Global Security Markets Lecture 1

Global Security Markets
Prof Nand Kishore Patil
Raising Capital
Borrower Issuer Seller
Securities Equity/Bonds/Bank Loans
Lender
Investor
Buyer
Methods of Financing
Bank Loan
Through international Syndicated bank lending base in London. Rate is fixed for 3 months & Change after 3 months Many European Domestic Mkts, Banks tradition is to lend to corporate at fixed rate.
Bonds Equity
Share called Equity Issue of Share first time called new issue. Issue of Share to existing Share holders called rights issue. Right of first is not protected in US and some European countries like Germany.
V a lu e o f G lo b a l F in a n c ia l As s e ts . (D o lla r in T r illio
250 200 Dollar in Trillion 150 100 50 0 20002001200220032004200520062007
Source:- McKinsey Global Institute
E quity P rivate Debt S ec urities G ovt. Debt S ec urities Depos its Total
World Banking System

Central Banks: Commercial Banks Merchant / Investment Banks Savings Banks Cooperative Banks Mortgage Banks Giro Banks & National Saving Banks Credit Unions Islamic Banks
Central Banks
Federal Reserve in US; European Central Bank (ECB) Bundes bank in Germany, Bank of England in UK. Bank of Japan in Japan Reserve Bank of India in India
Commercial Banks
Taking deposits/lending money
Retail and Wholesale Banking
Retails deals with general public, shops etc
While dealing with retail customer banks settled transaction using cheques and cards. Transactions are high volume with low value. Private Banking.
Whole sale deals with banks, central bank, corporate, pension fund and other institutes.
Transactions are low volume with high value Settlement & clearance done through electronic systems
Settlement & Clearance

CHIPS( Clearing House Inter bank Payments) in New York. CHAPS (Clearing House Automated Payments) in UK SIT (Systeme Interbancaire de Telecompensation) in France EAF2 ( Elektronishe Abrechung Frankfurt or Euro Acess Frankfurt) in Germany TARGET (Trans-European Automated Real-time Gross settlement Express Transfer system) for Euro. The Zengin system is used for clearing and electronic payments in Japan.
Merchant / Investment Banks

Helping people in finding money
Helps in pricing Issue Bond/Share Helps in selling issues Some time under writes the issue
Activities
Accepting
Accepting Bill of Exchange
Corporate Finance
New Issues Equities/Bonds Right Issues Merger & Acquisition Research
Merchant / Investment Banks

Security Trading Investment Management
HNI Corporate i.e. Saudi Arabian Monetary Authority (SAMA) Pension Funds Mutual Funds
Loan arrangement Foreign Exchange

Exchange desk for Clients
Savings Banks
Some European Countries are having such banks.
France, Germany, Italy, Austria, Netherlands, Finland, UK, US, Japan & Spain.
They are not owned by share holders but own by mutual members. Now functions like commercial banks due to
Growing mergers among autonomous saving banks. Deregulation, removing restrictions on activates.
Savings Banks
US
Called as Saving & Loan Association or Thrifts Deregulated in 1981 due to mixture of fraud and mismanagement.
Germany
Central bank for Saving banks called Landesbank Federal state or country guarantees deposit and raise cheap capital . app. 500 Saving banks with 15000 branch network. Accounts 34% of bank deposit
UK
Started in 1810 by passing act and authorised trustee to run bank This act repealed in 1976 and given normal banking powers.
Japan
It called as Sogo Banks. 70 Sogo are orating in Japan which are the important lenders to small business.
France
Accounts 20% of bank deposit 450 local saving banks
Cooperative Banks
Own by members Aim to provide low cost loan to members. Mainly driven from trade & profession Some agricultural co-op. banks
Credit Agricole in France Rabobank in the Netherlands Norinchukin bank in Japan. Doctors & Chemist banks in Germany
E.g., Apotheker & Arzetebank.
Agriculture bank of China Co-operative banks in India
Giro Banks
Giro derive from Greek word Guros it means wheel or circle. One can imagine the circle of debts as trader A owes B who owes C who also owes A. The state of Venice, set up set up in 1619 called Banco Del Giro to speedup settlement. Clearing System known as giro di partita.
A c
Giro Banks
Giro crops two connections First is simply refers to money transfer by an individual sends a giro slip to their bank instructing them to pay sum of money to e.g. electricity or gas company In Germany & Holland uses giro bank service rather than sending cheques directly to company
Giro Banks
Second is Giro bank helps those who does not have bank a/c pay their bills using post offices. This idea began in Austria in 1883. In France it called as Caisse Nationale dEpargne. In UK called as National Saving Bank In Spain & Ireland called as Post Office Saving Bank. In the Netherlands merger of the post office & national saving bank called Post Bank. Other countries are Germany, Japan , Finland , Belgium etc.
Credit Union
Started in Germany in 1849 By early 1900s idea had spread to Australia, Canada, New Zealand, Ireland UK & US. Issue common bonds among members. Have tax benefits like members does not have to pay federal tax in US on credit union bond investment. In US Credit Union regulated by National Credit Union Administrator. In Ireland 23% of the population are member of Credit Union. In Japan there are 469 credit associations and enjoys tax privileges.
Islamic Banks
Managed according to Islamic Law or Sharia. In Koran riba i.e. interest is forbidden. First Islamic bank is thought to be Mitshamr in Egypt in 1963, Islamic bank of Britain form in 2004. More than 250 institute mange fund as per Islamic law or Sharia. Ijra means contract. Murabha means monthly installments. Singapore is promoting Islamic finance and Malaysia is most proactive country in promoting Islamic Finance and believes will be account 30% of their whole market. Use in Mortgage finance and lease finance. Sale of assets and refund in monthly installments.
Role of Central Bank

Structure of Central Bank:
160 Central Banks in the World, employing 352,000 people.
7 Major Central Banks: China, France, Germany, India, Japan, UK, US, European Central Bank (ECB).
Structure of Central Bank

France
Governor 2 Dy. Governor appoint for six yr term These three heads General Council of ten people appointed for six yr. Central bank was given independent in 1993. Some of its powers were passed to the European Central bank from 1999.

Germany
Central Bank Council consist of 11 members President, Dy. President and other 8 members appointed by president of federal and state government. President appointed for 8 yrs. Some of its powers were passed to the European Central bank from 1999.

Japan
Modeled on Bank of England set up in 1882. 9 members forms Executive Board. The Governor and Assistant Governor are appointed by Cabinet for 5 yrs. 7 Executive directors appointed by Ministry of Finance (MoF) on govt. recommendation.

UK
Formed in 1694. Bank run by a body of quaintly called Court, headed by the Governor, 2 Dy. Governor and 16 non-executive directors. Governor appoint by Prime Minister for 5 yrs.

US In 1913 Federal Reserve System setup. Operating through 12 Federal Reserve Districts. The Board of Governors appointed by President

European Central Bank
ECB created by Maastricht Treaty on Dec 1991. The Maastricht Treaty prohibits it from taking order from politicians and members. Began operations on 1 June 1998. It consist of the President, Vice President and 4 other members. Policies govern by Governing Council Governing Council consist of the Executive board plus governors or 12 central banks of member countries, it is referred as the European Systems of Central Banks (ESCB).
Central Bank Activities

Supervision of the Banking System. Advising the Government on Monetary Policy. Issuing Banknotes. Banker to other banks. Banker to the Government. Controlling the Nations currency reserves. Lender of last resort. Liaison with international bodies.
Banking Structure
US
Commercial Banks Nationalised Banks subject to under supervision and regulation by Comptroller of Currency, Federal Reserve & Federal Deposit Insurance Corporation (FDIC) Non Banking Financial Institutions Depositary Institution
E.g. Saving and loan associations, mutual saving banks and credit unions UK
Banking Structure
Germany
Base on indirect rather than direct financing Bundesbank regulator for all banking sector Commercial bank i.e. syndicate of banks
Deutsehe bank Dresdner bank Commerz bank
Banking regulation
US
Regulator
Comptroller of Currency Federal Reserve Federal Deposit Insurance Corporation (FDIC)
Wall Street crash in 1929. Commercial Banks might risking depositors money if they invest in stock market. Passed Glass- Steagall Act 1933: deposit protection scheme Federal Reserve Bank greater powers of supervision. Separated commercial and investment banking. Glass-Steagall act repealed in November 1999. Deposit up to $100,000 is insured.
Banking regulation
US commercial banks
Citibank, Chase Manhattan, Chemical, JP Morgan etc.
US investment banks
Salomon Bros, Goldman Sachs, Merrill Lynch etc.
Banking regulation
Japan
Bank of Japan
Crucial role in Monetary & Credit functions
Finance Ministry (Okurasho)

National Budget Operations of financial institutions
Same resolution passed into Article 65 security & Exchange Act in Japanese version.
Japan commercial banks

Dai chi Kangyo, Mitsubishi, Sumitomo, Sakura.
Japan investment banks

Nomura, Daiwa and Nikko.
Ministry of finance in Japan announced for complete deregulation of this act by 2001 in June 1997.
Banking regulation
Italy
Also passed same regulation for separation of commercial and investment bank in early 1930 but this law was repealed in 1988. It has leave only one investment bank i.e. Mediobanca (partly state owned)
Securities Market
Securities Markets
Money and Bond Markets Stock Exchanges Hedge Funds & Private Equity
Money and Bond Markets

Rate of Interest = price of money. Risk
Lender expects a greater reward for higher risk.
OECD countries or US government:

Lowest rate of interest applies to government transactions (safest).
Govt rate is benchmark for other rates. US corporate may borrow at Treasuries plus 1%.
Credit Ratings
Creditworthiness
Higher the Rating lower the rate of Interest
Credit-rating Agencies. S&P (McGraw-Hill) S & P bond ratings

A1, A2, A3, B, C, D
S & P bond ratings

AAA, AA, A, BBB, BB, B, CCC, CC, C, C1, D.
Moodys (Dun & Bradstreet) Fitch Investor Services Junk Bonds.
Credit Ratings
Credit Rating is based on Likelihood of Default Nature and Provisions of obligation Protection afforded to and relative position of the obligation in event of bankruptcy.
Polly Pecks commercial paper default in UK led to an use of credit rating in Europe. Extensively used in US & Euro Markets
Money Markets
Domestic Money Markets
Call Money Inter Bank Market Money market securities
TB Local Authorities/Public Utility Bills Certificate of Deposit Commercial Paper Bill of Exchange
Call Money Market

Money lent by one bank to another for overnight Overnight is from 12.pm of a day to 12 pm on next day. World wide Overnight Rates are
EONIA
For Euro zone
EURONIA
Used as overnight indexed rate for dealing Euro in London as opposed to Euro zone.
SONIA
Overnight Index rate for London in Sterling.
Inter Bank Market

Loan for More than a week to one year. BID and OFFER rate World Inter bank rates
US
Federal Funds Rate
Euro zone
EURIBOR
Tokyo
TIBOR
London
LIBOR & LIBID
TB
Term use for TB
Treasury Bill called in US & UK Bon du tresor called in France GKOs in Russia
US
Issue for 3 months, 6 months and one year Sold by auction Sold to primary dealers who buys notes and bonds
UK
Issue for 3 & 6 Months Sold by Auction every Friday Sold to Banks
France
Issue for 3 months, 6 months and one year sold weekly Anyone who having a/c with Central Bank Sold to money market dealers
Germany
Bundesbank sells 6 month bill called Bubills every quarter
CD
Sold by Banks Active market in US & Europe Holder can sell CD easily to any one in US & Europe except Germany.
Domestic Bond Market

Terminology US
Up to 2, 5, 10 yr. called Treasury Notes and 30 yr. called Bond.
UK
Same 5 yr instrument . Called as Bond
France
Call instruments up to 5 yr called Bons du tresor Call instruments from 7 yr called Obligations du tresor
Spain
Call instruments up to 5 yr called Bonos del estado. Call instruments above 5 yr called Obligaciones del estado.
Italy
10 yr. issue called as buoni del tesoro.
Types of Bond
Government Bond Local Authority/Public utility bonds Mortgage and other asset back bonds Corporate bonds Foreign bonds Junk Bonds Islamic Bonds
Government Bond
Secondary market is run on stock exchange in France, Germany, UK where as outside exchange in US. Issuer
Central Bank
US, Germany, France
Ministry of finance
Netherlands, Japan
Debt Management Office

UK, Ireland, Sweden, Portugal, New Zealand
Issue Day are fixed per month/quater
Government Bond
Issued to
Syndicate of Banks
Switzerland
Specialist Dealers
US, UK, France, Germany, Italy
Interest Payment
Semi Annually
By US, UK, Japan, Italy
Annually
France, Germany, Netherlands, Spain, Belgium
Pricing
US govt. bond as price fractions (down to 1/32) Elsewhere bonds are priced in decimals.
Government Bond
US
2 yr Treasury Notes issue every month 5 ,10, 30 (start from 2006) yr Treasury Notes issue every quarter by Auction
France
Called as OATS (Obligations Assimilables du Tresor) Sold monthly by auction (1st Thursday every month) 2 & 5 yr issues called as TB rather than bonds and known as BTAN (Bons du Tresor a Interet Annuel) & sold on third Thursday every month Short term Tresuary called as BTF i.e. Bons du Tresor a Taux Fixe Issue 50 year bond in Feb 2005.
Government Bond
Germany
2 & 4 yr Medium term bond called as Bundesschatz anweisungen 5 yr bonds called as Bundesobligationen 10-30 yr bond called as Bundesanleihen Dealers are called as Federal Loan Bidding Group.
Japan
40 % sold to syndicate of banks & 60 % by Auction method. 2, 4, 5, 6, 10 yr bond issued monthly & 20 yr bond issued quarterly.
Government Bond
Spain
Bond called as bonos del estado ( 3, 5 yr maturity) Bond called as Obligaciones del estado ( 10 yr maturity)
Italy
Bond called as BTP i.e. Buoni del Tesoro Poliennali fixed rate bond of 210 yr maturity Bond called as CCT i.e. Certificati Credito del Tesoro floating rate bond of 2-10 yr maturity 6 yr bond which can be sell back called CTO i.e. Certificati Credito del Tesoro con Opzione Issue to both banks and primary dealers.
UK
Called as gilts or gilt-edged Dealers called as gilt-edged market makers Issued for 5 25 and 50 yr. maturity
Foreign bonds
Bond issued by non resident Terminology UK call it as Bulldogs US call it as Yankees Spain call it as matadors Tokyo call it as samurai Australia call it as Kangaroo bonds Denominated in local currency.
Islamic Bond
Islamic bond issued on Islamic banking techniques (with Islamic law/ Sharia), it called as sukuks. Malaysia is the largest Islamic bond market in the world. E.g.
P&O Ports & DP World from Dubai issued one of the biggest sukuks of 3.5 billion UD dollar for 2 yrs.
International Markets
Euro bond Market Medium Term Notes (MTN) Money Market Repo
Euro Bond Market

Term for Euro bond
Range 3 - 25 yrs Longest of 50 yrs issued by British Gas in 1994
Trade Settlement
T+2 days
Settlement & Clearing Organisation

Cedel own by Deutsche Borse AG in Luxembourg Euroclear owned by banks in Brussels
Euro Bond Market

Borrowers
Governments Quasi governments like EU International Financial Institution like WB Banks Large Corporate
Euro Bond Market

Lenders
All retail investors Banks Investment institutions
Euro Bond Market

Factor responsible for development of Euro Bond market
UK restriction for finance third country trade in sterling due to Suez crisis and the currencys weakness. Interest Equilisation imposed from 1963 to 1974 Regulation Q imposed in 1966 Voluntary foreign credit restraint programme imposed in 1965 to stop capital outflow replace by Control imposed by office of Foreign Direct Investments in 1968.
Euro Bond Market

Instruments
Syndicated Loan on Variable interest rate basis
Loan through syndication for medium term of 7 yrs. Amortisations after grace period Interest as spread over LIBOR
Bond issue
Bond issued on the basis of prospectus with getting issue listed in an appropriate center like London, Luxemburg etc. Issue can be fixed or floated rate basis
Note Issuance Facilities (NIFs)

Underwriting of issue Provide investor facility of unload their position at short intervals Facilities secutrisation process.
Commercial paper (CP)/ MTN Equity related bonds
Euro Bond Market

Euro Market Centre
London Frankfurt, Paris, Zurich US
Called in Domestic Market as International Banking Facility (IBF) Eurodollar operation from 1981.
Offshore Banking Centers (OBCs)

Asian dollar Market in Singapore Dragon bond market in Hong Kong
Medium Term Notes (MTNs)

Issue through Programmes Coupons are fixed or floating Allows then bypass costly and time consuming documentation Some time are underwritten like bonds Some of issuer
IBM international Abbey National
Money Market
Short term instrument Euro certificates of Deposit Euro commercial paper Euro currency reference are
Eurodollar Libor Euroyen Libor etc.
Stock Exchange
Capital Map
Emerging markets a/cs 10%
80% world capital flows between the United States, United Kingdom, the Euro zone area
US a/c 85% of Foreign Inflow
Net exporters of capital Japan, China Middle East
Source:- McKinsey Global Institute
Who are the New Power Brokers?

Oil, Asia, Hedge Funds, and Private Equity Are Shaping Global Capital Markets. Player in World Financial Markets
Petrodollar investors, Asian central banks, hedge funds, and private equity Even under the best circumstances, the assets of the new power petrodollars will nearly double to as much as USD$15.2 trillion by 2012.
Growing cross-border capital flows and integration

Cross border flows of capital In US
Foreigners holding Increases from 4% in 1975 to 12% in 2007 in US equities, Increases from 1% in 1975 to 25% in 2007 of US corporate bonds,
Increases from 20% in 1975 to 44% in 2007 of Treasury securities,
Since 1995, cross-border capital flows have more than tripled, and they now total upward of $4 trillion annually, including foreign purchases of equity and debt securities, foreign direct investment by corporations, and crossborder bank lending.
Capital Raising/Investment in Capital Market
Source:- The World Federation of Exchanges Annual Report 2008
Stock Exchanges
Role of Exchange
Regulation for Company Authorisation of members Price information Mechanism Settlement of transactions Publication of data and price
The 10 biggest stock markets in the world by domestic market capitalization in 2008 (USD bn) NYSE Euronext (US) Tokyo SE Group NASDAQ OMX NYSE Euronext (Europe) London SE Shanghai SE Hong Kong Exchanges Deutsche Brse TSX Group BME Spanish Exchanges 9,208.9 3,115.8 2,396.3 2,101.7 1,868.2 1,425.4 1,328.8 1,110.6 1,033.4 948.4
Stock Exchanges
International Equity
Started on 1980s & 1990s Multinational companies to seek listing on several exchanges. German Daimler-Benz listed in New York exchange French insurer Axa first financial service company listed in US exchange in mid 1996
Scandals of Enron and other brought new legislation called Sarbanes-Oxley (SOX) legislation.
It makes manager fully responsible for maintaining adequate internal control structure and procedures for financial reporting. It lay down new rules and audit and accounting and has established a Public Company Oversight Accounting Board.
There are 113 British firm with listing in the US. Biggest privatisation of all time was Deutsche Telekom offered to markets all world at end of 1996.
Germany America UK Rest of Europe Rest of world 462 million share 98 million share 57 million share 38 million share 34 million share
The World Federation of Exchange Members

Amman Stock Exchange Athens Exchange Australian Securities Exchange Bermuda Stock Exchange BM&FBOVESPA BME Spanish Exchanges Bolsa de Comercio de Buenos Aires Bolsa de Comercio de Santiago Bolsa de Valores de Colombia Bolsa de Valores de Lima Bolsa Mexicana de Valores Bombay Stock Exchange Bourse de Luxembourg Bursa Malaysia Chicago Board Options Exchange CME Group Colombo Stock Exchange Cyprus Stock Exchange Colombo Stock Exchange Cyprus Stock Exchange Deutsche Brse Hong Kong Exchanges and Clearing Indonesia Stock Exchange IntercontinentalExchange International Securities Exchange Irish Stock Exchange Istanbul Stock Exchange JSE Limited Korea Exchange London Stock Exchange Group Malta Stock Exchange NASDAQ OMX National Stock Exchange of India New Zealand Exchange NYSE Euronext (New York) NYSE Euronext (Paris)
Indices
US
All are based on market capitalisation S&P 500 S&P 100 NASDAQ Composite Index (1984) NASDAQ Industrial Index (1984) NASDAQ-100 Index (1985) Major Market Index (1980) Dow Jones (1896) is based on share price averages
Indices
Japan
Base on average price of stock
Nikkei Dow 225 Nikkei Dow 300 (1984)
Base on Capitalisation
Tokyo Stock Exchange Price Index (TOPIX)
Indices
UK
Based on Market Capitalisation
FTSE 100 (1984) FTSE 250 (1992) FTSE Actuaries 350 (1962) widen to 800 stock in 1992 . It calculated every minutes. It cover also most 97% of Market capitalisation.
Indices
France
CAC 40 (1987)
It is based on capitalisation and calculated every 30 seconds
SBF 250 (1993)

Calculated every minutes and integrated dividend also
CAC 120 MIDCAC (1995), middle capitalisation stocks
Indices
Germany
FAZ 100 & Commerzbank index (1950)
Exchange - Dusseldorf Exchange Calculated once per day
DAX (Deutscher Aktienindex) with 30 stocks

Calculated constantly 80 % of stock market capitalisation
MDAX 70 share index
Consolidation
NYSE Euronext Consist of
NYSE Euronext (US) mainly includes the New York Stock Exchange and NYSEArca NYSEEuronext (Europe) is the operator of Amsterdam, Brussels, Lisbon and Paris exchanges NYSELIFFE is the operator of the NYSE Euronext's derivatives markets.
BME (Spanish Exchanges) is the holding company of

Barcelona, Bilbao, Madrid and Valencia exchanges.
NASDAQ OMX Consist of - NASDAQOMX operating in the USA

- NASDAQOMX Nordic Exchange which includes
the Copenhagen, Helsinki, Iceland, Stockholm, Tallinn, Riga and Vilnius Stock Exchanges
Traded Instruments
Real Assets
Physical and agricultural commodities, real estate and precious metals
Financial Assets
Stock, bonds, and currencies
Derivatives contract
Options, swaps, Forwards and Futures
Hybrid contracts
Structured instruments
Measure of Market Size

Market Capitalisation Notional Amount Turnover Number of trade
Dealing Systems
Order Driven Market Quote Driven Market A Mixture of the two
Quote Driven Markets

Also called as Market Maker system. In pure quote-driven market, dealers supply all liquidity Dealers quote their bid and ask prices
Firm quotes (for specified size) are prices that dealers must honor
Source:- slides of Dr. Alfonso Dufour 2007
Quote Driven System

Quote driven markets examples
Old NASDAQ (prior to 1996) in US and LSE (prior to 1997) in UK SEAQ (Stock Exchange Automated Quotations) modeled on NASDAQ & SEATS (the Stock Exchange Electronic Trading System) in UK. OTC bond market Foreign Exchange Markets (Reuters 3000)
Order Driven Market

In this market all trader issues order to the exchange Trading rules govern the price discovery process
Order precedence rules first match buy order with sell order Pricing rules then determine the trade price
Any trader can take or offer liquidity. Dealer can choose to offer liquidity Since traders can not choose with whom to trade clearing house are required.
Order Driven Market

Some Examples are
Euronext, Spanish and Italian Stock Exchanges Tokyo stock exchange Most futures exchanges NYSE bond market
Order Driven Market

Prevailed in France, Germany, Belgium, Italy, Spain and Switzerland System used
Europe
CATS (Computer Assisted Trading System) taken from Toronto Exchange Canada.
France
Catation Assistee en Cotinu (CAC)
UK
SETS (Stock Exchange Electronic Trading System) is used for FTSE.
Order Driven Market

Japan
Order Matching through Outcry System and details are circulated on computers. Osaka doing 18% out of total 70% trading among all exchanges
Order Precedence Rules

Rank buy and sell order of increasing precedence separately. Highest precedence order are matched first Primary precedence rule apply first and then secondary precedence rules.
Primary precedence rule

Price is the first Price priority attributes highest ranking to
Buy order that bid the highest price Sell order that offer the lowest price
Market order always rank the first

Price at which they can trade are not limited.
Secondary Precedence Rules

These are used to rank order at the same price level These are based on specific order characteristics (time, size display)
Time precedence
Rank order by submission times (floor or strict time precedence)
Size precedence
Rank order by submission based on order size (large first, small first, pro-rata)
Display precedence
Gives precedence to displayed over hidden orders
Public Order precedence

Prohibits exchange member to trade ahead of public traders at the same price Source:- slides of Dr. Alfonso Dufour 2007
Trade pricing rules

Uniform pricing rule (single price auction) Discriminatory pricing rule (rule base order matching auctions) Derivative pricing rules (Crossing networks)
Example
Uniform pricing rule (single price auction)
Steps to follow
Start with set of orders Construct an order book Match trade Construct order book after the market clears
Set of Order
Time Trader 10.00A 10.05B 10.08C 10.09D 10.10E 10.15F 10.18G 10.20H 10.31I Order Side BUY SELL BUY SELL SELL BUY BUY SELL BUY Size Price 3 20.00 2 20.10 2 20.00 1 19.80 5 20.20 4MARKET 2 20.10 6 20.00 7 19.80
Order Book
Ranking Order book by price- time priority
Buy Side F G A C I
4MARKET 20.2 2 3 2 7 20.1 20 20 20 19.8
Sale Side Order Size Trader 5E 2B 6H 1D
Trader Order Size Price
Matching of Orders Trade Buyer 1F 2F 3G 4A Total Seller Qty D 1 H 3 H 2 H 1 7
Ds Trade Settled Fs Trade Settled
Hs Trade Settled
Order Book after the market Clears

Buy Side Sale Side Trader Order Price Order Trader Size Size 20.2 5E 20.1 2B A 2 20 C 2 20 I 7 19.8
Example
Uniform pricing rule & Continuous Twosided Auction)
Steps to follow
Assume an orders flow Construct an order book of standing orders Let order arrive and describe the resulting trades and changes in the order book Show new order book
The assumption of flow of order

Assume same set of order as used in single price auction example. In practice, traders would send different orders to different market structures
Assumed order flow

Buy Side Price Sale Side Order Size Trader 20.00 20.10 2 2 7 20.00 19.80 20.20 4MARKET 20.10 20.00 19.80 2B 1D 5E 6H
Time
Trader Order Size 10.00A 10.05 10.08C 10.09 10.10 10.15F 10.18G 10.20 10.31I 3
Order book after first 3 order

Buy Side Trader Order Size A C Price Sale Side Order Trader Size 2B
20.10 3 20.00 2 20.00
Order from D to sell 1 at 19.80 arrives, A buys 1 from D and leaves 2 order book after trade
Buy Side Trader Order Size A C Price Sale Side Order Size 2 20.00 20.10 2 20.00 Trader
2B
Order from E to sell 5 at 20.20 arrives Order book after arrival

Buy Side Trader Order Size Price Sale Side Order Size 20.205 A C 2 2 20.102 20.00 20.00 Trader E B
Order from F to buy 4 at market price arrives. It trade 2 with B at 20.1 and 2 with E at 20.20, Order book after trade Buy Side Trader Order Size Price Sale Side Order Size 20.203 20.202 20.102 A C 2 2 20.00 20.00 Trader E E B
E & Bs Trade Settled
Order Book after trade

Buy Side Trader Order Size Price Sale Side Order Size Trader 20.203 A C 2 2 20.00 20.00 E
Order from G to buy 2 at 20.10 arrives Order book after arrival

Buy Side Trader Order Size Price Sale Side Order Size Trader
20.203 G A C 2 2 2 20.10 20.00 20.00
Order from H to sell 6 at 20.00 arrives. It trade with all standing buy order. Order book after arrival
Buy Side Trader Order Size Price Sale Side Order Size 20.006 20.203 G A C 2 20.10 2 20.00 2 20.00 Trader
H E
Hs Trade Settled
G, A, & Cs Trade Settled
Order from I to buy 7 at 19.80 arrives. Order book after arrival

Buy Side Trader Order Size Price Sale Side Order Size 20.203 I 7 19.80 Trader E
Executed Trade
Trade Buyer Seller Qty 1A D 2F B 3 E 4A H 5G H 6C H Source:- slides of Dr. Alfonso Dufour 2007 1 2 2 2 2 2 11
Total
Effects on market
Single price auction produces more gain for traders Whereas Continuous order book auction provides more trading volume and large number of trade.
Other Systems
Hybrid System
Combination of both order driven and quote driven characteristics, are found in New York and Amsterdam. A broker executive trade for other broker on commission basis
Inter dealers broker

Transactions between market dealers.
Brought Deals/Block Trades

Investment buying share with own capital hopes to sell them to investors at a profit
Settlement
Delivery Vs Payment
Stock can not be credited without money being credited to pay for it.
Rolling Settlement i.e. T+5 Rolling 5 working day settlement G30 report recommends t+5 days for rolling settlement, if possible t+3. Settlement systems in
US there is t+3 Germany there is t+2 France there is t+3, Under RELIT System (Reglement Livraison De Titres)
Regulation
EU Rules
Investment Services Directive (ISD) From 1st Jan 1996, it allows stock broker in one country have the right to deal in the shares of any other EU country without having set up a local office or buy a local stockbroker. It include all Exchanges, futures and options markets in EU. This is subject to local rules on conduct of business.
E.g. NatWest Markets began trading on Swedish stock exchange. German DTB, the derivative exchange open assess point in London for local members do business directly with Frankfurt.
Regulation
Market in Financial Instruments Directive (MIFID)
It replaces Investment Services Directive (ISD) It is due to be implemented from Spring 2007. Aim is to open Europes financial markets by making easier to trade cross border.
Capital Adequacy Directive (CAD)

From 1st Jan 1996, European CAD came into operations Investment banks must allocate capital to cover the risks of losses through changes in market prices.
Regulation
USA
Reg NMS effective from 29th Aug 2005 It converse Order Protection, Access and subpenny rules, New market data rules.
UK
FSA introduces new principals for the conduct of business of firms
Hedge Funds & Private Equity
WHAT IS A HEDGE FUND?

There is no agreed definition of what constitutes a hedge fund, A very heterogeneous asset class i.e. any profitable Around 7,000 known hedge funds - 400 created in 2004 managing total assets of around $1 trillion As per IMF, hedge fund grown from 6200 in 1999 to 9000 by end of 2004 investing 1000 billion US dollar. Currently industry has managed around $2.5 trillion at its peak in the summer of 2008. Largely unregulated.
Hedge Fund Industry: Key events 2008
HEDGE FUND FEATURES

Hedge funds are legally limited partnerships. Hedge funds are unregistered (i.e., unregistered with the SEC) investment companies. That is, they are not regulated by the SEC (more on this later). Hedge funds can be users of a variety of investment strategies and products, including options, future, swaps and short selling. Hedge funds often employ leverage, in that the amount of notional market exposure often exceeds the investment capital of the fund. Hedge funds have limited liquidity. Typically investors can only get into funds on certain dates and can only get their money out of funds on certain dates.
Hedge Fund Fee Structures

Hedge funds almost always have a fee structure that includes
A fixed fee:- usually ranges between 1 and 2% of AUM A management fee:-ranges between 20 and 25% of upside performance. Performance Fees:- The performance fee is sometimes calculated net of a benchmark.
As hedge funds are unregulated, these ranges are often exceeded, and can be as high as 5% fixed fee and 25% management fee. Hedge fund fees are often quoted in language such as "2 and 20" meaning 2% fixed fee and 20% management fee. There are two additional important points about hedge fund fees:
The benchmark High water mark
Performance Fees on The benchmark

That is, the returns that fees are paid on are sometimes only those returns in excess of some benchmark. Sometimes the benchmark is a risk-free interest rate such as LIBOR (often called the cash benchmark, meaning performance fees are paid on the profit that would be made in excess of an investment in cash) and other times it is a market index such as the MSCI World Index or the S&P 500 index.
Example
Suppose at the beginning of year 1 a hedge fund has a net asset value of 100, and throughout the year the fund realizes a 25% return, raising the net asset value to 125. Then if an investor entered the fund with a $1,000,000 investment at the beginning of year 1 then his or her "shares" would be worth $1,250,000 gross of fees. If the benchmark was cash, say 5%, then the fees would be paid on the $200,000 upside in excess of cash. That is, the first 5% of the return would not have to have fees paid on it. If the fees were 2 and 20, then the investor would pay $20,000 in fixed fee (2%) and 20% of the upside above cash, that is, an additional $40,000 for a total of $60,000 in fees. This would make the investment value, gross of fees, equal to $1,190,000.
High water mark

The high water mark is an important concept:
Investors in hedge funds enter the fund at a certain net asset value, which we'll call the entering NAV. If the fund loses money in a given year and then makes back that money in a subsequent year, the investor is usually not required to pay a management fee on any portion of the upside in the subsequent year that was below the entering NAV.
Example
Suppose an investor enters a hedge fund with a $1,000,000 at the beginning of year 1, and in that year the fund is down 20%, that is, the value of the investment drops to $800,000 gross of fees. The investor still pays the management fee (that is why it is called a fixed fee), but the investor pays no management fee. Now suppose that after year two the investment value is up to $1,200,000, representing over a 30% gain in year two for the fund. The investor, nevertheless, only pays a management fee on $200,000, that is, he or she only pays a fee on the amount in excess of the entering NAV. The entering NAV in this case is called the high water mark. In subsequent years if there is a drop in NAV, the new high water mark will be the entering NAV of the previous year, or the previous high water mark, whichever is greater.
WHERE DO HEDGE FUNDS COME FROM?

Proprietary trading desks of investment banks Experienced fund managers Experienced traders Traditional fund management organisations Established hedge funds
Liquidity in Hedge Funds

Hedge funds, unlike mutual funds, are not able to stand ready to buy and sell shares on any given date. Rather they have two forms of liquidity constraints that they impose on investors:
Liquidity dates
Liquidity dates refer to pre-specified times of the year when an investor is allowed to redeem shares. Hedge funds typically have quarterly liquidity dates. Moreover, it is often required that investors give advanced notice of the desired to redeem: these redemption notices are often required 30 days in advance of actual redemption.
Liquidity in Hedge Funds

Lockup
Lockup refers to the initial amount of time an investor is required to keep his or her money in the fund before redeem shares. Lockup therefore represents a commitment to keep initial investment in a fund for a period of time. Once the lockup period is over, the investor is free to redeem shares on any liquidity date. The length of the lockup period represents a cushion to the hedge fund manager, especially a new one.
Legal Structure
U.S. hedge funds are structured as limited partnerships. A limited partnership is characterized by the fact that it has two types of partners:
General partners (GP's) Limited partners (LP's)
Limited partners have limited liability with respect to the creditors of the partnership. In other words, the extent of the liability of a limited partner is the partner's investment. In the context of hedge funds, limited partners buy shares in the "corporation" (the hedge fund) and the value of the shares, gross of fees, are tied to the net asset value of the fund. In practical terms, the general partners run the hedge fund. They are often referred to as the hedge fund manager. The limited partners are the investors.
Types of Hedge Funds

Hedge funds are generally classified according to the type of investment strategy they run.
Market Neutral (or Relative Value) Funds Event Driven Funds Long/Short Funds Tactical Trading
Market Neutral (or Relative Value) Funds

Market neutral funds attempt to produce return series that have no or low correlation with traditional markets such as the US equity or fixed income markets. Market neutral strategies are characterized less by what they invest in than by the nature of the returns. They often are highly quantitative in their portfolio construction process, and market themselves as an investment that can improve the overall risk/return structure of a portfolio of investments. The key feature of market neutral funds are the low correlation between their returns and the traditional asset's.
Event Driven Funds

Event driven funds seek to make profitable investments by investing in a timely manner in securities that are presently affected by particular events. Such events include distressed debt investing, merger arbitrage (sometimes called risk arbitrage) and corporate spin-offs and restructuring.
Long/Short Funds
Funds employing long/short strategies generally invest in equity and fixed income securities taking directional bets on either an individual security, sector or country level.
For example, a fund might do pairs trading, and buy stocks that they think will move up and sell stocks they think will move down. Or go long sectors they think will go up and short countries they think will go down.
Long/Short strategies are not automatically market neutral. That is, a long/short strategy can have significant correlation with traditional markets, and surprisingly have seen large down turns in exactly the same times as major market downturns.
Tactical Trading
Quoting from Hedge Funds Demystified: Tactical trading refers to strategies that speculate on the direction of market prices of currencies, commodities, equities and/or bonds. Managers typically are either systematic or discretionary.
Systematic managers are primarily trend followers who rely on computer models based on technical analysis. Discretionary managers usually take a less quantitative approach and rely on both fundamental and technical analysis.
This is the most volatile sector in terms of performance because many managers combine long and/or short positions with leverage to maximize returns...
HEDGE FUND TOOLS: LEVERAGE

Investment trusts make use of leverage, but in much the same way that an ordinary corporate Does Leverage, in an investment context, involves borrowing to invest Traditional investment funds rarely, if ever, use leverage, most are prevented from doing so by mandate and/or regulatory restrictions Most hedge fund trades involve leverage
LEVERAGE
LEVERAGE
CASH TRANSACTIONS
The following shows the cash flows for a purchase and sale of an asset/security:
Long Buy Cash
Hedge Fund
Long Sell Assets Cash
Market
Hedge Fund
Assets
Market
Traditional fund managers conduct buy and sell
THE IMPACT OF LEVERAGE

Buy an asset for $100 with own capital, sell it later for $110; return = 10% Borrow $90 add $10 of own capital and buy asset for $100, sell it later for $110 Pay back loan of $90 (plus interest) Return = [($20 less interest) - $10]/$10 J 100% By leveraging market positions, returns can be drastically enhanced for the same economic event.
THE IMPACT OF LEVERAGE

Buy an asset for $100 from own capital and sell it later for $90; return = -10% Borrow $90 add $10 of own capital and buy asset for $100 and sell it later for $90 Pay back loan of $90 (plus interest) Return = [$0 (less interest) - $10]/$10 J -100% Leveraged positions enhance both gains and losses dramatically When LTCM collapsed its leverage was estimated to be 500:1; for every dollar of capital another $499 was borrowed
ACHIEVING LEVERAGE
Hedge funds typically achieve leverage through one of three mechanisms
buying on margin shorting securities derivative contracts
NB: traditional, long only fund managers often refer to their short positions, but these are relative to a benchmark; in actuality their positions are nearly always long
HEDGE FUND TOOLS: BUYING ON MARGIN

This involves buying securities using credit extended (usually) by a bank or investment bank:
Creditor Cash
Collateral Hedge Funds
Cash Markets Assets
Allows fund to take many more positions than would otherwise be the case Margin loans cheaper because of collateral (securities kept in account) Banks make money on loan and commission from greater trade volume Its great IF the market is UP
BUYING ON MARGIN: COLLATERAL

Bankers prefer T-Bonds, hedge funds might prefer to deposit proportion of securities they have bought on margin What if market value of collateral changes such that it is insufficient to cover the position? Variety of rules governing margin accounts:
initial margin maintenance margin
For the hedge fund, buying on margin creates a leveraged position
CLOSING THE MARGIN PURCHASE

Usually closed by selling the asset purchased, or by selling other assets
Creditor
Cash + Interest
Collateral
Cash Markets Assets
Hedge Funds
If the asset rises in value the fund makes a leveraged gain If the asset falls in value then the fund makes a leveraged loss
HEDGE FUND TOOLS: SELLING SHORT

This effectively involves selling an asset that one does not own.
Creditor
Stock
Collateral Hedge Funds
Stock Markets Cash
Stock lenders: fund managers, banks, investment banks etc Stock lenders are still the owners of the asset Short seller benefits if the stock goes down in value
RETURN FROM SHORT SELLING

Asset price down
Asset sold for $100 Asset bought back at $90
Net = 10
Asset price up Asset sold for $100 Asset bought back at $110 Net = -10
CLOSING A SHORT POSITION

Involves buying back the asset that was not owned in first place
Stock lenders pension funds, insurance companies, banks, investment banks etc earn additional cash on their long positions Brokers earn commission on trades
HEDGE FUND STRATEGIES

A diverse range of strategies Hedge funds follow many different trading strategies Their strategy is specific to the skills-base of the managers Often dependent upon the markets in which they choose to operate Numerous hedge fund index providers try to categories the investment styles/strategies, based on fund manager descriptions
A FEW OF THE STRATEGIES EMPLOYED

Long-short strategies Market neutral strategies Arbitrage strategies Event-driven strategies Directional strategies
LONG/SHORT STRATEGIES
In this example, the hedge fund buys stock A (undervalued) and sells stock B (overvalued) This trade can make money for a hedge fund in a variety of ways E.g.: Sell B as it is overvalued, get higher price. Hence when it goes back to fair value, its easy to purchase at lower price and pay back the (stock B) loan. Make some profit. Borrow to buy Stock A as its undervalued, pay lower price. When it gets back to fair value, its easy to sell it at higher price and repay the loan
SOURCES OF RETURN FROM LONG/SHORT STRATEGIES

Long asset appreciates (short position unchanged) e.g. stock A Short asset depreciates (long position unchanged) e.g. stock B Long asset appreciates, short asset depreciated in value: both happen Plus: Income on long asset greater than income on short asset Plus: interest on margin account Of course if the long position depreciates and the short position rises, losses could be incurred
EVENT DRIVEN STRATEGIES

These strategies focus on unusual corporate activity i.e. when the followings happen:
public to private buyouts: similar to equitization buys mergers and acquisitions share buy-backs reorganisation following bankruptcy Debt/equity capital restructuring
Corporations and regulators often very critical of hedge fund activity around these events
EVENT DRIVEN STRATEGIES

EVENT DRIVEN: DISTRESSED SECURITIES Some funds specialise in under-priced, distressed securities (Land Rover bought by Chinese). Why do they become under-priced?
Investor overreaction Legal/mandate restrictions Limited market knowledge of entity Low analyst coverage Complicated structures that require intensive, specialized research
Some hedge funds try to influence outcome in their favour by obtaining seat on board etc
EVENT DRIVEN: MERGER ARBITRAGE

Merger arbitrage is another event driven strategy Take position based upon assessment of likelihood of success of merger/takeover activity Post-announcement:
Buy stock of companies they believe will be acquired, sell stock of the acquirer Sell stock of companies where they believe takeover will fail, buy stock of the acquirer
Pre-announcement: using models to identify takeover targets i.e. valuation as usual! The risk is that the deals do not evolve as predicted
DIRECTIONAL STRATEGIES
Many hedge funds simply use leverage in variety of markets to benefit from broad market movements i.e. no hedging involved. Global macro funds (e.g. George Soros fund) Emerging market funds: high risk markets with potentially high returns.
Sector specialists: commodities technology energy etc
INVESTING IN HEDGE FUNDS

Why the interest in hedge funds ? Poor equity market performance encouraged both institutional and retail investors to seek alternative asset classes
corporate bonds high yield commercial property
Yields on these very low now, increasing further the attractiveness of alternative asset classes like hedge funds and private equity funds. Hedge funds target absolute return, claim to be able to offer a positive return in good and bad times
Regulation
The US SEC ruled that from Feb 2006 any fund with holding more than $25 Million, must post results through them for all to see In UK FSA having spend more than 12 months analysing this sector and has identified 25 hedge funds which it will watch carefully.
SUMMARY
Institutional demand for alternative investments, plus the lucrative business that hedge funds can generate for investment banks have combined to encourage a rapid increase in hedge fund numbers over the past few years Huge variety of hedge fund strategies, but few are truly hedging all risks as the name implies Most combine a specific strategy with leverage to magnify returns As hedge fund numbers increase, average returns will almost certainly decline
Hedge Fund return
Hedge Fund return
Hedge fund performance
AUM
PRIVATE EQUITY
What is PE
Definition of private equity
Private equity is a broad term that refers to any type of equity investment in an asset in which the equity is not freely tradable on a public stock market. This also includes public companies that are delisted as part of the transaction.
Private Equity Activity

Investments represent the financing of businesses through venture capital, buyouts and other forms of financing. Venture capital represents investment in companies that have undeveloped or developing products. Investments can be classified into:
Seed stage: Financing provided to research, assess and develop an initial concept before a business has reached the start-up phase. Start-up stage: Financing for product development and initial marketing. Expansion stage: Financing for growth and expansion of a company which is breaking even or trading profitably. Replacement capital: Purchase of shares from another investor or to reduce gearing via the refinancing of debt.

Buyout funds typically target the acquisition of a significant portion or majority control of businesses which normally entails a change of ownership. These are generally investments in more mature companies. Special situation includes a range of investments such as distressed debt, equity-linked debt, project finance and leasing. This category includes investment in subordinated debt, referred to as mezzanine debt financing.

Fund raising refers to the money investors have committed to private equity funds in any one year. Divestments represent the realisation or exiting of a private equity investment.
This is generally done by: selling the company; writing off the investment or floating the company on a stock market.
Exits
Private equity firms buy companies in order to sell them at a profit at a later stage. This has become more difficult since the start of the economic slowdown. Private equity exit transactions in which portfolio companies are sold to a buyer or another private equity firm.
Industry breakdown
High-tech, consumer, communications and other services sectors have attracted a large proportion of private equity investments, worldwide over the past decade. In the UK: Industrial products generated 29% of investments in 2008 (up from 17% in 2007), Consumer services 22% (down from 51%), Health care 15% (up from 7%).
The financial sector and consumer services were sectors where investment fell markedly in 2008.
STRUCTURE OF THE PRIVATE EQUITY MARKET

A private equity firm is usually structured as a limited partnership, where the general partner receives capital from limited partners (pension funds, hedge funds, etc), and pays the managers, advisers and lenders out of fees.
STRUCTURE OF THE PRIVATE EQUITY MARKET
Investors in private equity
Intermediaries
The growth in the private equity market over the past decade is largely attributable to the emergence of private equity funds. Private equity funds are organised mainly as
limited partnerships:- Investors who contribute to the funds capital are the limited partners general partners:- Professional managers running the fund.
About four-fifths of private equity investments flow through specialised intermediaries, almost all of which are in the form of limited partnerships. The remainder is invested directly in firms through coinvestments (direct investing alongside private equity firms) and other forms of direct investments.
Issuers
Issuers in the private equity market vary widely in size and in their reasons for raising capital. As private equity is one of the most expensive forms of finance, issuers generally are firms that do not have an alternative source of financing such as a bank loan, private placement or the public equity market. Firms seeking venture capital are typically young firms that are projected to show high growth rates. Seed or start-up capital is the money used to purchase equity-based interest in a new or existing company which is not yet operational. Venture capital also includes early-stage capital provided for companies that have commenced trading but have not moved into profitability or proved its commercial viability. Later stage investments where the product or service is widely available are also considered as venture capital investments. Non-venture private equity investments include middle-market companies that use the private equity market to raise finance for expansion or a change in their capital structure. Public companies can also be issuers in the non-venture private equity market. These companies issue a combination of debt and private equity to finance a management or leveraged buyout. They also issue private equity to help them through periods of financial distress.
Private Equity As An Asset Class

Investing in private equity contributes to portfolio diversification. Although there is some correlation between returns on private equity and public equity and bond markets the correlation is not high. For many institutions, the potential higher returns of private equity investments over conventional asset classes justify the higher risk of such investments. Private equity investments are relatively illiquid, particularly in the early years. The life-cycle of an average private equity fund investment averages three to seven years. Investors in private securities generally exit their investment and achieve returns through an initial public offering, a sale (to corporate buyers or another private equity firm), a merger, or a recapitalization. As the companies are not listed on a public exchange, investors wishing to exit their private equity holding do so by selling the holding to another investor through the secondary market.
PE Returns
Secondary market for private equity
EMERGING MARKETS
WHICH ARE EMERGING MARKETS?
Global giants
Painting BRIC by numbers
Categories Area Population GDP (nominal) GDP (PPP) Exports Imports Current account balance Received FDI Foreign exchange reserves External debt Public debt Electricity consumption Number of mobile phones Number of internet users
Brazil 5th 5th 10th 9th 21st 27th 47th 16th 7th 24th 47th 10th 5th 5th
Russia 1st 9th 8th 6th 11th 17th 5th 12th 3rd 20th 117th 3rd 4th 11th
India 7th 2nd 12th 4th 23rd 16th 169th 29th 4th 27th 29th 7th 2nd 4th
China 3rd / 4th (disputed) 1st 3rd 2nd 2nd 3rd 1st 5th 1st 19th 98th 2nd 1st 1st
MSCI list As of emerging markets (22) April 2009

Brazil Chile China Colombia Czech Republic Egypt Hungary India South Korea Indonesia Israel[8] Malaysia Mexico Morocco Peru Taiwan South Africa Russia Poland Philippines
Turkey Thailand
FTSE emerging markets list
The Advanced Emerging Markets (6) are Hungary, Brazil Mexico,
Poland,
South Africa,
Taiwan.
The Secondary Emerging Markets (17) are:

China, Argentina[14], India, Chile, Egypt, Pakistan, Colombia,[15] Peru, Turkey[16], UAE[17]. Morocco, Thailand,
Czech Republic[16], Malaysia[16], Philippines,
Indonesia, Russia,
WHAT ARE EMERGING MARKETS?
Emerging Markets: What Are They?

The term "emerging markets" was coined by the World Bank's International Finance Corporation in the early 1980s. Typically, emerging markets are in countries that:
are in the process of industrialization, and Have lower per capita gross national product (GNP) than the more developed countries.
Of the 130 countries that the international financial community generally considers to be emerging or developing countries, approximately 40 currently have stock markets.
A LOOK AT GLOBAL DIVERSIFICATION
Do Security Returns Vary Across Country?

In the 1970s, when the investing world began to discover the benefits of global diversification, security returns showed little correlation. 1973-1982 Data; US Stock Market to:
German Market: 0.170 Japanese Market: 0.137 United Kingdom Market: 0.279
Late 1980s and into the 1990s

During this period, stock returns across markets started to show a greater relationship.
Driven by the globalization process.
First evidence: October 1987 global stock market crash when most developed markets declined together. 1980-2000 correlation data of US markets to:
German market: 0.45 (0.170) Japanese market: 0.31 (0.137) United Kingdom market: 0.58 (0.279)
YEAR TO YEAR (IN)CONSISTENCY AMONG THE EMERGING MARKETS
Emerging Market Consistency

STOCK EXCHANGE Egypt Columbia Saudi Arabia Russia Turkey Korea Pakistan Brazil Mexico India % Change 2005/2004 (in USD) 146.4% 126.3% 113.2% 83.3% 67.1% 62.3% 57.4% 53.4% 52.2% 42.0%

STOCK EXCHANGE China Venezuela Indonesia Russia Poland India Mexico Brazil Singapore South Africa % Change 2006/2005 (in USD) 138.4% 99.0% 73.1% 70.7% 61.4% 51.3% 47.8% 45.2% 40.4% 24.9%

STOCK EXCHANGE China Turkey Poland Malaysia Pakistan Brazil Czech Republic Chile South Africa Singapore % Change 2007 (4/25) / 2006 (in USD) 60.2% 30.9% 24.1% 23.8% 21.6% 17.7% 16.6% 15.6% 14.4% 14.1%
IMPACT OF EXCHANGE RATES ON US DOLLAR RETURNS
Exchange Rates Impact in 2006

Region Americas Asia-Pacific 2006 Return in 2006 Return in Local Currency US dollars 16.8% 24.6% 17.0% 33.8% 27.1% 23.8%
Europe/Africa/M 19.5% iddle East Average 19.1%
Exchange Rates Impact in 2005

Region Americas Asia-Pacific 2005 Return in 2005 Return in Local Currency US dollars 7.6% 27.2% 8.2% 18.3% 8.1% 10.0%
Europe/Africa/M 23.6% iddle East Average 16.0%
THE CASE FOR EMERGING MARKETS
History of Emerging Markets

In the late 1980s, emerging markets became the new frontier of global investing. In the early 1990s, these markets exhibited spectacular returns, only to be followed by an exceptionally long span of volatile and disappointing results. During the 1990s these markets moved from one crisis to the next:
the Mexican peso devaluation of 1994. the Asian financial crisis of 1997-1998, the Russian ruble devaluation and debt default of 1998. Argentina debt crisis of 2000
The Case for Emerging Markets Today

1. Economic growth: Emerging markets are growing much faster than the developed countries in North America, Western Europe, and Asia. Over the ten-year period ended December 2005, emerging countries average annual growth rate was 5.5%, which was more than double the 2.7% growth recorded by developed countries during the same period. Economists expect this growth trend to continue for the foreseeable future.

2. Inflation has been on a downward trend in emerging markets for some time now.
Within this group. measured inflation has halved from the double digit numbers seen in the late 1990s.
Low inflation supports a continuation of high growth environment in the emerging countries. The IMF forecasts are for inflation to remain low.

3. Interest Rates: Interest rates in the emerging countries has trended down. The interest rate spread (which is a measure of risk) on emerging markets bonds has fallen significantly in the last five years from more than 1000 points to about 200 points today. The fall in rates and spreads is due primarily to low inflation and stable monetary policies.
Emerging Markets.
Development measures G.D.P. Per capita income Industries and Industrial production Infrastructure Technological development and applications Health and Health care.
Big Emerging Markets

Asia - ASEAN, CEA, India, South Korea. Latin America - Mexico, Argentina, Brazil. Africa - South Africa. Europe - Poland, Turkey
Big Emerging Markets

Physically large with significant populations. Strong growth rates. Undertaken significant programs of economic reform. Big import markets. Bigger than Japan and the E.C. combined by the year 2010 Growth potential for U.S. businesses.
China
China.
Beginning in late 1978, a move towards market driven economy, but still under communist control. High Growth Rate 10-11% per year (compounded) through most of 1990s. Currently ~ 9.0%. And As per Asian Development bank forecasted GDP rate for 2009, 2010 is 7% and 8% respectively. Rank first largest recipient of FDI in 2009. Largest potential market in the world. And 3rd largest economy after US and Japan. From January to August this year, the top ten nations and regions with investment in China (as per the actual input of foreign capital) are as follows: Hong Kong (USD32.476b), Taiwan Province(USD4.552b), Japan(USD2.774b), Singapore (USD2.396b), U.S.A.(USD2.333b), R.O.K.(USD1.761b), U.K. (USD0.856b), Germany(USD0.684b), the Nertherlands(USD0.543b) and Macau(USD0.509b), total of which accounted for 87.5% of total actual use of foreign investment in the country.
Total economy of about $4.4 (2008) trillion, though its GDP per capita is around $$3,180 (ranked 104th) in 2008 as per IMF, $1.95 (2008) trillion foreign Reserves. Highly regulated business environment under political control. State Owned Enterprises (Privatization)
China (SEZs & FTZs)

Special economic zones (SEZ's) - are development zones established by the PRC to encourage foreign investment in China, bringing much need jobs, technical knowledge, and future tax revenues in return for significant tax concessions at start-up of the operations and over a number of years. Since 1992, the State Council has opened a number of border cities, and in addition, opened all the capital cities of inland provinces and autonomous regions. In addition, 15 free trade zones, 32 state-level economic and technological development zones, and 53 new- and high-tech industrial development zones have been established in large and medium-sized cities.
China (Contd.)
Had Normal Trade Relations Status with US. Similar trading privileges in trading with the U.S. as other G.A.T.T. countries. 2002 became a member of WTO. Special agreements with U.S. and E.U. ensuring access to Chinese markets and dealing with specific problems like intellectual property protection.
India
India.
Among the last of the eco. Imp. developing nations to open its markets. Had central planning based on socialist inspired policy of a large public sector with extensive controls on the private sector. Traditionally imposed high tariffs and import bans. Sold mainly to the former soviet union and eastern Europe. Textiles and Handicrafts were the main exports to other countries.
India (Contd.)
Has had robust growth since 1991 when the government reversed its policies and began to liberalize the economy. Liberalization has proceeded in fits and starts since then, mainly due to political pressures, but the economy has responded well by posting strong growth in many sectors (averaging around 6%). Open markets and direct foreign inv. However not with the same degree of vigor found in other developing markets.
India (Contd.)
3.3 trillion economy as compared to 6.5 trillion for china and 11 trillion for the US. Estimated growth rate of 2008 & forecasted GDP rate is 2009, 2010 is 7.1%, 5% and 6.5% respectively as per Asian Development bank. Per capita GDP of $ 1016(2008) vs. $5000 for China. India-Thailand Free Trade Agreement in 2000. Member of the South Asia Free Trade Agreement (SAFTA 2004) - a framework for the creation of a free trade zone covering India, Pakistan, Nepal, Sri Lanka, Bangladesh, Bhutan and the Maldives. Zero customs duty on the trade of practically all products in the region by 2012. Recently Inks Free Trade Agreement with ASEAN in 2009.
India (Contd.)
High potential. Low-cost, educated, and English-speaking labor pool. In the 1990s emerged as a center for computer soft-ware development (outsourcing). Largest concentration of engineers and IT professionals outside the US. I.B.M, Microsoft, Unisys, Intel all have joint ventures. Now attracting outsourcing of backoffice functions, accounting, finance etc. Also call centers like Dell, British Airways, Delta airlines, GE capital etc. Can I help you jobs. Outsourcing capital of the world.
India (Contd.)
Dual economies big differences between the rural and urban markets and the haves and have nots. Labour force 523.5 million (2008 est.) Also a huge market for consumer goods. General motors, Ford, Coke, Pepsi, McDonalds, Pizza hut, Dominos etc. High competition from Japanese, Asian and local products. Difficult business environment, Infrastructure problems, Political problems.
Asian Pacific Rim.

Newly Industrialised Countries (NICs ) H.K., Singapore, South Korea, Taiwan are the Four Asian Tigers. Major Global Competitors in all consumer and industrial Products. Developing countries of Malaysia, Indonesia, Thailand . Japan is increasingly dominant.
Eastern Europe.
Countries establishing free market systems. Transition difficult, lack of skills, know-how and experience. Each has its own set of economic and infrastructure problems. Poland and Hungary have made the most progress. Poland Since 1989 has undergone great political, social and economic changes. Market forces allowed to shape the economy, liberalization of trade, zloty become convertible, infrastructure developing rapidly. Currently a strong economy with 6% growth rates, low inflation, rising standard of living, and global competitiveness. IT industry is fastest developing. Hungary continues to demonstrate strong economic growth of around 3-4%, the private sector has grown substantially and accounts for over 80% of GDP. Foreign direct investment totaled more than $23 billion since 1989. Inflation has declined substantially, from 14% in 1998 to 4.7% in 2003. Germany is their largest economic partner. Poland, Hungary, Slovakia, Slovenia, Czech Republic, Lithuania, Latvia, Estonia became members of the EU in 2004.
Eastern Europe.
Poland, Hungary, Slovakia, Slovenia, Czech Republic, Lithuania, Latvia, Estonia became members of the EU in 2004. Czech Republic after adopting economic and political reforms in the early 1990s went through a Political and financial crises in 1997. It also had economic problems during the early 2000s but has recovered recently with its entry into the EU. Current growth rates are at 5% but the economy still faces threats in the form of public sector debt and needs financial and monetary policy reform.
Latin America.
Economic and trade liberalization. Privatization and control of inflation. Economic cooperation between them and with the U.S. Free Trade Agreement of the Americas (FTAA), a potential market of 800 million. stretching from Alaska to Patagonia.
Free trade Agreement with the E.U.
Brazil
Brazil.
Brazil is Latin Americas biggest economy - US$ 1.994 trillion (2008) per capita GDP US$ 10,551 (2008), Export US$ 197.9 billion (2008) consist of United States 15.8%, Argentina 9.9%, China 7.9%, Netherlands 5.4%, Germany 4.7% (2008*) Economic problems in 1990s 1000% inflation in 1994. From 2001-03 real wages fell and Brazil's economy grew, only 2.2% per year, as the country absorbed a series of domestic and international economic shocks. Economy has stabilized only recently - In 2004, Brazil enjoyed robust growth (5.1%) that yielded increases in employment and real wages. Privatization of state owned enterprises. Debt is the main problem US$ 103.2 billion; 6,4% of GDP (2008 est.)
Argentina
Argentina.
Argentina.
Went through tremendous economic and political upheaval in the 90s and upto 2002. Negative growth, Inflation, debt default, Political turmoil. Economic course prescribed by I.M.F. - $3 billion loan. The economy contracted 20% during the four-year recession ending in 2002. Currently economy of $572.9 billion (2008), per capita GDP $14,413 (2008), 15.3% (2008) of population below poverty line. The government estimates 2005 GDP growth of above 6 percent after the economy expanded 9.0 percent in 2004 and 8.8 percent in 2003 and 1.5% (2009, estimated). More open market than Brazil. Currency pegged to the U.S. dollar peso dropped 70% to the $ in 2003.
Argentina: Historical Economic Growth Rates. Period Average Growth Rate Per Capita Year % growth 1900 to 1913 5.7%-1.7% 1913 to 1929 3.6%-1.0% 1929 to 1945 1.2%-0.6% 1945 to 1974 4.0%2.3% 1974 to 1990 0.4%-1.8% 1990 to 2008 4.2%-3.0%
Emerging Asian Capital Markets at a Glance

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Global Security Markets

Prof Nand Kishore Patil

Securities Equity/Bonds/Bank Loans

World Banking System

Settlement & Clearance

Merchant / Investment Banks

Merchant / Investment Banks

Loan arrangement Foreign Exchange

Agriculture bank of China Co-operative banks in India

Role of Central Bank

Structure of Central Bank

Structure of Central Bank

Structure of Central Bank

Structure of Central Bank

Structure of Central Bank

Structure of Central Bank

Central Bank Activities

Finance Ministry (Okurasho)

Japan commercial banks

Japan investment banks

Money and Bond Markets

OECD countries or US government:

Credit-rating Agencies. S&P (McGraw-Hill) S & P bond ratings

S & P bond ratings

Moodys (Dun & Bradstreet) Fitch Investor Services Junk Bonds.

Call Money Market

Inter Bank Market

Domestic Bond Market

Debt Management Office

Issue Day are fixed per month/quater

Euro Bond Market

Settlement & Clearing Organisation

Euro Bond Market

Euro Bond Market

Euro Bond Market

Euro Bond Market

Note Issuance Facilities (NIFs)

Commercial paper (CP)/ MTN Equity related bonds

Euro Bond Market

Offshore Banking Centers (OBCs)

Medium Term Notes (MTNs)

US a/c 85% of Foreign Inflow

Net exporters of capital Japan, China Middle East

Source:- McKinsey Global Institute

Who are the New Power Brokers?

Growing cross-border capital flows and integration

Capital Raising/Investment in Capital Market

Source:- The World Federation of Exchanges Annual Report 2008

Source:- The World Federation of Exchanges Annual Report 2008

Source:- The World Federation of Exchanges Annual Report 2008

Source:- The World Federation of Exchanges Annual Report 2008

Source:- The World Federation of Exchanges Annual Report 2008

Source:- The World Federation of Exchanges Annual Report 2008

Source:- The World Federation of Exchanges Annual Report 2008

Source:- The World Federation of Exchanges Annual Report 2008

The World Federation of Exchange Members

SBF 250 (1993)

CAC 120 MIDCAC (1995), middle capitalisation stocks

DAX (Deutscher Aktienindex) with 30 stocks

MDAX 70 share index

BME (Spanish Exchanges) is the holding company of

NASDAQ OMX Consist of - NASDAQOMX operating in the USA

Measure of Market Size