Key Financial Markets Traded

1.
Key Financial Markets Traded
The first chapter is a very gentle introduction to the different types of financial instruments
traded in the United States of America. It mainly is a collection of functions and definitions of
financial instruments in general. We also briefly set the scene for some of the later chapters by
classifying the types of markets these products trade along with classification of the products
itself. Depending on your background, you can choose to read the chapter thoroughly or skim
through. We have written this chapter to be informative rather than instructive.
Before, we discuss about the types of financial instruments let us first discuss why do financial
markets exist? What are the benefits of having financial markets to the society? Financial
Markets like any other markets are there to facilitate the exchange of goods, the good here
being value. The value of each financial product may be different for different people. Due to
this disagreement in value some of the people are buyers and some are sellers of this value.
Financial Markets facilitate these transactions by connecting the buyers and the sellers. This
value can be in the form of value of equity in the company, value of a particular commodity, or
value of a particular currency with respect to the other currency. The other very subtle reason
for existence of financial markets is to connect the issuers and borrowers of securities to those
who wish to purchase those securities. For example, a company may want to issue shares to
raise capital or a country may want to issue debt to build its roads and infrastructure in such a
situation it can go to financial markets to raise funds by issuing debt or equity. We have
introduced two major categories of financial instruments Debt and Equity. We will define these
and many more, later in this chapter. To sum up the discussion of existence of financial markets
it is worth mentioning that financial markets exist for three major reasons. Firstly, to connect the
investors and lenders to issuers and borrowers respectively, Secondly, to help nations build
infrastructure and other developmental activities and finally to better position companies and
businesses to take bigger challenges and projects and hence drive innovation and industrial
development. There are various other uses and functions of financial markets and products
which will be clear as we discuss each of the products in this chapter.
As we discussed above, Equity and Debt are the two major instruments of value, we will from
now call them asset classes. Together with Commodities and FOREX, they constitute the four
major asset classes in financial markets1. Although market structures differ by asset class which
is the discussion of this book, all of them share some common characteristics of market
structure on a broader scale. This can be classified as Primary or Secondary Markets, OTC or
Exchange traded and Cash or Derivatives market. We will leave the discussion for the former
two structures later, but it is worth mentioning the Cash or Derivatives market at this point to
continue the discussion.
Cash (Spot) or Derivatives Market

Credit may be considered as an asset class for simplicity we mention it in Debt.

Key Financial Markets Traded

Cash or Sport Markets provide actual ownership of the asset to participants in the financial
markets. A Cash or a Spot is traded for immediate (within the allowed settlement period)
delivery or possession of asset. A Derivatives Market on the other hand gives the holder either
an obligation or choice to buy or sell an asset at some future point in time. Derivatives Markets
has financial contracts that derive their value from underlying in the Cash or Spot market.
Equity:
Stock
Belgium boasted a stock exchange as far back as 1531, in Antwerp. Brokers and
moneylenders would meet there to deal in business, government and even individual debt
issues. It is odd to think of a stock exchange that dealt exclusively in promissory notes and
bonds, but in the 1500s there were no real stocks. There were many flavors of businessfinancier partnerships that produced income like stocks do, but there was no official share that
changed hands.
( Beattie, Andrew. "The Birth Of Stock Exchanges." Investopedia. N.p., n.d. Web. 02 Nov.
2014.)

Stock represents the residual asset of the company that would be due to stockholders
after discharge of all senior claims such as secured and unsecured debt. Stockholders equity
cannot be withdrawn from the company in a way that is intended to be detrimental to the
companys creditors.
A holder of stock (a shareholder) has a claim to a part of the corporation's assets and
earnings. In other words, a shareholder is an owner of a company. Ownership is determined by
the number of shares a person owns relative to the number of outstanding shares. For example,
if a company has 1,000 shares of stock outstanding and one person owns 100 shares, that
person would own and have claim to 10% of the company's assets.
Stocks are the foundation of nearly every portfolio. Historically, they have outperformed most
other investments over the long run.
When you own a share of stock , you are a part owner in the company with a claim on
every asset and every penny in earnings. Individual stock buyers rarely think like owners, and
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Credit may be considered as an asset class for simplicity we mention it in Debt.

Key Financial Markets Traded

it's not as if they actually have a say in how things are done.
There have two types of Stock, one is common Stock, the other is preferred stock.
Common Stock
A security that represents ownership in a corporation. Holders of common stock exercise
control by electing a board of directors and voting on corporate policy. Common stockholders
are on the bottom of the priority ladder for ownership structure. In the event of liquidation,
common shareholders have rights to a company's assets only after bondholders, preferred
shareholders and other debt holders have been paid in full.
In the U.K., these are called "ordinary shares"
If the company goes bankrupt, the common stockholders will not receive their money
until the creditors and preferred shareholders have received their respective share of the
leftover assets. This makes common stock riskier than debt or preferred shares. The upside to
common shares is that they usually outperform bonds and preferred shares in the long run.
Preferred Stock

A class of ownership in a corporation that has a higher claim on the assets and earnings
than common stock. Preferred stock generally has a dividend that must be paid out before
dividends to common stockholders and the shares usually do not have voting rights.
The precise details as to the structure of preferred stock is specific to each corporation.
However, the best way to think of preferred stock is as a financial instrument that has
characteristics of both debt (fixed dividends) and equity (potential appreciation). Also known as
"preferred shares".
There are certainly pros and cons when looking at preferred shares. Preferred
shareholders have priority over common stockholders on earnings and assets in the event of
liquidation and they have a fixed dividend (paid before common stockholders), but investors
must weigh these positives against the negatives, including giving up their voting rights and less
potential for appreciation.

Credit may be considered as an asset class for simplicity we mention it in Debt.

Key Financial Markets Traded

The number of companies traded on major U.S. stock exchanges rose by 92 last year,
taking the count of U.S.-listed companies to 5,008 at year-end, according to data provided by
the World Federation of Exchanges, a trade association.
(Strumpf, Dan. "U.S. Public Companies Rise Again." The Wall Street Journal. N.p., n.d. Web. 5
Feb. 2014.)

Credit may be considered as an asset class for simplicity we mention it in Debt.

Key Financial Markets Traded

Top 10 Stock Exchange(By market capitalization) in the world:
Rank

Exchange

1
2
3
4

New York Stock Exchange

NASDAQ
Japan Exchange Group
Euronext

6
7
8
9
10

Country

United States
United States
Japan
Netherlands
France
Belgium
Portugal
London Stock Exchange
United
Kingdom
Italy
Hong
Kong
Stock China
Exchange
Shanghai Stock Exchange China
TMX Group
Canada
Shenzhen Stock
China
Deutsche Bourse
Germany

Market
Cap($Billion)
18,779
6,683
4,485
3,504

Trade
Volume(Billion)
11,299
8,739
4,011
1443

3,396

1,890

3,146

1,093

2,869
2,204
1,913
1,716

2,920
1,008
3,677
1,095

American Depositary Receipt (ADR)

Introduced to the financial markets in 1927, an American depositary receipt(ADR) is a
stock that trades in the United States but represents a specified number of shares in a foreign
corporation. ADRs are bought and sold on American markets just like regular stocks, and are
issued/sponsored in the U.S. by a bank or brokerage.
The stocks of most foreign companies that trade in the U.S. markets are traded as
American Depositary Receipts (ADRs). U.S. depositary banks issue these stocks. Each ADR
represents one or more shares of foreign stock or a fraction of a share. If you own an ADR, you
have the right to obtain the foreign stock it represents, but U.S. investors usually find it more
convenient to own the ADR. The price of an ADR corresponds to the price of the foreign stock in
its home market, adjusted to the ratio of the ADRs to foreign company shares. (SEC.gov)

Credit may be considered as an asset class for simplicity we mention it in Debt.

Key Financial Markets Traded

Manish. "American Depositary Receipts (ADRs) - Finance Train." Finance Train. N.p., n.d.
Web. 05 Nov. 2014.

A negotiable certificate issued by a U.S. bank representing a specified number of shares

(or one share) in a foreign stock that is traded on a U.S. exchange. ADRs are denominated in
U.S. dollars, with the underlying security held by a U.S. financial institution overseas. ADRs help
to reduce administration and duty costs that would otherwise be levied on each transaction.
This is an excellent way to buy shares in a foreign company while realizing any
dividends and capital gains in U.S. dollars. However, ADRs do not eliminate the currency and
economic risks for the underlying shares in another country. For example, dividend payments in
euros would be converted to U.S. dollars, net of conversion expenses and foreign taxes and in
accordance with the deposit agreement. ADRs are listed on either the NYSE, AMEX or Nasdaq
as well as OTC.
Exchange Traded Fund(ETF)
A security that tracks an index, a commodity or a basket of assets like an index fund, but
trades like a stock on an exchange. ETFs experience price changes throughout the day as they
are bought and sold.
In less than 20 years, exchange-traded funds (ETFs) have become one of the most
popular investment vehicles for both institutional and individual investors. Often promoted as
cheaper, and better, than mutual funds, ETFs offer low-cost diversification, trading and arbitrage
options
for
investors.
Now with over $1 trillion assets under management, new ETF launches number from several
dozen to hundreds, in any particular year. ETFs are so popular that many brokerages offer free
trading in a limited number of ETFs to their customers.

Credit may be considered as an asset class for simplicity we mention it in Debt.

Key Financial Markets Traded

Because it trades like a stock, an ETF does not have its net asset value (NAV)
calculated every day like a mutual fund does.Think of an ETF as a mutual fund that trades like a
stock. Just like an index fund, an ETF represents a basket of stocks that reflect an index such
as the S&P 500. An ETF, however, isn't a mutual fund; it trades just like any other company on
a stock exchange. Unlike a mutual fund that has its net-asset value (NAV) calculated at the end
of each trading day, an ETF's price changes throughout the day, fluctuating with supply and
demand. It is important to remember that while ETFs attempt to replicate the return on indexes,
there is no guarantee that they will do so exactly. It is not uncommon to see a 1% or more
difference between the actual index's year-end return and that of an ETF.
By owning an ETF, you get the diversification of an index fund as well as the ability to
sell short, buy on margin and purchase as little as one share. Another advantage is that the
expense ratios for most ETFs are lower than those of the average mutual fund. When buying
and selling ETFs, you have to pay the same commission to your broker that you'd pay on any
regular order. One of the most widely known ETFs is called the Spider (SPDR), which tracks the
S&P 500 index and trades under the symbol SPY.

Derivatives:
Derivatives markets have become more and more important in the finance world. It has
become necessary for finance people to know how these markets work, and how they can be
used, and what determines there price.
Futures
Futures markets have formed in the middle ages. Originally they were used to meet the
needs of farmers and merchants.
A future contract is an agreement to buy or sell an asset at a certain time in the future for
a certain price. There are many exchanges throughout the world trading futures contracts. The
Chicago Board of Trade, the Chicago Mercantile Exchange, and the New York Mercantile
Exchange have merged to form the CME Group. Other large exchanges include NYSE
Euronext, Eurex, BM&FBOVESPA, and the Tokyo Financial Exchange.
Future exchanges allow people buy or sell assets in the future to trade with each other.
For Example:
In September a trader in Chicago might contact a broker with instructions to buy 500
barrel of crude oil for December delivery. The broker would immediately communicate the
clients instructions to the Chicago Board of Trade. At about the same, another trader in Los
Angels might instruct a broker to sell 500 Barrel of crude oil for December delivery. These
instructions would also be passed on the Chicago Board of Trade. A price would be determined
and the deal would be done.

Options
There are two types of options Call option and Put option.
A call option gives the holder of the option the right to buy an asset by a certain date for
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Credit may be considered as an asset class for simplicity we mention it in Debt.

Key Financial Markets Traded

a certain price.
A put option gives the holder the right to sell an asset by a certain date for a certain
price.
The date specified in the contract is know as the expiration date or the maturity date.
The price specified in the contract is know as the exercise price or the strike price.

Swaps
Traditionally, the exchange of one security for another to change the maturity (bonds),
quality of issues (stocks or bonds), or because investment objectives have changed. Recently,
swaps have grown to include currency swaps and interest rate swaps.
If firms in separate countries have comparative advantages on interest rates, then a
swap could benefit both firms. For example, one firm may have a lower fixed interest rate, while
another has access to a lower floating interest rate. These firms could swap to take advantage
of the lower rates.

Credit may be considered as an asset class for simplicity we mention it in Debt.

Key Financial Markets Traded

(WEINBERG, ARI I. "'Swaps' Add a New Risk." The Wall Street Journal. Dow Jones &
Company, n.d. Web. 05 Nov. 2014.)
( Hull, John C. Fundamentals of Futures and Options Markets. Boston: Prentice Hall, 2011)

Credit may be considered as an asset class for simplicity we mention it in Debt.

Key Financial Markets Traded

Credit may be considered as an asset class for simplicity we mention it in Debt.

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Credit may be considered as an asset class for simplicity we mention it in Debt.

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Credit may be considered as an asset class for simplicity we mention it in Debt.

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Credit may be considered as an asset class for simplicity we mention it in Debt.

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Credit may be considered as an asset class for simplicity we mention it in Debt.

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Credit may be considered as an asset class for simplicity we mention it in Debt.

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Credit may be considered as an asset class for simplicity we mention it in Debt.

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Credit may be considered as an asset class for simplicity we mention it in Debt.

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Credit may be considered as an asset class for simplicity we mention it in Debt.

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Credit may be considered as an asset class for simplicity we mention it in Debt.

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