial instruments and commodities, or they may carve a niche on specific types of assets. Trading is usually completed through brokers of the exchange who act as the market makers. Assets traded on exchanges are standardized, as per the exchange standard.
There are likely to be minimum contract prices for assets being traded or in specific quantities and values. Prices are set through many buyers’ bids (prices offered to buy) and sellers’ offers (prices offered to sell). Spot prices can change every minute or even milliseconds.
Exchanges are regulated, where all procedures and trading are standardized. Examples of popular exchanges are the Jamaica Stock Exchange (JSE), which trades mostly in stocks, and the Chicago Mercantile Exchange Group, which trades mostly in commodities and offers trading in options and futures.
Spot Market 17
Businesses exchanging currencies at their local bank receive a buy rate - the rate at which a bank will buy a currency
an ask rate - the rate at which a bank will sell a currency
The spot market helps companies to: • Convert income from sales abroad into the home-country’s currency.
• Convert funds into the currency of an international supplier (pay supplier in their currency).
• Convert funds into the currency of a country in which it will invest (invest in another national market).
Spot Market Instruments 18
Financial instruments traded on spot markets include equity, fixed- income instruments such as bonds and treasury bills, and foreign exchange.
Commodities also dominate spot markets through the trading of energy, metals, agriculture, and livestock.
Spot markets also trade in perishable and non-perishable commodities.
Commodities are standardized in order to trade efficiently on spot markets. Crude oil is the most traded commodity. Recently, technology – such as bandwidth and mobile minutes – has been featured in spot markets with commodities.
Advantages of using the Spot Market 19
Spot markets facilitate trading in a transparent environment, where transactions occur at prevailing prices that are public information and known to all parties. Basically, it is easier to execute spot market contracts.
Traders in spot markets can hold and find a better deal if they are not satisfied with current prices and terms.
Trades are done and completed on the spot.
There may be no minimum capital requirements in spot market transactions compared to some contracts on the futures market that have minimum investment amounts for a single contract.
Disadvantages of using the Spot Market 20
Due to the volatility of some financial instruments and commodities, investors can buy on the spot at inflated prices before assets find their “true price.” Hence, trading on the spot market can present significant risks, especially for volatile assets.
There may be no recourse if a party notices some irregularities in the trade after the spot market transaction is concluded.
There is usually a lack of planning in spot trades, as opposed to forwards and futures trading where parties agree on settlement and delivery at a future date.
The spot market is not flexible in terms of timing, as parties will have to handle physical delivery on the spot.
The interest rate spot market is affected by counterparty default risk. Currency trading in spot markets is prone to counterparty risk due to the
solvency of the market maker.
Managing Risks in the Spot Market 21
Understand the market - understand the demand and supply function, price discovery mechanism, trading terms, jargon of the spot market, the nature of other market participants, as well as the regulatory structure of a spot market exchange. In OTC spot markets, participants should evaluate the counterparty to reduce counterparty default risk.
Develop a trading strategy - traders should determine their own entry and exit points on specific assets before a position is opened. The use of price limits and price floors and the ability to detect risk on a trade or counterparty instantly are other strategies that can be employed. Using stops and limits will assist a trader to be more efficient in deciding whether to proceed with a trade, hold and wait or disengage the trade. Various stops and limits, such as the following, are helpful: Limit order: Closes your position once the price breaches your chosen level. Normal stop: Position is closed automatically if the market moves adversely against your
position. Guaranteed stop: Closes position at exactly the specified price, which eliminates the risk of
slippage. Trailing stop: Follows a positive price movement and closes if the price begins to move against
the target position.
Futures Market 22
A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts
Futures contracts are contracts to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future.
These types of contracts fall into the category of derivatives. the value of these instruments are derived from another asset class
Such instruments are priced according to the movement of the underlying asset (stock, physical commodity, index, etc.)
The derivative itself is a contract between two or more parties
Characteristics of Futures Contracts 23
In a futures contract there are two parties: The long position or buyer, agrees to purchase the underlying at a later date or at the
expiration date at a price that is agreed to at the beginning of the transaction. Buyers benefit from price increases.
The short position or seller, agrees to sell the underlying at a later date or at the expiration date at a price that is agreed to at the beginning of the transaction. Sellers benefit from price decreases.
Prices change daily in the marketplace and are marked to market on a daily basis. Mark to market is the process of converting daily gains and losses into actual cash gains
and losses each night. As one party loses on the trade the other party gains, and the clearing house moves the payments for the counterparty through this process
At expiration, the buyer takes delivery of the underlying from the seller or the parties can agree to make a cash settlement.
Futures Contract 24
Investors may purchase the right to buy or sell the underlying asset at a later date for a predetermined price.
By purchasing the right to buy, an investor expects to profit from an increase in the price of the underlying asset. The investor would then exercise his right to buy the asset at the lower price obtained
through buying the futures contract, and then resell the asset at the higher current market price.
By purchasing the right to sell, the investor expects to profit from a decrease in the price of the underlying asset. An investor would profit from the right to sell if the price of the underlying asset
decreases. The investor would sell the asset at the higher market price secured through the futures contract and then buy it back at the lower price.
Futures Market 25
Derivatives can trade over-the-counter (OTC) or on an exchange.
OTC derivatives constitute a greater proportion of the derivatives market.
These generally have a greater possibility of counterparty risk. Counterparty risk is the danger that one of the parties involved in the transaction
might default.
These parties trade between two private parties and are unregulated.
Conversely, derivatives that are exchange-traded are standardized and more heavily regulated. Examples of exchange traded derivatives are: stock, index, currency, commodities,
and real estate.
Future Market: Nature of Contracts 26
Exchange-traded contracts are standardized by the stock exchanges where they trade.
The contract details the following: what asset is to be bought or sold how, when, where and in what quantity it is to be delivered the currency in which the contract will trade minimum tick value the last trading day and expiry or delivery month
Standardized commodity futures contracts may also contain: provisions for adjusting the contracted price based on deviations from the "standard"
commodity, for example, a contract might specify delivery of heavier USDA Number 1 oats at par
value but permit delivery of Number 2 oats for a certain seller's penalty per bushel.
To make sure liquidity is high, there is only a limited number of standardized contracts.
Future Market: Nature of Contracts 27
Before the market opens a new futures contract, on the first day of trading, there is a specification but no actual contracts exist.
Futures contracts are not issued like other securities, they are "created" whenever Open interest increases;
that is, when one party first buys (goes long) a contract from another party (who goes short).
Contracts are also "destroyed" in the opposite manner; whenever open interest decreases. This is where traders resell to reduce their long positions or rebuy to reduce
their short positions.
Who Trades Futures Contracts? 28
There are two types of people who trade (buy or sell) futures contracts: Hedgers and Speculators.
Hedgers
These are businesses or individuals that use futures contracts for protection against volatile price movements in the underlying commodity.
Take for instance a corn farmer and a corn canner. A corn farmer would want protection from corn prices decreasing, and a corn canner would want protection from corn prices increasing. So, to mitigate the risk, the corn farmer would purchase the right to sell corn at a later date for a predetermined price, and the corn canner would purchase the right to buy corn at a later date for a predetermined price.
Each party takes a side of the contract. Both the farmer and canner hedge their exposure to price volatility.
Who Trades Futures Contracts? 29
The farmer’s situation is that he’s worried that the price of corn may decline significantly by the time he’s ready to harvest his crop and sell it. To hedge the risk, in July he sells short a number of December corn futures contracts roughly equal to the size of his expected crop. December futures contracts are contracts to deliver the commodity in December. When he sells short in July, the market price of corn is $3 a bushel. The farmer is selling short corn futures in the same way that one can sell stocks short.
When December rolls around, the market price of corn has dropped to $2.50 a bushel. The farmer sells his corn for the going market price of $2.50 a bushel and closes out his futures contracts trade by buying the contracts back at the lower price of $2.50. Because he had sold short at a price of $3, he makes up the 50-cent market price drop through a 50-cent per bushel profit on his futures trade. If the farmer had not hedged his crop with futures contracts, he would have made 50 cents per bushel less for his corn crop.
Who Trades Futures Contracts? 30
In this case, the corn canner, who buys December corn futures in July, will lose 50 cents per bushel on his futures trade, but will benefit from being able to buy corn at just $2.50 a bushel in December in the open market.
In effect, both the farmer and the canner have used futures contracts to lock in a price of $3 per bushel in July, protecting themselves against a large adverse price change.
Future Market: Nature of Contracts 31
Speculators Speculators are independent traders and investors. Some trade using their own money
and some trade on behalf of clients or brokerage firms. Speculators who do not intend to make or take ultimate delivery must take care to "zero
their positions" prior to the contract's expiration. After expiration, each contract will be settled, either by physical delivery (typically for
commodity underlyings) or by a cash settlement (typically for financial underlyings).
The contracts ultimately are not between the original buyer and the original seller, but between the holders at expiration and the exchange. Contracts may pass through many hands after it is created by its initial purchase and sale, or
even be liquidated, settling parties do not know with whom they have ultimately traded. In essence, there is not a primary market when an issuer issues the security, and a secondary
market where the security is later traded independently of the issuer.
Legally, the security represents an obligation of the issuer rather than the buyer and seller; even if the issuer buys back some securities, they still exist. Only if they are legally cancelled
can they disappear.
Advantages of Futures Contracts 32
There is greater volatility within the futures market. On average, futures prices tend to fluctuate more than stocks or bond prices. Although this also means greater risk, it provides traders with more opportunities to profit from short-term price fluctuations in the futures markets.
Futures are highly leveraged investments. The trader typically only needs to put up 10%-15% of the value of the underlying asset as margin, but he can ride the full value of the contract as the price moves up and down. Thus, he can do more trading (trade larger amounts) with less money.
Futures are harder to trade on insider trading. That’s because normally there is no such thing as insider information on the weather or other factors affecting commodity prices.
Commission charges on futures trades are small relative to other investments.
Commodity markets are very liquid. Transactions can be completed quickly, decreasing the chances of market movement between decision and execution.
The Clearing House 33
In practice, a clearing house is used to facilitate futures (and all derivative) transactions by being on the other side of all trades. A clearing house is a financial institution formed specifically to facilitate derivative transactions.
When two parties enter into a futures contract, they are not actually entering into a contract with each other. Instead, both parties are entering into a contract with the clearing house. The clearing house acts as a guarantor by assuming the credit risk of transactions through a process called novation. However, the clearing house will not take on the market risk. Thus, gains and losses will be transferred to and from the clearing house to the respective parties’ accounts on a daily basis.
Forwards Market 34
A forward rate is a rate at which two parties agree to exchange currencies on a specified future date.
• A forward contract requires exchange of an agreed-upon amount of a currency on an agreed-upon date at a specific exchange rate. • It is used to insure against unfavorable changes in exchange rates.
• Forward contracts are commonly created for 30, 90, and 180 days into the future • but customized contracts are also possible.
Futures vs Forwards 35
A forward contract is a private transaction - a futures contract is not. Futures contracts are reported to the future's exchange, the clearing house and at
least one regulatory agency. The price is recorded and available from pricing services.
A future takes place on an organized exchange where all of the contract's terms and conditions, except price, are formalized. Forwards are customized to meet the user's special needs.
The future's standardization helps to create liquidity in the marketplace enabling participants to close out positions before expiration.
Futures vs Forwards 36
Forwards have credit risk, but futures do not a clearing house guarantees against default risk in futures by taking both sides
of the trade and marking to market their positions every night.
Mark to market is the process of converting daily gains and losses into actual cash gains and losses each night. As one party loses on the trade the other party gains, and the clearing house moves the payments for the counterparty through this process.
Forwards are basically unregulated, while future contract are regulated at the federal government level. regulation ensures that no manipulation occurs
that trades are reported in a timely manner
that professionals in the market are qualified and honest
Futures vs Forwards 37
The forward market has produced three additional types of currency instruments. • A currency swap is used to reduce exchange-rate risk and lock in a future
exchange rate.
• Simultaneous purchase and sale of foreign exchange for two different dates.
• A currency option is used to hedge against exchange-rate risk and obtain foreign currency at a favorable rate.
• Option to exchange a specific amount of a currency on a specific date at a specific rate
• A currency futures contract is similar to a currency option but is an enforceable contract and all conditions are fixed.
• Contract requiring the exchange of a specific amount of a currency on a specific date at a specific rate, with all conditions fixed and not adjustable.
Foreign Exchange Market
Foreign Exchange Market is a market in which currencies are bought and sold and their prices determined.
Financial Institutions convert one currency into another at a specific exchange rate.
Foreign currency is only a part of things exchanged in foreign exchange market. Foreign exchange consists of foreign currencies, bank deposits, and other foreign financial assets in various currencies.
The foreign exchange market provides the physical and institutional structure through which:
the money of one country is exchanged for that of another country.
the rate of exchange between currencies is determined.
foreign exchange transactions are physically completed.
A foreign exchange transaction is an agreement between a buyer and a seller that a given amount of one currency is to be delivered at a specified rate for some other currency.
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Foreign Exchange Market 39
The foreign exchange market today is a collection of physical locations and an electronic network of traders, banks, and investment firms.
• Major trading centers are the United Kingdom, the United States, and Japan. • London dominates the foreign exchange market for historic and geographic
reasons.
• A vehicle currency is used as an intermediary to convert funds between two other currencies. • The most popular vehicle currencies include the U.S. dollar, British pound,
Japanese yen, and the European Union euro.
Functions of Foreign Exchange Market
Currency Conversion
helps facilitate international transactions, investments abroad, and the repatriation of
profits back to the home country.
Currency Hedging
helps insure against potential losses from adverse changes in exchange rates.
Currency Arbitrage
lets investors seek profits by conducting an instantaneous purchase and sale of a
currency in different markets.
Currency Speculation
allows traders purchase or sell a currency with the expectation that its value will change
over time and generate a profit.
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Institutions of the Foreign Exchange Market
Three key institutions comprise the foreign exchange market
The Interbank Market
• The interbank market is where the world’s largest banks exchange currencies at spot and forward rates for clients.
• Companies tend to obtain foreign exchange services from the bank where they do most of their business.
Individual transactions in the interbank market usually involve large sums that are multiples of a million USD or the equivalent value in other currencies.
By contrast, contracts between a bank and its client are usually for specific amounts, sometimes down to the last penny.
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Interbank Market Transactions 42
Transactions can be executed on a spot, forward, or swap basis.
Spot transactions involve the purchase of foreign exchange with delivery and payment between banks to take place, normally, on the second following business day.
The date of settlement is referred to as the "value date." Spot transactions are the most important single type of transaction (43 % of all transactions).
Forward transactions require delivery at a future value date of a specified amount of one currency for a specified amount of another currency.
The exchange rate to prevail at the value date is established at the time of the agreement, but payment and delivery are not required until maturity. Forward exchange rates are normally quoted for value dates of one, two, three, six, and twelve months. Actual contracts can be arranged for other lengths.
Outright forward transactions only account for about 9% of all foreign exchange transactions.
Interbank Market Transactions 43
Swap transactions involve the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.
Both purchase and sale are conducted with the same counterparty .
The most common type of swap is a spot against forward, where the dealer buys a currency in the spot market and simultaneously sells the same amount back to the same bank in the forward market.
Since this agreement is executed as a single transaction, the dealer incurs no unexpected foreign exchange risk. Swap transactions account for about 48 % of all foreign exchange transactions
Institutions of the Foreign Exchange Market 44
Securities Exchange
• Securities exchanges specialize in currency futures and options transactions that are smaller than those in the interbank market.
• Buying and selling currencies on these exchanges entails the use of securities brokers, who facilitate transactions by transmitting and executing clients’ orders.
Over-the Counter Market
The over-the-counter market is a global computer network of traders and other
participants with no central trading location. This market offers greater
opportunities for designing customized transactions.
Other Foreign Exchange Market Participants 45
Foreign Exchange Dealers Banks, and a few nonbank foreign exchange dealers, operate in both the interbank and client
markets. They profit from buying foreign exchange at a bid price and reselling it at a slightly higher ask price. Worldwide competitions among dealers narrows the spread between bid and ask and so
contributes to making the foreign exchange market efficient in the same sense as securities markets.
Dealers in the foreign exchange departments of large international banks often function as market makers. They stand willing to buy and sell those currencies in which they specialize by maintaining an
inventory position in those currencies.
Participants in Commercial and Investment Transactions Importers and exporters, international portfolio investors, multinational firms, tourists, and
others use the foreign exchange market to facilitate execution of commercial or investment transactions. They are price-takers – they have to buy/sell at the rate stated by the banks or dealers.
Some of these participants use the foreign exchange market to hedge foreign exchange risk.
Other Foreign Exchange Market Participants 46
Speculators and Arbitragers: Speculators and arbitragers seek to profit from trading in the market.
They operate in their own interest, without a need or obligation to serve clients or to ensure a continuous market.
Speculators seek all of their profit from exchange rate changes.
Arbitragers try to profit from simultaneous exchange rate differences
Central Banks and Treasuries: Central banks and treasuries use the market to acquire or spend their country's
foreign exchange reserves as well as to influence the price at which their own currency is traded.
In many instances they do best when they willingly take a loss on their foreign exchange transactions. As willing loss takers, central banks and treasuries differ in motive and behaviour from all other market participants.
Other Foreign Exchange Market Participants 47
Foreign Exchange Brokers: Foreign exchange brokers are agents who facilitate trading between dealers
without themselves becoming principals in the transaction.
For this service, they charge a small commission, and maintain access to hundreds of dealers worldwide via open telephone lines.
It is a broker's business to know at any moment exactly which dealers want to buy or sell any currency. This knowledge enables the broker to find a counterparty for a client quickly
without revealing the identity of either party until after an agreement has been reached.
Managing Foreign Exchange 48
Global managers should observe several points to get the best deals on foreign exchange transactions.
Match the company’s foreign currency needs with the best provider the company can afford.
Major banks located in financial centers often have cost and service advantages over local banks.
Consolidate individual money exchanges into larger ones to reduce fees.
Get the best rate possible by developing relationships with big banks and monitoring fees charged.
Technology can help reduce errors, speed execution, and reduce time needed to exchange currencies.
Mortgage Markets 49
This is a market for loans to individual investors, and institutional investors who have interest in buying property. A mortgage is a loan secured by the collateral of some specific real estate property.
The mortgagee obliges the borrower (mortgagor) to make predetermined series of payments.
The lender (mortgagee) has the right of foreclosure (can seize the property) if the mortgagor defaults.
Mortgage loan structure Fixed-rate mortgage (FRM) – level monthly payments of principal and interest until
maturity, typically 15 or 30 years.
Adjustable-rate mortgage (ARM) – monthly payments based on a floating interest rate, adjusted periodically, according to a predetermined interest rate index. It usually also has interest rate caps.
Balloon mortgage – like FRM until balloon date when all principal comes due - (a large portion of the borrowed principal is repaid in a single payment at the end of the loan period).
Graduated payment mortgage (GPM) – monthly payments increase over time. Borrower has the option to pay the loan off early (prepay) at pre-specified terms.
Primary Mortgage Markets 50
The market where borrowers and mortgage originators come together to negotiate terms and effectuate mortgage transaction.
Mortgage brokers, mortgage bankers, credit unions and banks are all part of the primary mortgage market. After being originated in the primary mortgage market, most mortgages are sold into
the secondary mortgage market.
Unknown to many borrowers is that their mortgages usually end up as part of a package of mortgages that comprise a mortgage-backed security (MBS), asset-backed security (ABS) or collateralized debt obligation (CDO).
Primary Mortgage Markets 51
An asset-backed security (ABS) is a type of investment that is backed by a pool of debt, such as auto loans or home equity loans.
A collateralized debt obligation (CDO) is a version of an ABS that may include mortgages as well as other types of assets.
A mortgage backed security (MBS) is comprised of mortgages that are sold by the banking institutions that issued them. An investment bank or other financial institution will buy these debts and repackage them, after sorting them into categories such as residential or commercial. Each package becomes an MBS that can be purchased by investors.
Secondary Mortgage Markets 52
This is the market for the sale of securities or bonds, collateralized by the value of mortgage loans. A mortgage lender, commercial banks, or specialized firm will group together many loans
(from the "primary mortgage market") and sell grouped loans known as collateralized mortgage obligations (CMOs) or mortgage-backed securities (MBS) to investors such as pension funds, insurance companies and hedge funds.
Mortgage-backed securities were often combined into collateralized debt obligations (CDOs), which may include other types of debt obligations such as corporate loans.
The secondary mortgage market was intended to provide a new source of capital for the market when the traditional source in one market—such as thrifts in the United States—was unable to. It also was hoped to be more efficient than the old localized market for funds which might
have a shortage or surplus depending on the location. In theory, the risk of default on individual loans was greatly reduced by this aggregation
process, such that even high-risk individual loans could be treated as part of an AAA-risk (safest possible) investment.
Mortgage Backed Securities 53
There are two basic types of mortgage-backed security: pass-through mortgage- backed security and collateralized mortgage obligation (CMO). Pass-through MBS
The pass-through mortgage-backed security is the simplest MBS, structured as a trust, so that principal and interests payments are passed through to the investors. It comes with a specific maturity date, but the average life may be less than the stated maturity age.
The trust that sells pass-through MBS is taxed under the grantor trust rules, which dictates that the holders of the pass-through certificates should be taxed as the direct owners of the trust apportioned to the certificate.
Collateralized Mortgage Obligation (CMO) Collateralized mortgage obligations comprise multiple pools of securities, also known as
tranches. Each tranche comes with different maturities and priorities in the receipt of the principal and the interest.
The tranches are also given separate credit ratings. The least risky tranches offer the lowest interest rates while the riskier tranches come with higher interest rates and, thus, are generally more preferred by investors.
Commodities Market 54
A market that trades in the primary economic sector rather than manufactured products. Hard commodities are mined, such as gold and oil. Soft commodities are agricultural products or livestock—such as corn, wheat, coffee, sugar,
soybeans, and pork. Investors can also purchase stock in corporations whose business relies on commodities prices,
or purchase mutual funds, index funds or exchange-traded funds (ETFs) that have a focus on commodities-related companies.
Futures contracts are the oldest way and the most direct means of investing in commodities. Futures contracts obligates the holder to buy or sell a commodity at a predetermined price on a
delivery date in the future.
Commodity markets can include physical trading and derivatives trading using spot prices, forwards, futures, and options on futures. The major U.S. commodity exchanges are the Chicago Board of Trade, the Chicago Mercantile
Exchange, the New York Board of Trade, and the New York Mercantile Exchange.
Advantages of Investing in Commodities Market 55
Diversification Commodities can diversify a portfolio. Commodities may react differently from other assets in
various economic and geopolitical situations. For example, the prices of stocks may fall during a financial crisis but gold prices may rise as demand for this safe asset increases. Thus, investing in commodities ensures diversification and improves risk-adjusted returns.
Inflation Protection Inflation has a different impact on commodities than financial assets like stocks and bonds. This
is because inflation causes currency to depreciate. This erodes the real value of financial assets like stocks and bonds. Commodities, however, maintain their value and price even during high inflation. In this environment, investors can turn to hard assets such as gold and other precious metals.
Hedge against event risk Events risks such as natural disasters, wars, and economic crises can lead to depreciation of an
investor’s assets. Such events affect financial assets like stocks and bonds negatively and may also lead to a rise in the prices of certain commodities. For example, supply disruptions due to wars may raise the prices of commodities like oil. So, these commodities may act as a potential hedge against some event risks—a buffer against losses.
Advantages of Investing in Commodities Market 56
Liquidity Unlike investment in assets like real estate, investment in commodity futures offers high
liquidity. It is easy to buy and sell commodity futures. An investor can liquidate his position whenever required.
Trading on lower margin An investor in commodity futures needs to deposit a certain amount as a margin with the
broker. The margin can be close to 5–10% of the total value of the contract. This is much lower than the margin required for other asset classes. Thus, the investor can take larger positions while investing less capital. This also helps increase the potential for high profits.
High returns Commodity markets are volatile. They can experience huge swings in prices. For
example, war in a major oil-producing country like Iraq can cause oil prices to shoot up. Smart investors can take advantage of these price swings to make gains. Well-planned commodity investments can provide higher returns than investments in other assets.
Risks of Investing in Commodities Market 57
Despite these advantages, investors need to be careful, as investing in commodities also carries considerable risks: Because the volatility in commodity returns is generally high, adverse market
circumstances can result in losses.
The fundamental characteristics and mechanics of commodity markets can evaporate in times of market stress. For example, the correlation with other asset classes, normally low, may increase in times of crisis.
The market for some individual commodities is not large, which can lead to liquidity risk.
Investing in individual commodities through sophisticated instruments like derivatives requires specific knowledge and expertise.
Regional and International Securities Exchange 58
A stock exchange is undoubtedly the most important component of any stock market, facilitating the trading of stocks and other securities.
An organized exchange gives companies the opportunity to raise capital through listing and
allows for information to be exchanged, through a broker, regarding prices and volumes
so that investors can buy or sell securities at a price.
In the Caribbean, there are more than a dozen national Stock Exchanges but only one formalized regional securities market known as the Eastern
Caribbean Securities Exchange (ECSE).
The Eastern Caribbean Stock Exchange (ECSE) 59
The Eastern Caribbean Securities Exchange Ltd (ECSE) was incorporated in St Kitts under the St Kitts Companies Act and began operations on 19th October 2001.
Unlike many exchanges, regionally and globally, it is a public ‘for profit’ limited liability company, with 49 shareholders in 11 Caribbean countries.
Along with its two wholly-owned subsidiaries, the Eastern Caribbean Central Securities Registry (ECCSR) and the Eastern Caribbean Central Securities Depository (ECCSD),
the ECSE operates a regional securities market facilitating the buying and selling of a range financial products, including corporate stocks and bonds and Government securities.
The Eastern Caribbean Stock Exchange (ECSE) 60
It is the first fully electronic regional exchange in the entire Western Hemisphere, with completely paperless trading.
It also has the fastest settlement period for trade execution at T+1.
The ECSE Group offers a full range of securities trading and ancillary services to listed and non listed companies in the entire CARICOM region
The ECSE provides a primary and a secondary market for trading securities.
The market capitalization as at March 31, 2017 stood at $8.3 billion.
Regional and International Securities Exchange 61
Among the largest are the Jamaica Stock Exchange (JSE), the Trinidad & Tobago Stock Exchange (TTSE) and the Barbados Stock Exchange (BSE). The JSE, which is the oldest Exchange in the region, was incorporated as a private
limited company in August 1968.
The TTSE was formally opened in 1981 under the auspices of the Ministry of Finance
The BSE, formerly known as the Securities Exchange of Barbados (SEB) was established in 1987.
These Exchanges offer the market a range of investment opportunities comprising equities, mutual funds and government bonds.
Other Major Stock Exchanges 62
Trinidad and Tobago Stock Exchange
The securities market which informally existed in Trinidad & Tobago for well over twenty years prior to the opening of the Trinidad & Tobago Stock Exchange really achieved significance in the early 1970s when Government decided as a matter of policy to localize the foreign owned commercial
banking and manufacturing sectors of the economy.
The thrust of the policy was to get such companies to divest and sell a majority of their shares to nationals.
Two bodies chosen to effect this policy were the Capital Issues Committee which was set up by the Ministry of Finance in July 1970 to
direct developments in the primary market
the Call Exchange (an association of share dealers) which was established under the umbrella of the Central Bank in August 1965 to monitor activities in the secondary market.
Other Major Stock Exchanges 63
Parallel to this development in the public sector in the early 1970s was the rapid establishment of private institutions such as trust companies and stock
brokering firms to satisfy the demands of investors in both the primary and secondary markets.
With such infrastructure in place and the simultaneous increase in the securities business the decision was taken to establish a securities market within a framework of established
Rules and Regulations to facilitate the development of the domestic capital market.
The establishment of the Stock Exchange, under the provisions of the Securities Industry Act 1981, was a natural extension of the policy to formalize the securities market in Trinidad and Tobago. This Act was proclaimed on the 23rd October, 1981 and the Stock Exchange was formally
opened on the 26th October, 1981 under the auspices of the Ministry of Finance.
Other Major Stock Exchanges 64
Over the years and leading up to the current time, there was no doubt that the original Securities Law, that is, The Securities Industry Act, 1981 became ineffective. In attempting to bring both Primary and Secondary market activity under one
umbrella, the Act created confusion, and for the most part the provisions were unenforceable.
The Ministry of Finance, in recognizing this problem, worked with the Exchange to introduce a more dynamic piece of legislation. As a remedial measure, the Government, through the Ministry of Finance, passed
legislation repealing the 1981 Act and replacing it with the Securities Industry Act of 1995 which brought into operation the establishment of a Securities and Exchange Commission.
Other Major Stock Exchanges 65
The 1995 Act entrusts the Commission with the authority to maintain surveillance over the securities market and ensure orderly, fair and equitable dealings in securities. All market actors: issuers, underwriters, investment advisers, stockbrokers and
dealers, etc. must register with the Commission, who will be responsible for controlling and supervising their activities.
The Exchange on the other hand will regulate trading on the secondary market, as well as the activities of the Members of the Exchange, subject of course to the oversight by the Commission.
On December 31, 2012 the Securities Industry Act of 1995 was repealed and replaced by the Securities Act, 2012.
Other Major Stock Exchanges 66
In 2012, the TTSE introduced the SME market, a junior stock market attached to an existing exchange which was developed to improve thriving SME’s access to equity funding. This SME Market of the exchange is intended to be used as a vehicle where SMEs can access
the required level of equity financing needed to accelerate growth of their business, and thereby allowing them to comfortably advance into larger companies, while at the same time, benefit from a degree of local, regional and international visibility.
Companies listed in the SME market of the exchange can also enjoy tax concessions granted by the Government of T&T, which allows for a 10 per cent rate in corporation tax applicable for a maximum five-year period following its listing.
Some additional benefits of listing on the SME market include no applicable admission fee and reduced listing fees. Companies who wish to list on the SME market must have a subscription capital of TT$5
million – TT$50 million and will have the option to raise capital in either TT-dollars or US- dollars.
Other Major Stock Exchanges 67
The Barbados Stock Exchange
The Barbados Stock Exchange or BSE is Barbados' main stock exchange. Its headquarters are in the capital-city Bridgetown. The body was established in 1987 by the Parliament of Barbados as a statutory body under
CAP. 318A, Section 44 of the Securities Exchange Act (1982).
Under this original charter it was constituted as the Securities Exchange of Barbados (SEB), and remained known as such until August 2, 2001 when Parliament repealed and replaced the prior act with an updated charter under The
Securities Act 2001–3
Since July 4, 2001 the BSE has operated under a fully electronic trading utilising the Order routing method. The electronic system succeeds the manual system, which comprised an open auction outcry
method of trading.
New York Stock Exchange 68
New York Stock Exchange – sometimes known as the "Big Board", is an American stock exchange located at 11 Wall Street, Lower Manhattan, New York City, New York, United States. It is by far the world's largest stock exchange by market capitalization of its listed companies at US$24.5 trillion as of January 2021. Average daily trading value was approximately US$4 billion in March 2021.
As the global leader in listings, New York Stock Exchange has been the venue of choice for innovators, visionaries and leaders for over 225 years. To help companies access capital and navigate global markets, the NYSE offers a unique market model, unmatched network, brand visibility and core services. The NYSE also maintains listings leadership in a range of sectors from technology and healthcare, to financials and energy.
The stock exchange trades stocks, bonds, and exchange-traded funds.
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